No, not another cannabis case. This is Alcohol and Tobacco Tax and Trade Bureau’s new whistleblower gambit. Here’s the skinny:
I see from the press release that that delightful luncheon companion and avid fisherman, Chief Whistler Lee D. Martin, is on the right track.
“The IRS Whistleblower Office is always looking to do more for whistleblowers.”
Just tell the Ogden Sunset crowd to go and do likewise.
I’m not using the above in its arcane technical sense, although Judge David Gustafson’s off-the-bencher shows that the petitioner wasn’t speaking thus, in TOT Property Holdings, LLC, TOT Land Manager, LLC, Tax Matters Partner, Docket No. 5600-17, filed 12/13/19. By way of illumination, Judge Gustafson tells us that “(‘TOT’ is the initials of ‘Trail of Tears’, the route of a 19th Century forced relocation of Native Americans, which route passed through or near the property at issue in this case.)” Transcript, at p. 3.
My use thereof has to do with placement on the table and speaking candidly.
This is another syndicated conservation easement case, like the Coalholders (see my blogposts “Diamonds Are Forever,” 10/28/19, and “Out On Parol,” 12/6/19). Like them, the owner of the property held it for some time, then transferred title into a couple LLCs (hi, Judge Holmes), ending up with 99% in one (whose membership interests he sold for FMV of the land, around $1.1 million). The buyers of the LLC interests took a $6.9 million conservation easement write-off on their 1065, but were down to claiming $3.7 million in Tax Court. No go, anyway.
The TOTs claimed the land should be valued as a housing development, although the three nearest developments could not be proven to be other than flops. Their comparables were properties with mountain views and lakes, but this property had neither.
“This subject property was at least 32 miles from the nearest interstate highway. It contained no mountains, and none was nearby. It contained two small streams (which were frequently dry) and no lakes. The utilities available on the subject property in [year at issue] included telephone and electricity, but no access to public water. There is no hospital in the County. The subject property was situated on a larger tract that had formerly been an artillery range. The surrounding area was hardwood forests (containing mostly oaks and hickory), but at some point in the past it had been clear cut and re-planted with row upon row of loblolly pine, a softwood common to the Cumberland Plateau that grows the fastest and is the easiest to manage compared to other softwoods. (Ex. 36-R, p. 12).” Transcript, at p. 5.
There’s a scrimmage about the savings clause (if anything violates the Regs, it’s out), TOT claiming it’s interpretive and doesn’t modify the original intent to preserve the 501(c)(3)’s proportional divvy-up of proceeds on judicial extinguishment. But it’s the same language the Coalholders used, and the testimony of the attorney-drafter is out on parol.
Judge Gustafson takes IRS’ appraiser’s number of the worth of the easement ($500K), and tags the TOTs with the 40% chop on everything over that, holding that the Letter 1807 (the preliminary notice to the TOTs on the FPAA) satisfied the Section 6751(b) Boss Hoss sign-off.
“TOT’s position is essentially that the Letter 1807 signed by the supervisor and transmitting summary report could simultaneously embody the agent’s initial determination of the penalty and lack written supervisory approval of it– even though the written signature of the supervisor appears on the face of the document. The supervisor was the sole signatory of the letter that advised of ‘all proposed adjustments’ and transmitted the report that detailed the penalties (which were later asserted in the FPAA). These facts establish that the supervisor gave written approval of the initial determination of the penalties. Accordingly, the Court holds that the Commissioner has established compliance with section 6751(b) as to the penalties asserted in this case.” Transcript, at pp. 32-33.
Edited to add, 6/23/21: My colleague Peter Reilly CPA informs me that 11 Cir has affirmed Judge David Gustafson. Now we have to wait on 6 Cir.
No, this is not the chronicle of a yuppie romance. Rather, this is how Judge Albert G (“Scholar Al”) Lauber describes Randy McRae’s low-income housing operation. Randy wound up paying $25K each to HUD and to Kenneth Brewer as restitution for criminal violations of the Prince George’s County, MD, housing code. He wanted to deduct these payments as Section 162 ordinaries and necessaries.
You’ll find the whole story in Randy McRae and Shelby McRae, 2019 T. C. Memo. 163, filed 12/12/19. Shelby did PR and Randy did accounting and tax, according to their Sched Cs, but their bookkeeping was a wee bit casual, their record keeping more than sparse, and their trial evidence was more than a trifle scanty.
There’s argy-bargy about their Form 872 SOL extension, but the bottom line is that, had they not signed, they’d have been hit with a big deficiency forthwith.
And here’s the story behind the headline. Although Randy wanted to deduct the aforesaid restitution, note that for the years at issue, Section 162(f) barred deduction for “any fine or similar penalty paid to a government for the violation of any law.” The term “government” was defined to include “a State” or any “political subdivision” thereof. Sec. 1.162-21(a)(1), (3).
But Judge Scholar Al doesn’t need to go there.
“Regardless of whether section 162(f) would bar the claimed deduction and whether petitioners previously included in income the funds of which they made restitution, they have failed to establish that the restitution payments of $50,000 were ordinary and necessary expenses of Mr. McRae’s Schedule C2 business.
“Mr. McRae’s Schedule C2 business involved general accounting work and tax return preparation. He supplied no testimony or documentary evidence to establish any link between these activities and his restitution payments. He testified that he was ‘accused of having improperly taken some money from Mr. Brewer and from HUD’ in connection with a project to develop low-income housing in Prince George’s County. For all that appears, this project involved an investment activity on Mr. McRae’s part, not an activity having any relationship to his Schedule C2 business.” 2019 T. C. Memo. 163, at p. 21.
Quoting Wang v. Commissioner, T.C. Memo. 1998-389, 76 T.C.M. (CCH) 753, 757, Judge Scholar Al finds Randy’s housing gig was “sporadic activity arising from “a limited opportunistic transactional relationship”). 2019 T. C. Memo. 163, at pp. 21-22.
More to the point, Randy “… submitted no evidence to show that Mr. McRae’s payment of restitution to HUD and Mr. Brewer was necessary to preserve the client base of his Schedule C2 business or otherwise to benefit that business. For all that appears, Mr. McRae paid the restitution, as the court ordered him to do, for purely personal reasons, viz., to satisfy the conditions of his probation and thus avoid jail time.” 2019 T. C. Memo. 163, at p. 22.
Sure, it was necessary, but hardly ordinary, and definitely not deductible.
We all know Rev. Rul.s. We also know Rev. Proc.s. These are the daily grist of Federal tax practice.
Mark Marineau, Docket No. 9469-16L, filed 12/11/19, is another last-known-address story. Mark’s last notice didn’t include his SSAN or his middle name, but Judge Buch doesn’t need to decide if those omissions are material, because IRS got the letter with the address change three (count ‘em, three) days before they sent Mark the SNOD off the SFR. IRS gets 45 (count ‘em, 45) days to process a change-of-address per Rev. Proc. 2010-16, and thereby hangs the cliché.
Judge Buch: “Mr. Marineau argues that he should not be bound by the 45-day processing window outlined in Rev. Proc. 2010-16. In support, Mr. Marineau quotes Macey’s Jewelry Corp. v. United States, 387 F.2d 70, 72 (5th Cir. 1967), which states ‘Revenue rulings, however, are not authority having the force of law, to be automatically applied in each and every case.’ Mr. Marineau conflates a ‘revenue ruling’-an IRS interpretation of tax law-with a ‘revenue procedure’-an official statement of procedure issued by the IRS. While it is also true that this Court is not bound by revenue procedures, we often look to them for guidance.” Order, at p. 7 (Footnote omitted, but it’s a cite to Hollimon v. Commissioner, T.C. Memo. 2015-157, at *7-*8.).
And Tax Court is often guided by Rev. Proc. 2010-16.
It’s not a good day for IRS. First Judge Goeke is less than charitable toward their arguments in Joyner (see my blogpost “We Don’t Need No Installment Method,” 12/11/19).
Now Judge Buch is on their case, twice, in Anthony I. Provitola & Kathleen A. Provitola, Docket No. 12357-16, filed 12/11/19.
First, IRS wants to bring electronics into the Jacksonville courtroom on Monday. But the local courthouse has its own limits on electrons (other than free-floating ions). However, Judge Buch has independently squared that away. But IRS calls its motion “Unopposed.” Order, at p. 1.
“Separately, we note that, in contrast to the title of the motion, paragraph 5 of the motion states:
“’5. Respondent called petitioners to determine their views on this motion, and left a voicemail message. Petitioners did not return this call as of the date of the motion, and as a result, petitioners’ views on this motion are unknown.’
“The title of the motion (characterizing the motion as ‘unopposed’) is either misleading or false.” Order, at p. 1.
But Judge Buch is in a mellow mood, so he just tosses the motion as moot, since he made the electronic arrangements himself.
Now don’t go away, because here’s the canard. Same parties, Docket No. 16168-17, filed 12/11/19.
IRS filed “a motion in limine asking that we ‘exclude all facts, evidence, and testimony not related to the circular flow of funds between petitioners, their Schedule C entity, and petitioner Anthony I. Provitola’s law practice.’
“According to the parties’ pretrial memoranda, the Provitolas attempted to develop and market something, what exactly is unclear. In connection with that something, the Provitolas, perhaps through entities controlled by them, purport to have made payments to a law firm run by Mr. Provitola.
“The parties’ arguments are easily summarized: the Provitolas argue that they have a bona fide business; the Commissioner argues that this is all a sham and there is no real business. Based on prior testimony from Mr. Provitola, it appears that he intends to testify about development and marketing of the something underlying the Provitolas purported business.” Order, at p. 1.
But ya gotta love IRS counsel’s go-for-broke motion practice.
“One might recharacterize the Commissioner’s motion as asking the Court to prohibit testimony inconsistent with his theory of the case. We will issue no such order.” Order, at p. 1.
IRS counsel argues that courts routinely ignore self-serving testimony. True, except.
“The canard that Courts disregard self-serving testimony is simply false. We disregard self-serving testimony when there is some demonstrable flaw or when the witness does not appear credible. If we were to disregard testimony merely because it is self-serving, we would disregard the testimony of every petitioner who testifies in furtherance of their own case and of all the revenue agents or collections officers who testify that they do their jobs properly, because that testimony would also be self-serving.” Order, at p. 2.
If IRS counsel is unhappy when Anthony tells his tale on the stand, he can object. Of course, he can also cross-examine.
IRS counsel, whom I’ll call Randy, didn’t have a good day.
I’ll only cite to the last paragraph of Growmark Inc. & Subsidiaries, 2019 T. C. Memo. 161, filed 12/11/19, because it’s largely a repeat of AG Processing, as to which see my blogpost “A Hill of Beans,” 10/16/19.
Judge Paris: “The Court concludes that in accordance with this Court’s holding in AgProcessing, petitioner is not required to compute separate DPAD amounts for its patronage and nonpatronage activities. Also in accordance with this Court’s holding in Ag Processing, petitioner must allocate its aggregately computed DPAD between its patronage and nonpatronage accounts. Because the Schedule G allocation is done pursuant to subchapter T, not section 199, petitioner should allocate the aggregate DPAD on its Schedule G using the same method it used for its other Schedule G allocations.” 2019 T. C. Memo. 161, at p. 18.
If any of this makes sense to you, please accept my heartfelt condolences.
Oh, and Judge Paris will deal with Growmark’s COGS issues in a later opinion. I’m sure you’re all “hanging, breathless, on its fate,” as a far better writer than I put it.
Though it’s not a business model any of my developer clients would use, and I certainly would not recommend it, Joyner Family Limited Partnership, Gary Joyner Revocable Trust, A Partner Other Than The Tax Matters Partner, Janel Joyner Revocable Trust, A Partner Other Than The Tax Matters Partner, And Joyner Investment Company, Inc., Tax Matters Partner, 2019 T. C. Memo. 159, filed 12/11/19, can continue using cash method accounting even though they are dealers and thus precluded from using Section 453 installment method reporting.
IRS wants to slug the Joyners with $8 million in tax, claiming the notes the Joyners took from their down-and-out customers in payment for marked-up land and mobile homes were worth face. Except. Six years into the program, 92% of the notes were in default, and the Joyners’ expert witnesses testified no bank would buy them.
“Typically, JFLP’s customers had not previously owned homes. They were primarily low income, had poor credit histories and unstable employment histories, and could not obtain traditional financing to purchase homes. JFLP offered affordable housing. Mr. Joyner determined the amount of the monthly payment on the basis of what the customer could afford. Monthly payments ranged from $100 to $700.“ 2019 T. C. Memo. 159, at pp. 7-8.
Judge Goeke has this one.
“The Joyners are well respected in the community. They rarely declined to sell to a prospective buyer except if they suspected the buyer was involved with drugs. Their philosophy was to give people a chance. For some buyers JFLP obtained the necessary information to perform credit checks, but the Joyners did not perform credit checks because of the costs of running credit checks and because Mr. Joyner believed that the buyers’ poor financial situation made the credit checks pointless. Mr. Joyner would ask prospective buyers whether they had jobs, but he did not request any documentation, such as pay stubs, or otherwise verify their employment or income.” 2019 T. C. Memo. 159, at p. 8.
The Joyners let defaulting purchaser/borrowers transition to renters, and waited until several note payments were in default before trying to collect. They used their trusty CPA who had advised other developers similarly situated. They bought their land sale agreements, notes, and landlord-tenant documents from an office supply store. I hope it was the one with which one of my nearest and dearest is associated.
By now my developer clients have stopped reading, and reached for an Anacin.
IRS wins on the Section 453 closeout. No question the Joyners are dealers.
But IRS goes full-throttle Michael Corleone on everything else.
They raise the accounting stuff post-trial, so that’s out. No Section 446 change in accounting method; IRS is too late in asserting right to change method, and their method is no better than the Joyners’ cash basis. The Joyners’ bookkeeping flaws don’t disturb Judge Goeke’s result. IRS claims Section 1038 bars the Joyners from bad debt treatment on defaulted notes when they took back the mobile homes, but when they claimed a bad debt deduction the IRS first allowed it on the FPAA, and then disallowed it in the amendment to the answer. “Further, respondent makes the nonsensical argument that JFLP should be taxed on the notes’ face values but denied a worthless debt deduction because petitioners have not established the notes had value when executed, a requirement for a worthless debt deduction.” 159 T. C. Memo. 159, at p. 47, footnote 11 (Citation omitted).
I’ll spare you the rest. There’s a Rule 155 beancount, of course, but the Joyners should congratulate their able counsel, Juan F. Vasquez., Jr., Esq., Jaime Vasquez, Esq., A. Leonides Unzeitig, Esq., and Adrian Ochoa, Esq.
I spent a lot of time and electrons on MCM Investment Management today (see my blogpost “Pith O’ Sense and Pride O’ Worth”, 12/10/19). My trusty word processing program says 807 words, far above my usual 450 or fewer.
So I’ll only deal with private letter rulings, as Judge Buch deals with them in Dasher’s Bay At Effingham, LLC, Dasher’s Bay Management Group, LLC, Tax Matters Partner, Docket No. 4078-18, filed 12/10/19.*
The Dashers get their hopes for summary J on their conservation easement dashed for a bunch of reasons, but they include (without in any way limiting the generality of the foregoing, as my already-on-their-second Grey-Goose-Gibson colleagues would say) credit for improvements in case of judicial extinguishment overrules perpetuity, failure to state basis on their 8283, and Reg. 1.170A-13(c)(4)(ii)(E) is valid. There are three (count ‘em, three) other Dashers beside this one, all designated hitters, but they’re all same same.
We all know PLRs are only precedent for the requesting taxpayer, for the transaction in question, and the tax year(s) in question. They’re not precedent for anyone or anything else.
Judge Buch: “Dasher’s Bay argues that its deed of easement complies with the extinguishment regulation because the Commissioner previously allowed a deduction of a similar deed in Private Letter Ruling 200836014.
“Private Letter Rulings are written for specific taxpayers and other taxpayers may not rely on them as precedent. Courts are not required to consider private letter rulings; however, they may provide useful guidance.” Order, at p 8 (Footnotes omitted, but read them, as they have the relevant citations.)
MCM Investment Management, LLC, Mark and C’ann McMillin Family Trust Dated 04/09/1990, Tax Matters Partner, 2019 T. C. Memo. 158, filed 12/10/19, had pith o’ sense and pride o’ worth, as Scotland’s Greatest put it, because Judge Pugh finds that the interests MCMIM held in the family’s real estate business had become worthless when MCMIM said it did.
The McMillins were owners and builders in CA and TX in the early ‘00s, leveraged up the cliché when the Black ’08 hit. They had tiered debt ahead of the equity and debt-for-equity in the business, their accountants had going concern issues, and their senior lenders were threatening fire and slaughter.
The McMillins decided to wind down the business, as a bankruptcy would be catastrophic (and they were personally on some paper).
Even though they were still winding down after year at issue, Judge Pugh allows the $40 million ordinary loss in year at issue, because she finds that, subjectively and objectively, the partnership interests were worthless. Even though intrafamily.
“First, respondent objects that [family business] did not itself acquire the subordinate debt at a discount. But that was beyond its control because the senior lender would not permit it. Instead the McMillin children formed [affiliate] to invest new capital in [family business] by acquiring the subordinate debt from an unrelated lender. Moreover, [family business] and its owners wanted an affiliate to purchase the debt because it ensured that a third-party owner of the debt–such as a distressed debt purchaser–would not push [family business] into bankruptcy. [Affiliate] later converted the subordinated debt to equity for a legitimate business reason: to revive [family business]’ balance sheet by reversing its negative net worth, thus enabling [family business] to satisfy its minimum net-worth covenant and put it in a better position in restructuring negotiations with the senior lender. The debt-to-equity conversion had economic substance for the parties: [Family business] shed significant debt and the risk profile of [affiliate]’s investment fundamentally changed when it traded various creditor’s rights and priorities for higher upside.
“Second, respondent argues that MCMIM and [affiliate] were two pockets of the same pair of pants. We reject that analogy. The McMillin entities were separate legal entities. Respondent has not challenged their separate existence; indeed, he emphasized in his brief that ‘[w]hether the McMillin family entities are recognized as separate entities is not an issue in this case.’” 2019 T. C. Memo. 158, at p. 60. There was a real transfer, for non-tax business reasons.
Worthlessness has two separate but equal parts: subjective and objective (identifiable events).
“We conclude that MCMIM subjectively determined that its partnership interest in [family business] was worthless by the end of [year at issue]. First, MCMIM took the position on its tax return that the partnership interest was worthless in [year at issue]…. Second, the owners and management of MCMIM and Companies testified credibly at trial that they believed MCMIM’s interest became worthless in [year at issue]. They based their belief, in part, on the dramatic and devastating impact of the financial crisis…, [family business]’ consistent operating losses in the years leading up to and including [year at issue], the subordinate position of MCMIM’s partnership interest to [affiliate], and the overwhelming debt burden of [family business] and its project entities. The owners and management took into account [family business]’ deteriorating cashflow projections during [year at issue]. Those projections showed that [family business] would be unable to satisfy financial obligations owed to the senior lender, the subordinate lender, or the project debt lenders. Ultimately, the McMillin family decided to wind down [family business] in an orderly manner to maximize value for the creditors. These facts support our conclusion that MCMIM subjectively believed its partnership interest in Companies was worthless in [year at issue].” 2019 T. C. Memo. 158, at pp. 28-29.
There’s plenty of evidence of identifiable events underpinning MCMIM’s subjective decision that their LLC interests were worthless. They got cashflow projections from competent staff, their Big Four accounting firm was waving red flags, senior debt would have wiped them out in a liquidation, and no lender would look at them except to demand payment.
There was no appraisal here, but there doesn’t have to be, although IRS argues there should have been. Ditto foreclosure. You don’t have to ride the plane into the ground to justifiably bail out.
Having a positive capital account on a K-1 doesn’t mean the interest has residual value. And MCMIM’s operating agreement provides for liquidating preference only if computed per Section 704(b), not per GAAP, as the K-1 did. “Because section 704(b) capital accounts can differ from GAAP capital accounts, the GAAP capital account reported on the Schedule K-1 does not necessarily reflect what liquidating distributions MCMIM would have been entitled to under … the operating agreement.” 2019 T. C. Memo. 158, at p. 40 (citation omitted).
So MCMIM winds up with both pride o’ sense (they were right their interests were worthless in year at issue), and pith o’ worth (even though worthless).
I’ve inveighed against trial-by-ambush before. When it came to Indians, accountants, pro ses or ranchers, I was there. So today, I continue my “don’t ambush” series with the above-entitled.
Here’s Brent Lamb & Deanne Lamb, Docket No. 4748-18, filed 12/9/18.
Brent & Deanne are on for trial on Monday. Thursday evening their trusty attorney files a motion for summary J “calling into question the validity of Treas. Reg. 1.274-5T. The following morning, counsel for the Commissioner filed a motion in limine asking the Court to preclude any argument regarding the validity of that regulation.” Order, at p. 1.
Judge Buch is not amused.
Aside from the Rule 121 60-day pretrial cutoff for summary J motions without leave of Court (and you’d best have a real good story for that one), “(T)he Court’s record shows no indication of the validity of Treas. Reg. 1.274-5T being raised at any time before the filing of Mr. Lamb’s pretrial memo. And although Mr. Lamb initially filed his case pro se, counsel has been in this case since December 2018.” Order, at p. 1.
A quick docket search shows the Lamb’s pretrial memo was filed 12/2/19, last Monday.
You can see where this is going.
“The regulation Mr. Lamb seek to challenge relates to substantiation requirements for certain expenses. See I.R.C. § 274(d) and Treas. Reg. 1.274-5T. What is required for substantiation, by its very nature, affects what might be included in evidence at a trial. And it may affect what evidence is gathered for trial and what subpoenas are issued for trial. Seeking to change the evidentiary foundation upon which a case is based mere days before trial is an unfair surprise to both the opposing party and the Court.” Order, at pp. 1-2.
No go. IRS’ motion in limine granted.
Don’t ambush the judge. Don’t even ambush the IRS.
