And She Also Got the Deduction

Judge Laro tells the story of Estate of Steve K. Backemeyer, Deceased, Julie K. Backemeyer, Personal Representative, and Julie K. Backemeyer, 147 T.C. 17, filed 12/8/16.

The late Steve farmed in Cass County, NE, and in the year prior to the year at issue, bought a lot of inputs, like seed, fertilizer, insecticide and diesel fuel, which would help him transform Cass County soil, rain and sunshine into corn and soybeans. Being a cash basis sole proprietor, the late Steve wrote off all the costs thereof on his Schedule F for that year.

In the next succeeding year, being the year at issue, but before he could use any thereof, the late Steve bought the farm. The inputs aforesaid turned up on the estate inventory, at cost. The late Steve had a bushelbasketful of receipts for all but $203 thereof.

The farmland and inputs passed to Julie via the family trust. Julie took the inputs as an in-kind distribution from the trust and promptly took up farming. And wrote off the inputs she had gotten against the income from the sales of corn and soybeans.

IRS yells a lot of things, but settles on tax-benefit rule: if you took a deduction in one year, but a fundamental change took place inconsistent with the premise upon which the deduction was taken, and no nonrecognition provision applies, that item is income in the next year. IRS says this is fundamental.

Yes it is. But Julie got a stepped-up basis in the inputs because of Steve’s death. And estate tax and income tax are two separate things.

Steve’s deduction of the inputs is OK even though he didn’t use them in the year he bought them. See my blogpost “The Field Pack Question,” 7/30/15.

And Julie’s deduction is OK, too.

“…neither Mr. Backemeyer’s death nor the distribution of the farm inputs to and their use by Mrs. Backemeyer was fundamentally inconsistent with the premises on which the initial section 162 deduction for tax year 2010 was based.  “A current event is considered fundamentally inconsistent with the premises on which the deduction was originally based when the current event would have foreclosed the deduction if that event had occurred within the year that the deduction was taken.’  Frederick v. Commissioner, 101 T.C. at 41.  Had Mr. Backemeyer died and Mrs. Backemeyer inherited and used the farm inputs in [year preceding death], the initial section 162 deduction would not have been recaptured for purposes of the income tax.

“The reason for this is that the estate tax effectively ‘recaptures’ section 162 deductions by way of its normal operation, obviating any need to separately apply the tax benefit rule.  When Mr. Backemeyer died, all of his assets, including the farm inputs, became subject to the estate tax, which operates similarly to a mark -to-market tax when the mark-to-market tax is imposed on zero-basis assets.” 147 T. C. 17, at pp. 26-27.

Requiring Julie to relinquish the deduction on the inputs would mean double taxation…estate and income.

While it may be beneficial for tax purposes, death is not generally recommended for tax planning purposes.

Judge Laro doesn’t state whether estate tax was actually paid, but the Section 1014 step-up doesn’t require that tax be paid.

IRS says that Julie is getting a double deduction, one on the 1040 MFJ she and Steve filed for Steve’s last full tax year, and one on her own the next year.

OK, says Judge Laro, but Congress has monkeyed with Section 1014 as recently as last year (2015), and presumably knows the laws they are amending. Wanna bet, Judge?

“It is hardly unforeseeable that taxpayers would attempt to deduct previously expensed inherited assets for which they received a stepped-up basis, yet at no point has  Congress acted to prevent it.” 147 T. C. 17, at pp. 30-31.

A classic tax benefit rule is recapture depreciation in Sections 1245 and 1250. But they don’t apply at death.

Finally, a nonrecognition statute blocks the tax benefit rule, and nonrecognition of stepped-up gain at death is a fundamental nonrecognition statute.

So no deficiency, except for the tax on the $203 Julie concedes. And that’s way below the radar for the substantial understatement chop IRS was looking for.

Some mothers do ‘ave ‘em, as the old English slogan goes, but the STJs at 400 Second Street, NW, get more than their share.

And today STJ Lewis (“The Name”) Carluzzo has a pair of designated hitters.

Start with a return by Bruce Edward Haddix & Rae Anne Haddix, Docket No. 7385-16L, filed 12/7/16. Bruce & Rae were last here in my blogpost “No Deus, Much Machina,” 11/18/15.

I’m rather surprised Bruce & Rae are back, as you can see from the abovecited blogpost they had accused Tax Court of participating in a fraud. Howbeit, they seem to have discovered the subpoena, and have served the same far and wide, even before the Branerton play-nice, interrogs and document productions.

Apparently there’s less than a billion bucks on the table, and the third parties subpoenaed seem to have little to do with the matter at hand.

“More problematic, however, is petitioners’ attempts to use the Court’s Rules to obtain information that seems to have no bearing on the issues typically involved in proceedings such as this one. This is true with respect to each moving party. The individuals/moving parties apparently have some prior employment related connection with at least one of the petitioners, but the relationship of each of those individuals with respect to the underlying liabilities or the proposed collection action here in dispute is hardly apparent. As demonstrated in this case and at least one other previously dismissed Tax Court case, petitioners’ apparent propensity to issue and have served subpoenas upon individuals for information that hardly seems reasonably calculated to lead to admissible evidence in a Tax Court proceeding is an abuse of the Court’s Rules. See Rule 70(b). It would be improper for the Court to allow this practice to continue unchecked.” Order, at p. 2.

So no subpoenas on third parties without leave of Court, whether or not IRS agrees, with sanctions and costs to follow.

Next up is Chastity Kirven, Docket No. 30393-15W, filed 12/7/16, again a repeat performance (see my blogpost “Honey, I Shrunk the Kids,” 6/17/16).

As Chas won’t stip with IRS for a protective order before IRS gives her the Section 6103 material she wants, STJ Lew decides that allowing limited discovery is premature.

“…the Court indicated that it was inclined to allow petitioner limited discovery as requested in her opposition to respondent’s motion for summary judgment…and her motion for discovery…. However, upon further consideration…allowing discovery at this stage of the proceedings without some suggestion of a factual dispute would seem to be little more than an inappropriate ‘fishing expedition’, not to mention contrary to the Court’s requirement that the parties informally consult or communicate before discovery is initiated. See Rule 70(a); Branerton Corp. v. Commissioner, 64 T.C. 191 (1975). Petitioner is entitled to present information that challenges the statements contained in the declaration, and she will be given an opportunity to do so.” Order, at pp.1-2.

So Chas gets to put in credible information why IRS is wrong.

But STJ Lew has some advice for Chas that it would be well to heed.

“…petitioner objected to scheduling multiple motions for hearing on the same day, and she has repeatedly challenged the jurisdiction of a special trial judge to act in this case. At the hearing the Court noted for the record the provisions of I.R.C. §7443A(b)(6) and (c), which upon assignment by the chief judge, specifically grants jurisdiction in cases such as this one to a special trial judge. In many of her filings petitioner has also relied upon inapplicable provisions of the Federal Rules of Civil Procedure in her opposition to the assignment of the motions here under consideration to the undersigned. She would be well advised to review the transcript of the hearing so as to be better informed as to the merits, or lack thereof, of many of her positions.” Order, at p. 1, footnote 1.

A tip of the battered Stetson to a long-time reader of this my blog (a poor thing, but mine own) for pointing out Estate Of Michael J. Jackson, Deceased, John G. Branca, Co-Executor and John McClain, Co- Executor, Docket No. 17152-13, filed 12/5/16.

I’d told the long-time reader that there wasn’t anything new in this rehash of a “Win Your Case at Discovery” CLE, but upon re-reading and ruminating, this order seems worthy of a note, even though it echoes previous learning. So I retract my previous opinion, Mr B.

For background, see my blogposts “Letter to the Editor,” 11/19/13, and “The Real McCoy,” 4/27/16.

We all know the Rule 74(c)(1)(B) truism: “The taking of a deposition of a party, a nonparty witness, or an expert witness…is an extraordinary method of discovery….”

Well, IRS wants depositions (what we NYS practitioners call “EBTs”, examinations before trial) of both co-ex’rs, a paralegal who worked on the 706, and an accountant who was the late King’s business manager.

Seems like a lot, especially when the play-nice Branerton informals, interrogs and document productions are all available. And Tax Court doesn’t play referee in discovery jousts, except to tell the players to play nice.

But there is here a key fact, which appeared also in the second of my blogposts above cited. And I’ll let The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being, s/a/k/a The Implacable, Illustrious, Indefatigable, Imperturbable, Ineffable, Ineluctable and Incontrovertible Foe of the Partitive Genitive, and Old China Hand, Judge Mark V. Holmes, tell us.

“The key fact here is that the stakes in this case exceed $1 billion. The Court acknowledges the parties’ disagreements about how cooperative each has been in informal discovery, but in a case of this size there is bound to be toing-and-froing between two highly qualified teams of lawyers. It is reasonable to lock down the testimony of a central witness on the key underlying facts, which should shorten the trial and better focus it on what are likely to be quite complicated valuation issues. Respondent’s motion is reasonable, and the marginal cost small in relation to the stakes.” Order, at p. 3 (misnumbered as p. 2 in original).

And to tie in the title of this little essay, I quote from the late Senator from IL, E. McKinley Dirksen: “A billion here, a billion there, and pretty soon you’re talking about real money.”

So the win-your-case-at-discovery gang get a bye.

Except. What would tax law be without “except”?

One co-ex’r is ill. “He is also described as very seriously ill and subject to very poor reactions to stress — descriptions buttressed by specifics from his doctors that the Court will seal out of respect for his privacy — that would seem inconsistent with the ability to manage a complex enterprise in an industry not widely known for the placidity with which its commercial activity is carried out.” Order, at p. 3 (misnumbered as p. 2 in original).

“Very poor reactions to stress” definitely take one out of the profession I love.

However, lest the co-ex’r grow too elated, Judge Holmes, like a much more exalted personage, has a thorn for his flesh.

“…should respondent [IRS] issue a trial subpoena for his testimony, and should petitioner or [co-ex’r] object to it, the Court would expect to hold a brief hearing to determine if [co-ex’r’s] health has interfered with his ability to tend to the estate’s day-to-day business.” Order, at p. 3 (misnumbered as aforesaid in original.)(Name omitted).

Judge Holmes is wandering outside the record, and verging on the loquacious, in Boris Putanec and Jeana J. Toney, 2016 T. C. Memo. 221, filed 12/6/16.

Boris was a computer hotshot, and Jeana is along for the ride, having filed MFJ.

Judge Holmes, obviously intrigued by Boris’ meteoric rise to millionairedom, regales us with arcanery such as lockups, blackouts, dead-cat bounces and tax lawyers who flog dodges and get locked up their own selves.

Boris was one of the creators of Ariba, a B2B online that was a poster child for the Great Illusion of Y2K, the dot.com boom.

“We note that this short course on Ariba’s history is drawn from extrarecord sources.  The history is for engaging background alone and is immaterial to the contested facts and issues.” 2015 T. C. Memo. 221, at p. 4.

Well, Judge Goeke got caught up in golf mania with Retief Goosen and Sergio Garcia. See my blogpost “Icon v. Iceman,” 3/15/13.

Boris wanted to cash out some of his Ariba stock while keeping most of it. So he took the road which led Mark (“Shades”) Kerman to disaster. For a much briefer account of the pitfalls dug by the Chenery gang, which ensnared Mark, and later Boris, see my blogpost “House of CARDS,” 3/8/11.

Boris crashes at the same fence as Shades. No economic substance. Pure tax dodge.

And Boris obligingly sticks his head in the noose. “Putanec was admirably honest with this admission.  At trial he even said the last redemption was done in order to get the loss so that he could ‘take [his] aggressive tax position * * * .’” 2016 T. C. Memo. 221, at p. 21, footnote 14.

But since Boris ran his redemptions of debt denominated in Euros through traded currency options, he does get to deduct his Section 1256 mark-to-markets.

Confidentially speaking, Judge Holmes knows his way around. Today, he grapples with the Health Insurance Portability and Accountability Act, the “onlie begetter” of so many eye-glazing CLEs, in Continuing Life Communities Thousand Oaks LLC, Spieker CLC, LLC,  Tax Matters Partner, Docket No. 4806-15, filed 12/6/16.

The Thousand Oakies are afeared that IRS wants confidential health info.

Judge Holmes, the King of the Phonathon, gets the Thousand Oakies and IRS on the hoot-‘n’-holler, and they hammer out a Rule 103 spectacular, with marking of confidential stuff, a 45-day clawback, list of permitted eyeballers, challenge procedures, and a whole lot more, complete with citations to relevant statutes and regs.

Practitioners representing the disciples of Asclepius should get this language in their forms files.

I shift my hands in a horizontal plane while contemplating Chinweike Nwabasili, 2016 T. C. Memo. 220, filed 12/5/16. Chin and his brother ran an event-promotion (music performance) business and a car exporting business together, and Chin testifies they were partners, except Chin files his business income and expenses for both businesses on a single Schedule C.

This is not a good start, but Judge Morrison does find that Chin did make some business payments, like buying three cars to sell offshore, and hiring bars and similar venues, such as for “musician Flavour Nabania and his band to perform at the bar New Karibbean City in Oakland, California,…..” 2016 T. C. Memo. 220, at p. 4.

IRS agrees that Chin was in business but balks at Chin’s substantiation of expenses.

Though on the trial Chin claims he and his brother were partners, that’s the first IRS heard of it. IRS claims each brother had his own business.

Well, Judge Morrison found that the bulk of the expenses Chin claimed were business-type expenses and he paid them.

But how to deal with the losses?

“Nwabasili credibly testified that he and his brother were partners in the two businesses.  He credibly testified that he and his brother agreed to share the income and expenses of the two businesses.  He explained how they divided the tasks with respect to the businesses.  Although many of the business documents referred to his brother and not him, Nwabasili explained that this was because his brother was the front man for the businesses even though they considered themselves equal partners.

“We find that the brothers intended to join together to conduct the businesses.  The event-promotion business and the car-export business were conducted in partnership.” Order, at p. 13.

So the expenses are partnership expenses, there being no showing the brother-partners agreed that each should bear his own expenses, or so engaged as a course of conduct.

But there’s no way to compute partnership income, because Chin didn’t report everything the partners took in. Ditto the partnership expenses, and some items might be disallowable personal expenses.

“Even if we could calculate the partnership’s loss, we face another problem in determining the deductible portion of Nwabasili’s distributive share of the loss. Section 704(d) provides that a partner’s distributive share of a partnership loss is allowed as a deduction only to the extent of the adjusted basis of the partner’s interest in the partnership at the end of the tax year.

“To be entitled to his share of any partnership loss, Nwabasili had to have a sufficient adjusted basis in his partnership interest….  See sec. 704(d).  The basis of a partner’s interest in the partnership acquired by a contribution of money is initially equal to the money the partner initially contributed.  Sec. 722.  It is increased by any other contributions by the partner to the partnership.” 2016 T. C. 220, at p. 16.

And of course there is no information sufficient to calculate Chin’s adjusted basis in the partnership.

So no fix on partnership income, partnership expenses or Chin’s basis in the partnership.

OK, but nobody raised this on the trial.

“The IRS did not raise these matters regarding the difficulty of calculating Nwabasili’s distributive share of the partnership loss.  Normally we do not consider matters not raised by the parties.  We make an exception in this instance.  Nwabasili did not explain to the IRS until trial that he had a partnership with his brother.  He filed his tax return as if he was not in partnership with his brother.  This gave the IRS the false impression that his disputed Schedule C expenses related to businesses that were exclusively his and that he had paid the disputed expenses.  He manipulated documents in an attempt to show that he had made payments that were actually made by his brother….  Given Nwabasili’s subterfuge, it is understandable that the IRS remained skeptical of whether the disputed expenses related to Nwabasili at all, whether directly or through a partnership.  That the IRS did not contend that the disputed deductions should be evaluated under the partnership tax rules (subchapter K of the Internal Revenue Code, sections 701 to 777) and disallowed for lack of information about the partnership’s gross income, the partnership’s deductions, or the adjusted basis in the partnership, does not prevent us from holding that the deductions should be denied on these grounds.  After all, it was Nwabasili who presented persuasive evidence that his businesses were conducted in partnership with brother.  For us to sustain the deductions he seeks on the ground that his businesses were conducted not in partnership with his brother would be contrary to what he argued at trial.  And it would be contrary to our view of the reality of the business arrangements.  We believe that Nwabasili conducted his businesses in partnership with his brother.  Partnerships are taxed under the partnership tax rules.”2016 T. C. Memo. 220, 18-20.

Chin, you broke it, you own it. No pass-through.

Buried among the spam, the clickbait, the propaganda, half-truths and downright lies spread abroad every nanosecond by the internet, one can find objective and useful information from trustworthy sources.

One might even stumble upon my blogposts, but modesty requires that I leave to your discretion into what category these shall go.

Judge Wherry reminds us that government agencies have websites. On such as these one can find data that cannot reasonably be questioned. FRCP 201(c) is the touchstone for permitting the Court to take juridical notice thereof.

Despite IRS’ claim that the proffer is untimely, and the proffered cyberinfo is cumulative of evidence already upon the record, Judge Wherry lets Lon B. Isaacson, Docket No. 29848-14, filed 12/5/16, introduce the webpage detailing his CA disbarment.

Judge Wherry relies on analogical Federal webpages locating inmates in Federal slammers and providing medical records for discharged military personnel, but apparently the CA Bar website passes muster.

“In general, the court may take notice of facts that are capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned. Fed. R. Evid. 201(b).” Order, at p. 1.

Lon hasn’t got a certified copy of the CA order, and Judge Wherry can’t find it either.

So in goes the website, but only, as the texters say, FWIW.

John Melvin Corker & Lisa Ann Adame-Corker, Docket No. 19090-16, filed 12/2/16, are pardonably peeved with having missed the cutoff due to the standard pro se conflation of IRS with Tax Court. John & Lisa apparently mailed all sorts of paperwork all over the lot, but missed the Glasshouse at 400 Second Street, NW, by 19 days.

Ch J L Paige (“Iron Fist”) Marvel gives John & Lisa the bad news sympathetically.

A sad tale, but what else is new? This happens almost every day. Notwithstanding all the political chatter about amending Title 26, I have yet to hear anyone suggesting a rule of reason for filing Tax Court petitions.

Well, John & Lisa want their sixty bucks back, especially since Ch J Iron Fist ordered them to send it in before telling them they were late.

Too bad, so sad, John & Lisa. “…, insofar as petitioners have suggested a degree of dissatisfaction with having been directed to pay the filing fee for a case subject to dismissal, they are advised that the filing fee is intended to defray the administrative expense of filing and processing a petitioner’s paperwork, without regard to whether such paperwork establishes a valid basis for jurisdiction and/or a continuing action. Subsequent dismissal or resolution does not affect the fact that a case was begun. Consequently, the filing fee is not refundable by the Court.” Order, at p. 4.

I’ll try again, as I am a man of great patience.

So what price Ethel M. Stewart, Docket No. 9223-16, filed 9/27/16?

Because it looked like John & Lisa wanted to start the case, and Ethel seemed uncertain (or maybe Ch J Iron Fist couldn’t figure out what Ethel wanted), Ethel gets her money back and John & Lisa don’t? But in both cases there was paperwork, a docket number assigned, and an order issued. And the sixty bucks is owed “without regard to whether such paperwork established a valid basis for jurisdiction,” right?

So what’s the rule?

And this is not just another irrelevant rant. More people are involved at the sixty-buck-ticket-to-justice phase than anywhere else. Every Tax Court case starts with something, be it even an unaccompanied money order, a partial copy of a NOD or SNOD, one or more of IRS’ multifarious billets doux that look like a SNOD but aren’t, or even a letter from a confused pro se without a clue.

If there’s a rule, let it be consistent. And let it be known.

Judge Chiechi, Meet Judge Holmes

The issue here involved shows up in a bushelbasketful of orders, but for ease of reference, let’s eyeball Edward J. Tangel & Beatrice C. Tangel, et al., Docket No. 27268-13, filed 12/2/16.

Judge Chiechi has a bushelbasketful of protective order requests from the Tangels and the als, apparently due to IRS subpoenas served on third parties pursuant to Rule 147.

Y’all remember Rule 147, eh what? Well, as a great American once remarked, “you could look it up.”

Rule 147 don’t say nothin’ ‘bout tellin’ the other side.

Judge Chiechi: “A party that issues a subpoena under Rule 147(a) and/or (b) is not required to give prior notice to the other party.” Order, at p. 1.

Moreover, the IRS was genteel. “The Court finds under the facts and circumstances presented that respondent did not issue the subpoenas in question to harass, annoy, embarrass, oppress, or cause an undue burden on petitioners.” Order, at pp. 1-2.

So what?

FRCP 45 does require notice. And Rule 147 hasn’t been touched since 1973, long before the 1991 amendment to FRCP 45.

Gentility has nothing to do with it.

See my blogposts “Judge Holmes’ Vendetta,” 7/8/16, and “The Stealth Subpoena,” 7/16/15.

Maybe Judge Holmes and Judge Chiechi ought to get together for a cup coffee and a piece pie, and peradventure discuss bringing Tax Court into the last decade of the Twentieth Century, if not into the second decade of the Twenty-First.

Innocent spousery is multiform. Today we deal with apportionment, or rather Judge Lauber, recovered from unscrambling defective lodgings and filings, takes up that task in Dwight McDonald and Donna McDonald, 2016 T. C. Sum. Op. 79, filed 12/1/16.

Apportionment falls under Section 6015(c). So let’s go down the checklist. Dwight and Donna filed jointly for years at issue. Check. Dwight and Donna are now divorced and living apart. Check. Donna seeks to bail not later than two (2) years after IRS starts to collect. Check.

So Donna’s cleared the bar.

Now what does she get?

Well, the State tax refunds (unreported) get split 50-50, as the returns that generated same were joint.

And Donna’s unreported wages are all hers.

The biggest items are current losses and carryforwards arising from Dwight’s real estate operation. Though Dwight had a full-time job in RI, both Dwight and Donna owned ten (count ‘em, ten) rental real estate parcels in FL and AL. And Donna did answer the phone when the managing agent called for Dwight’s decisions. She knew Dwight spent a lot of time on the real estate, but he kept all the records in a locked room, to which Donna did not have the key. Donna knows nothing of tax law and relied on Dwight and their CPA.

The CPA figured Dwight was a real estate pro, and told Donna so, but didn’t go over the tax returns with her.

IRS says Dwight “actually participated,” so he gets the $25K of losses, but did not “materially participate,” so loses the rest. Hence Dwight’s tears.

IRS says Donna is innocent, but Dwight disagrees.

Judge Lauber: “The statute does not address burden of proof in the situation we face here, where the IRS supports relief from joint and several liability and the nonrequesting spouse opposes it.  In such cases we ‘inquire whether actual knowledge has been established by a preponderance of the evidence’ presented by all three parties.

“’Actual knowledge’ means ‘an actual and clear awareness (as opposed to reason to know)’ about the item giving rise to the deficiency.  A taxpayer lacks actual knowledge if she ‘is unaware of the circumstances that give rise to error on the tax return.’  In the context of a disallowed deduction, the relevant question is whether the requesting spouse ‘had actual knowledge of the factual circumstances which made the item unallowable as a deduction.’”  2016 T. C. Sum. Op., 79, at pp. 9-10. (Citations omitted, but look them up for your next memo of law).

Quite Cartesian.

Dwight argues Donna knew about the real estate business, answered the phonecalls of the managing agent, and was told by the CPA that either she or Dwight or both were real estate pros. Therefore Donna knew about the dicey deductions.

No, says Judge Lauber. Yes, she knew about the real estate business. But that’s not enough.

Since the distinction between actually participating and materially participating means counting hours, knowing who did what and whether all activities were treated as a single activity (and appropriate election filed), and since Dwight called all the shots and kept the records locked away, no way could Donna know that Dwight was a short-timer. Especially when the CPA said he was the real deal.

The accuracy chops will follow the erroneous items.