The case is a supplement from Judge Cohen in Transupport, Incorporated, 2016 T. C. Memo. 216, filed 11/23/16. And if the names seem familiar, check out my blogpost  ”No Inventory? – No Fraud,” 9/14/15.

Even though Transupport had no inventory, IRS auditors made only slight revisions to Transupport’s creative numerology, until Harold tried to flog his enterprise, showing numbers far better than his tax returns. This prompted a whistleblowing buyer to howl to the Ogden Sunseteers.

Transupport’s COGS numbers get blown up (again), so IRS’s original numbers on that score survive, and the accuracy chop is sustained as well, but there’s still the question of compensation paid to Transupport’s only employees, Harold’s four sons. Was the compensation reasonable?

We get the usual dueling experts, with the usual result.

Judge Cohen has the usual response: “In most cases, as in this one, there is no dispute about the qualifications of the experts.  The problem is created by their willingness to use their résumés and their skills to advocate the position of the party who employs them without regard to objective and relevant facts, which is contrary to their professional obligations.   We conclude that petitioner’s experts disregarded objective and relevant facts and did not reach independent judgments, as is apparent from their stated opinions that petitioner’s reported income and deductions were correct as claimed on the returns filed.  We know from the factual evidence that the returns were consistently inaccurate and that the deductions were excessive.  Thus, the experts’ opinions fail a sanity check.  Respondent’s experts lacked complete information and acknowledged weaknesses.  As a result the parties were most effective in cross examination and exposing flaws in the work of their adversaries, leaving us with little to rely on other than the allocation of the burden of proof.” 2016 T. C. Memo. 216, at pp. 18-19. (Citation omitted).

Transupport’s attempted burden shift fails to convince as to the initial deficiency based upon excessive compensation.

“Petitioner had advance notice of respondent’s positions and conducted extensive depositions.  There was no surprise at trial and no unfairness in respondent’s more fully supported and justified recomputation of petitioner’s deductions for compensation to the Foote sons.  No different evidence on petitioner’s part was required because petitioner always had the burden of proving its deductible compensation, and that burden would not be satisfied by cross-examination of respondent’s expert.  If respondent had not presented any expert on compensation, petitioner would still be required to justify the amounts claimed on the returns, and none of the evidence does that.”2016 T. C. Memo., 216, at p. 31. Judge Cohen buys IRS’ expert as to the amounts shown in the SNOD.

But IRS has the burden as to the increased deficiency on the increase. And IRS’ expert also fails to connect.

The key is that IRS wild-carded in a new expert who didn’t bother to separate father’s compensation from sons’.

IRS’ wild-card “…uses total compensation because of the overlapping duties of petitioner’s officer-employees.  If the Foote sons had explained their duties and disavowed their knowledge and qualifications to the experts as they did during their trial testimony, respondent’s position might be stronger.  On balance, however, the failure to secure information from petitioner’s officers and notably the failure to consider Foote’s [senior’s] compensation separately undermines the reliability of [IRS expert’s] conclusions as to the comparisons between the Foote sons and others in comparable positions. [IRS’ expert’s] result is unpersuasive primarily because respondent has not seriously challenged the compensation paid to Foote.” 2016 T. C. Memo. 216, at pp. 33-34.

The years barred by SOL remain barred, and fraud is off the table, as before.

In short, back where it all started.

Edited to add, 2/21/18: Not quite, but sort of. 1 Cir affirmed Tax Court all the way in Transupport, Inc. v CIR, No. 17-1265, 2/14/18.  Thanks to Al Boudreau who let me know.

“As Of”

My transfer pricing readers, the few of the few, will remember Fifth Circuit’s blow-off of Tax Court in BMC Software. Everyone else can read my blogpost “Repatriation Isn’t Capitulation,” 4/8/15.

So today we have a reprise of the Section 99-32 accounts receivable cure to deemed dividend distribution in Analog Devices, Inc. & Subsidiaries, 145 T. C. 15, filed 11/22/16. Analog did a turn on this blog before, on a minor issue; see my blogpost “No Called Strike,” 2/8/16.

Tax Court adopts Fifth Circuit wholesale.

“The U.S. Court of Appeals for the Fifth Circuit, holding that the closing agreement did not alter the application of section 965, focused on the timing requirement in subsection (b)(3).  It stated that ‘[t]he text of * * * [section] 965(b)(3) specifically requires that the determination of the final amount of indebtedness be made “as of the close of the taxable year for which the [section 965] election * * * is in effect.”’  BMC Software II, 780 F.3d at 674-675.  BMC’s election year was 2006.  ‘[A]s of’ 2006 the accounts receivable did not exist and indeed could not have existed until the signing of the closing agreement in 2007, which was after the testing period had closed.  Id. at 675.  Even though the closing agreement deemed the accounts established in 2006, it did not change the reality that the accounts did not actually exist in that year.  Therefore, the Court held that the accounts did not constitute an increase in related party indebtedness during BMC’s testing period.  Id. at 676.

“Upon consideration, we agree with the Court of Appeals’ analysis that, under the plain meaning of section 965(b)(3), a CFC has an increase in related party indebtedness only if the indebtedness existed ‘as of’ the close of the election year.  Petitioner’s testing period closed long before the execution of its Rev. Proc. 99-32 closing agreement, and the accounts receivable did not exist before the closing agreement.  Respondent concedes that [CFC] would not have an increase in related party indebtedness if petitioner did not make an election under Rev. Proc. 99-32, supra, and did not execute the closing agreement.  Therefore, the only way in which the accounts receivable could have been established ‘as of’ the close of petitioner’s election year is if the closing agreement’s deemed established dates applied to the application of section 965(b)(3).  We held supra that the parties did not reach an agreement in their Rev. Proc. 99-32 closing agreement with respect to section 965(b)(3), and we do not take the deemed establishment dates of the accounts to alter subsection (b)(3).” 147 T. C. 15, at pp. 42-43.

There’s a lot here about stare decisis, and contract interpretation of Section 7121 settlement agreements, that practitioners should bookmark for their next memo of law.

Suffice it to say that, notwithstanding Judge Gustafson’s dissent that “all” means “all” (recalling a discussion I had with a very senior attorney when I was a young pup), which Judge Lauber, concurring, dismisses as a distinction without a difference, BMC I is overruled.

Judge Lauber, M.A. Clare College, Cambridge, seems to have studied philosophy as well as classics. Today he turns back to the early Twentieth Century German philosopher Hans Vaihinger, author of Die Philosophie des Als Ob (The Philosophy of “As If”), 1911.

No, this is not the dismissive rejoinder of my daughters’ school days, expressive of disbelief, which went something like this: “I got a date with Jeffrey this weekend.” “As if!”

Today we have Judge Lauber parsing the difference between “as” and “as if” in Zipora Klein, et al., Docket No. 24595-15L, filed 11/22/16.

Zip and the et als got nailed for tax crimes, and have mostly paid the restitution with which USDCCDCA hit them. But IRS wants interest. As a much better writer than I put it, “I crave the law, the penalty and forfeit of my bond.”

And IRS rests on IRM pt. 25.26.1.2 (March 24, 2014). But that isn’t law.

So Judge Lauber asks the parties to brief the law. But this being the commencement of the Season of Giving, Judge Lauber, though from the government, is actually here to help.

“Section 6201(a)(4)(A) provides that ‘[t]he Secretary shall assess and collect the amount of restitution under an order pursuant to section 3556 of Title 18, United States Code, for failure to pay any tax imposed under this title in the same manner as if such amount were such tax.’ (Emphasis added.) At least one court seems to have construed the phrase ‘as if such amount were such tax’ to mean that a resulting restitution-based assessment would not actually constitute ‘a tax’ imposed under Title 26. See United States v. Tilford, 810 F.3d 370, 372 (5th Cir. 2016) (‘Criminal restitution, even as a penalty for a failure to pay taxes, is not a tax.’). If restitution is assessed and collected as if it were a tax, rather than as an actual tax, a question arises whether underpayment interest under section 6601(a) should apply.” Order, at p. 2.

But Judge Lauber’s benevolent assistance is hardly so scanty.

“In Muncy v. Commissioner, T.C. Memo. 2014-251, 108 T.C.M. (CCH) 606, vacated and remanded on other grounds, 637 Fed. Appx. 276 (8th Cir. 2016), we contrasted the language of section 6201(a)(4)(A) with that of section 6665(a)(1). The latter section provides that various penalties, additions to tax, and additional amounts ‘shall be assessed, collected, and paid in the same manner as taxes.’ (Emphasis added). We noted in Muncy our belief ‘that the distinction between “as if” and “as” is significant.’ 108 T.C.M. (CCH) at 609. It is well-established that interest under section 6601(a) arises on penalties, additional amounts, and additions to tax. Since restitution is assessed and collected ‘as if it were a tax,’ rather than ‘in the same manner as a tax,’ a question arises whether underpayment interest under section 6601(a) should apply.” Order, at p. 2.

And take a look at Section 6305(a). Child support can be collected by IRS “as if it were a tax.” But Section 6305(a)(1) says no interest.

Judge Lauber isn’t through yet. “We invite the parties’ views as to whether any inference should be drawn, with respect to liability for interest on amounts assessed under section 6401(a)(4)(A), from section 6305(a) or other Code provisions that refer to amounts assessed ‘as if’ they were taxes.” Order, at pp. 2-3.

There’s yet more for IRS and Zip’s and the et als’ attorneys to digest along with their turkey and maple bourbon mashed sweet potatoes. And after they’ve swallowed a wee digestif, IRS has until the end of January, and Zip until the end of March, to send in their answers.

Since the hard-laboring intake clerks, the flailing date-stampers, the STJs, the Judges both Senior and ordinary… and even Ch J L Paige (“Iron Fist”) Marvel… are deserting the Glasshouse at 400 Second Street, NW, this Friday, November 25,  and probably camping out in front of Walmart for That Magic Moment when the sales begin, the Tax Court website bears the following legend (in red ink, yet): “The United States Tax Court will be closed and paper documents will not be accepted for filing on Friday, November 25, 2016.”

So what about non-electrics that must be paper-filed by the magic day?

Will Judge Lauber reprise his full-dress T. C., more particularly bounded and described in my blogpost “Neither Equity Nor Designation,” 6/2/16?

The suspense is killing me.

We can all recite in unison, even on a Friday afternoon, Judge Lauber’s mantra: FBAR penalties are Title 31s, whistleblowing payoffs are Article 26, and never the twain shall meet.

And if you can’t so recite, read my blogpost “FBAR or FUBAR? – Part Deux,” 3/14/16.

OK, but is there between Title 31 FBARing and Title 26 collection alternatives (such as Section 7122 OICs) “…a great gulf fixed: so that they which would pass from hence to you cannot; neither can they pass to us, that would come from thence,” as a far greater authority put it?

Remember IRS often settles FBAR infractions with Title 26 type penalties, rather than going for the eviscerating 31 USC §5321s, as Judge Lauber points out in the subject of the aforementioned blogpost.

But again, he was talking about Section 7623 whistleblowing.

On this Friday afternoon, with not a lot cooking at 400 Second Street, NW, we speed cross-country to the City of the Angels, where this conundrum is being unpacked by The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being, s/a/k/a The Implacable, Irrefragable, Ineluctable, Ineffable, Incontrovertible, Indefatigable and Indomitable Foe of the Partitive Genitive, and Old China Hand, Judge Mark V. Homes.

We have Jean Louis Rubin & Marie F. Charrier, a.k.a. Marie F. Rubin, a.k.a. Marie Rubin, Docket No. 26604-14, filed 11/18/16.

Lou (“Too Bad About the Spelling”) & Marie were facing an FBAR penalty, and wanted a doubt-about–collectibility OIC. But between their April trial date and their most recent teleconference, there fell the shadow of an assessment of FBAR penalty.

So now what?

Time to punt.

“Respondent [IRS] doesn’t think this’ll make an OIC processable; petitioners disagree. All agreed to see if petitioners are right. The Court is willing to keep the case on a status-report track….” Order, at p. 1.

Stay tuned.

Update 7/9/17, from your indefatigable “Quick Draw McGraw of Tax Court,” as Mr Peter Reilly of forbes.com styled me. Seems back on 6/30/17, Judge Holmes asked for another status report in a couple months, in his inimitable style, “…stating whether Ms. Charrier has in fact requested innocent-spouse relief, any their success in submitting an offer in compromise, and any other progress in settling the case.” Order, at p. 1. The OIC is dragging, and Ms Charrier is allegedly kicking poor Lou to the curb.

As Hank Longfellow put it, I’m “hanging breathless on her fate.”

No, not the much-contemned Section 1234A straddle, nor yet BOSS, Son-of-Boss, nor any other mix-and-match phony partnerships with foreign currency digital options. We have two Tax Court opinions today, one long and one short.

Judge Laro leads with Pizza Pro Equipment Leasing, Inc., 147 T. C. 14, filed 11/17/16. While the thought of pizza always delights me (and many thanks to an old friend, former boss and client for the delicious Italian buffet lunch he afforded us in honor of his birthday), this opinion is yet another reason why I avoided the college course in statistics.

The issue is whether the sole beneficiary and trustee of the Pizza Pro retirement plan overfunded same with deductible contributions, which turn out not to be deductible.

I’ll give you one sample, taken immediately before my eyes glazed over.

“Essentially, respondent applied a tripartite method to calculate the required reduction in the section 415 dollar limitation with respect to a retirement age earlier than 62.

“(1) Determine the actuarial equivalent value of each year’s respective limit payable at age 62 for life by converting that annual limit into a lump-sum value, assuming 5% interest and the probability of living each year to receive this annual benefit, and multiplying the limit by the appropriate APR.  In the table above, this requires multiplying [1] by [3].

“(2) Reduce the value derived in the first step from age 62 to age 45 by discounting it for interest only for 17 years.  In the table above, this entails multiplying [[1] × [3]] by [2].

“(3) Convert the value derived in the second step to a life annuity payable at age 45.  In the table above, this requires dividing [[1] × [2] × [3]] by [4], to arrive at the final number in [5].” 147 T. C. 14, at pp. 14-15.

The IRS won, based upon the regs at the time, which have since been completely superseded, so this full-dress T. C. is of historical interest only. Except maybe for Judge Laro holding that filing only a Form 5500 does not suffice when filing a Form 5330 is also required, as one is not a substitute for the other, and IRS couldn’t tell that the plan was overfunded with nondeductible cash until audit time. So no SOL.

And it takes Judge Laro 58 (count ’em, 58) pages to get there.

The short. A three-pager, Barry R. Skog, 2016 T. C. Memo. 210, filed 11/17/16, and you can guess who the Judge was on this one.

“Barry Skog claims that out of fear for his daughter’s financial future he withdrew money from his wife’s IRA during their divorce.  He also claims that he rolled it over into an account for the daughter’s benefit in some way that qualified as tax-free.  The Commissioner disagrees because the money seems to have disappeared.” 2016 T. C. Memo. 210, at pp. 1-2. (Footnote omitted).

So let’s look at the record.

“The stipulation shows that Skog made withdrawals from his wife’s IRA …that totaled nearly $45,000.  Skog claims that he moved this money into the Norvin A. Skog Irrevocable Trust (Trust), and that his daughter is the Trust’s beneficiary.  The Trust’s paperwork, however, does not name her as a beneficiary.  The Commissioner also subpoenaed the Trust’s investment account records.  They show some fluctuation in value and some withdrawals, but no deposits during [year at issue].  We don’t know where the money went, but these records show that it didn’t go to the Trust.” 2016 T. C. Memo. 210, at p. 2.

“Skog did not show where the money went.  If, contrary to the subpoenaed records, it did go into the Trust’s account, there is no evidence that it went there within 60 days of any of the distributions or that the Trust’s account was a qualifying retirement account.  And by Skog’s own admission, the Trust account was for the benefit of his daughter and not his soon-to-be ex-wife.” 2016 T. C. Memo. 210, at p. 3.

IRS wins.

I have said it so often that my readers must be bored: this is a non-political blog. While tax law and tax policy ignite virulent denunciations, philippics and polemics, I steer clear. I mean I steer clear here.

So I was of two minds whether or not to blog Patricia M. Rodriguez, Docket No. 6261-16S, filed 11/16/16. It might be that the fact pattern would indicate my political position, making me seem two-faced.

But the issues raised in this designated off-the-bencher from Judge Holmes need careful thought, not philippics. And I leave off my usual light-hearted honorifics for that reason. The matters raised, or implicated, in this case, are too important for levity.

Petitioner claims Schedule C waitress income of $13,000, exactly. And a bushelbasketful of child-based credits, that “swamp” (Judge Holmes’ word) the trifling SE tax she has to pay.

Judge Holmes: “Ms. Rodriguez didn’t know the full name of her employer. The business that she worked at was a bar that has closed; there were absolutely no written records of her employment there. There was no report by her employer of any wages paid, there was no report of tip income, and that caused her to use the wrong part of the form which she reported her self-employment tax.

“Even the amount of income, in exact amount of $13,000, suggests credibility problems. Few people have wages that end with three zeros.” Transcript, at p. 4.

So Judge Holmes blows off the claimed earned income. Petitioner is not credible.

And this gambit is played so often I’m surprised none of those who play have figured out that Sched C income doesn’t end with three zeros, or engender no deductions.

But the opinion has another side. Yes, there are minor children, but they aren’t petitioner’s, by blood, marriage or adoption.

“I find as a matter of fact, more likely than not, that MB and LPB were both small children during the [year at issue]. They were both birthright-citizen children. Their biological mother, who testified, Ms. Karina Rodriguez, is their mom. Their biological father, Mr. Efrain Bustamante, is their father. Neither of them are here in the country legally, and their unlawful presence might have affected the ability of the Rodriguezes to claim these children and some of the tax advantages that caring for small children have.” Transcript, at pp. 5-6.

Bustamante may have had a common-law marriage with Petitioner. Texas, where this case takes place, recognizes these, but Bustamante had enough of those, both in Texas and elsewhere, to befuddle Judge Holmes completely. It’s unclear from which, if any, of his several common-law wives he was divorced, or which of them died, if any.

Petitioner is legally in this country.

But Petitioner loses on all counts.

I leave it to my readers to draw what conclusions they want, if any, after reading this brief resume and after reading Judge Holmes’ opinion.

A colleague’s firm may have been tangentially involved in this one, so although the colleague just e-mailed an argument why Section 1031 wasn’t just a dodge for billionaires, this one turns out to be a dodge for non-billionaires.

At least Judge Gale says so, in The Malulani Group, Limited and Subsidiary, 2016 T. C. Memo. 209, filed 11/16/16.

The Malus owned real estate in Hawaii and Maryland. They had a couple subsidiaries (hi, Judge Holmes), but a hostile stockholder got a 30% stake in one of them out of bankruptcy court, so they set up separate boards, and The Malus made loans to the subs as they saw fit.

An unrelated entity offered to buy a Maryland parcel from a Malu sub for heavy cash, fifty percent above basis.

The Malus go for a 1031, get the appropriate QI, and gear up for the 45-180 day squaredance. That means find replacement property, identify same within 45 days of closing sale of relinquished, and close within 180 days (or end of tax year, as extended, whichever shorter).

Relinquished property closes, but no replacement on horizon except a Hawaiian parcel owned by related sub, which has a heavy-duty NOL. Related sub exchanges its parcel, and sells off acquired parcel, burying much gain with its NOL.

QI buys replacement as ordered. I am sure QI didn’t give the Malus, or anyone else, tax advice.

IRS blows up deal.

While 1031(f)((1) only bars non-recognition of direct transfers between related entities, and this wasn’t direct as the Malus used a third-party independent QI, 1031(f)(4) bars deals structured to avoid tax.

But there’s an exception (why not?). 1031(f)(2)(C) requires a look-see if there’s any non-tax avoidance part of the deal.

The Malus claim there was no tax avoidance, as they tried to find a replacement, but all they came up with was what their sub had. And IRS’ lead case involved structuring in advance, whereas The Malus only did the deal when they were running out of 45-day runway; no advance planning.

No good. “…the presence or absence of a prearranged plan to use property from a related person to complete a like-kind exchange is not dispositive of a violation of section 1031(f)(4).” 2016 T. C. Memo. 209, at p. 12.

“Instead, the inquiry into whether a transaction has been structured to avoid the purposes of section 1031(f) has focused on the actual tax consequences of the transaction to the taxpayer and the related party, considered in the aggregate, as compared to the hypothetical tax consequences of a direct sale of the relinquished property by the taxpayer.  Those actual consequences form the basis for an inference concerning whether the transaction was structured in violation of section 1031(f)(4).” 2016 T. C. Memo. 209, at pp. 12-13.

At close of play, it’s all about the numbers.

“Petitioner would have had to recognize a $1,888,040 gain had [relinquishing sub] directly sold the Maryland property to an unrelated third party.  Although petitioner’s NOLs would have offset a portion of this gain, it would have paid an additional $387,494 in tax for 2007 as a result of the direct sale.  Petitioner would have also owed an additional $264,171 of tax… because of the loss of that NOL carryback.  However, because the transaction was structured as a like-kind exchange, only [acquiring sub] was required to recognize gain–and that $3,127,004 of gain was almost entirely offset by its NOLs.  The substantial economic benefits to petitioner and [relinquishing sub] as a result of structuring the transaction as a deferred exchange are thus clear:  Malulani Group and [relinquishing sub] were able to cash out of the investment in the Maryland property almost tax free.  We thus infer that [relinquishing sub] structured the transaction with a tax-avoidance purpose.” 2016 T. C. Memo. 209, at pp. 14-15. (Footnotes omitted, but read them; though The Malus’ CEO claimed he didn’t know what was going on, he was on the committee that oversaw intercompany loans and got all the data).

And while there was no basis-shifting (swapping high-basis property for low-basis property between related entities), because the acquiring sub had more tax to pay when it unloaded the acquired parcel, acquiring sub had NOLs, and no evidence that using them would have unsheltered income for carryback years.

The idea behind 1031 is that the relinquisher is carrying on the investment program via the acquired like-kind property. Here, the relinquisher cashed out, and the acquirer enabled the deal by ducking behind its NOLs.

I give The Malus a Taishoff “good try, second class.”

Among the materials for tomorrow night’s meeting of the ABA/NYSBA Subcommittee on Taxation of Cooperatives and Condominiums that just hit my inbox, there comes Eighth Circuit giving IRS a heavy-duty mulligan in Estate of James Stuart, Jr., et al., 15-3319, filed 11/14/16.

While once again affirming that State voidable transfer law controls (and IRS doesn’t bother to fight this on appeal, as they’re 0-for-5 on the Circuits), Eighth Circuit gives Tax Court Judge James S. (“Big Jim”) Halpern the right-about-face.

For background, see my blogpost “State Law – With A Little Salt,” 4/1/15.

Judge Big Jim didn’t hit the Little Salties with the full tax that they would have paid if they’d played straight and not gone in with MidCoast. He only gave them the benefit they actually got, ex-MidCoast’s vigorish for putting this dodge together. He cites Nebraska law for this, while IRS argued liquidating distribution, as usual.

“Although the Tax Court concluded that the question of substantive liability under § 6901 is a question of state law, the court failed to consider the IRS argument that under Nebraska law the stock sale should be recharacterized as a liquidating distribution to the shareholders. The Tax Court instead respected the form of the transaction and concluded that the former shareholders were liable for a portion of Little Salt’s tax deficiency as beneficiaries of the transfer from Little Salt to MidCoast. On appeal the IRS argues that the Tax Court’s failure to consider whether the stock sale should be recharacterized under state law was error. We agree.”

State law is substance-over-form, equitable principles control, creditors must be protected from debtors’ chicanery, etc.

But Eighth Circuit declines to give IRS judgment for the whole nine yards.

“Although we agree with the IRS that the Tax Court should have considered whether the stock sale should be recharacterized as a liquidating distribution to the shareholders under Nebraska law, we decline its invitation to resolve this question in the first instance. A remand will allow for ‘adequate vetting through the adversarial process and avoid having the appellate court ‘try the action de novo.’’” (Citations omitted).

Sorry, no page cites, but it’s a short decision.

Anyway, back go the Little Salties to Tax Court, to play the liquidating distribution game.

Thanks to Martin Miller, Esq., for the heads-up on this. When colleagues’ children are seasoned practitioners and giving us tips, it’s time for another chorus of “Sunrise, Sunset.”

Judge Holmes Does the Split

 No, this is not C. S. Lewis’ voyage to the Celestial Realm, nor has The Great Dissenter taken up acrobatic dancing.

Here is the story of Benjamin Cornell Bridges, Docket No. 228-15, filed 11/15/16, a designated hitter off-the-bench from The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being, s/a/k/a The Implacable, Irrefragable, Indefatigable, Illustrious, Incomparable, Ineffable, Ineluctable, Incontrovertible and Irrefutable Foe of the Partitive Genitive, and Old China Hand, Judge Mark V. Holmes.

Ben Cornell is an honorable man. “He was very patient here. He was here all day and in the courthouse from beginning to end of the very long day, and he can tell his wife that, for sure.

“He volunteered to serve in the Army; he was discharged honorably. He served as a contract employee in our current wars, as a civilian where he was exposed to peril even in that capacity.” Transcript, at pp. 3-4.

But Ben Cornell was undone by ex-Mrs Ben Cornell, who, prior to being separated from Ben Cornell, had him sign with her the loan documents for her Ford Expedition. When they divorced, the decree gave her the vehicle and all benefits and obligations appurtenant thereto (as my expensive colleagues would say), including but not in any manner limited to, paying off said loan.

Ex-Mrs Ben Cornell didn’t, promptly defaulted, and after the said motor vehicle was repo’d, Ben Cornell got the 1099-C.

Ben Cornell never included the COD generated when the sale of the vehicle yielded less than the balance of the loan.

“So?” say you. “Joint and several on the paper means joint and several on the debt. And Tax Court isn’t bound by a State Court divorce decree. Both were relieved of indebtedness, therefore both are on the hook for the income thereby generated. All the divorce decree does is give Ben Cornell the right to sue ex-Mrs Ben Cornell for the tax, interest and additions to tax that Ben Cornell has to pay Uncle Sam.”

But in the words of the father of the Original Great Dissenter “ah, but stay,
I’ll tell you what happened without delay.”

Things get complicated. “Section 6050P of the Internal Revenue Code requires certain entities to report discharges of indebtedness. Under the regs for that section, 26 CFR Section 1.6050P-1(e)(1)(I), ‘In the case indebtedness incurred prior to January 1, 1995, and indebtedness of less than $10,000 incurred on or after January 1, 1995, involving multiple debtors, reporting under this section is required only with respect to the primary or first-named debtor.

“’Additionally, only one return of information is required under this section if the reporting entity knows or has reason to know to know that co-obligors were husband and wife living at the same address when an indebtedness was incurred and does not know or have reason to know that such circumstances have changed at the date of the discharge of the indebtedness.’” Transcript, at pp. 7-8.

But the lender knew they weren’t living at the same address, because the lender sent the shortfall calculation, which generated the COD, to ex-Mrs Ben Cornell at a different address than the 1099-C they sent to Ben Cornell.

Hang on, there’s more. Judge Holmes is just winding up.

Ordinarily, the right to sue for contribution when one co-obligor pays the entire indebtedness depends upon which of them got the debt proceeds, who had the benefit of any property purchased therewith, who had the basis in the property, and who got the interest deductions to the extent debt service was paid.

“In other words, property rights matter. Who owned the car after the divorce?” Transcript, at p. 11. And to determine this, Judge Holmes says we must look to State law. And Judge Holmes tried this case in Texas, wherein Ben Cornell resides.

Now the relieved indebtedness income must be apportioned among the co-obligors, and IRS agrees it can’t collect tax on the entire amount relieved from both co-obligors.

Judge Holmes looks to a non-binding, but useful, IRS Chief Counsel Advice, Memo 200023001.

And here we have the Texas twist, because Texas is a community property state. So one-half the car belonged to ex-Mrs Ben Cornell, and one-half to Ben Cornell. And the canceled debt was likewise split fifty-fifty.

So does Ben Cornell owe tax on half of the COD?

Negatory, good buddy. Judge Holmes performs a judicial double back flip jackknife, and Ben Cornell walks away scot free.

“What happened to that debt after the divorce? Well, for that again I looked at state law, which in this case is the state court divorce decree, and it says quite clearly, as Mr. Bridges emphatically put it, that the debt was hers, the car was hers — I’m sorry — the vehicle was hers. If she had had the right to take interest deductions, they would have belonged to her. If somehow she had souped the Ford Expedition up and it had become more valuable rather than less valuable and she had sold it, she would have been entitled to the profits; she would have had to pay the capital gains tax on it. And so here the income that’s attributable to the Ford Expedition, as a matter of state law, I find is entirely the former Mrs. Bridges’, and Mr. Bridges owes no deficiency. Oddly enough, representing himself, he has won.” Transcript, at p. 14.

Who says tax law is dull? Not when The Great Dissenter is on the case.