I was seriously of two minds about blogging William Cavallaro, Donor, 2014 T. C. Memo. 189, filed 9/17/14.

I’d had a lot to say lately about tax advisers getting it wrong. I didn’t want to appear to be engaging in schadenfreude, or calling penalties from the bleachers. Still less did I want to seem to be encouraging the disappointed taxpayer to sue their advisers when the metaphorical pot of gold turns out to be a pot of something much less desirable. And, worst of all, I do not want to seem to be claiming some kind of Olympian omniscience, when all I am doing is playing Monday morning quarterback.

And I’ll recite the clichés yet again: There but for the grace of you-know-Whom go any of us. Bad pilots don’t crack up jumbo jets; only good pilots do, because bad pilots never get to fly them. And all of us have awakened in the dark night of the soul at 3 a.m. thinking “OMG, did I do (or fail to do) that?”

OK, self-exculpatory patter done with.

The case is fact-specific. It’s a Pop-and-Mom business that starts at the dinner table. Mom and Pop barely made it through high school, but they build a multi-million dollar business. Their three sons are bright kids. The eldest devises a really good machine, and Pop-and-Mom’s corporation develops and manufactures it. But it never gets patented, and Pop-and-Mom took the R&D credits.

The sons’ corporation sells the device to various users, but never formally gets the IP that’s the valuable asset, and when the corporations merge, Pop-and-Mom get way less stock than their share of the assets.

Why? Because a Big Four accounting firm with two names, and a major league Boston law firm also with two names, advising Pop-and-Mom as to estate planning, decide, in the words of one of the attorneys “With regard to the ownership of the ‘technology,’ I am going to be guided by the history which comes out of [the] interviews with the key players. In any history there are a few events which do not fit the picture which the historian sees as ‘what happened.’ History does not formulate itself, the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force.” 2104 T. C. Memo. 189, at p. 29.

The accountants objected, simply because the “squeeze” was directly contrary to reality. But the lawyers prevailed. I wonder what they told the clients while this jumpball was going on. In any case, much of the correspondence between lawyers and accountants get into the record (as the clients are trying to avoid substantial understatement and allied penalties, which they do).

Cutting the story short, IRS blows up the deal, hits Pop-and-Mom with having made a gift to their sons of $29.6 million by giving them too much stock, having filed no return and paid no tax. And after various appraisals, which Judge Gustafson mostly tosses, Pop-and-Mom have to cough up the tax and interest.

I’m quoting Judge Gustafson’s comment on all this, because I suspect it’s the prelude to The Phone Call. “The fault in the positions the Cavallaros took was attributable not to them but to the professionals who advised them. (Since those professionals are not parties here and have not had a full opportunity to explain or defend themselves, we refrain from further comment on them.)” 2014 T. C. Memo. 189, at p. 70.

It hurts to blog this, but it might warn some practitioner, advising an unsophisticated client, to have what we call a CTJ (a heart-to-heart discussion) with the client, warn them that the brilliant idea might not work, and let them sleep on the proposition, before leaping into print and winning an argument that will cost the clients plenty.

No, not another façade easement appraisal case. This is predictive coding, and it doesn’t have anything to do with the late Jean Shepherd’s celebrated Little Orphan Annie Ring, either.

No, predictive coding is how one trains a computer to sniff out certain documents from a heterogeneous mass of bits, bytes, gigs and teras, by having a human review a sample, put the magic discriminators in the search engine, see what the electronic friend turns out, and refine, until the result statistically assures a high level of confidence that what is turned out is what is wanted.

This is new to Tax Court, so we get a full-dress 143 T. C. 9, filed 9/17/14, Dynamo Holdings Limited Partnership, Dynamo, GP, Inc., Tax Matters Partner.

The issue is gift v. loan. Did Dynamo’s owners get gifts from an allegedly-related outfit called Beekman Vista, Inc.? IRS wants a huge load of ESI (electronically stored information) from Dynamo.

Dynamo says it will cost $450K to sort the stuff for privileged info, like HIPAA, personal info, etc. IRS says, OK, give us everything and we’ll give you a “clawback agreement” so you can suppress anything confidential later, without waiver issues.

Dynamo says “let’s use predictive coding. We’ll agree on search terms, train the computer, and for a fifth of the cost of an all-human search, we’ll give you the relevant stuff. ” IRS says, no, unproven technology.

Judge Buch, obviously technologically-hip, goes with Dynamo, and Dynamo’s essentially uncontradicted expert.

But first, a word of caution. Tax Court doesn’t play nanny for discovery.

“Our Rules are clear that ‘the Court expects the parties to attempt to attain the objectives of discovery through informal consultation or communication’ before resorting to formal discovery procedures. Rule 70(a)(1). And although it is a proper role of the Court to supervise the discovery process and intervene when it is abused by the parties, the Court is not normally in the business of dictating to parties the process that they should use when responding to discovery. If our focus were on paper discovery, we would not (for example) be dictating to a party the manner in which it should review documents for responsiveness or privilege, such as whether that review should be done by a paralegal, a junior attorney, or a senior attorney. Yet that is, in essence, what the parties are asking the Court to consider–whether document review should be done by humans or with the assistance of computers. Respondent fears an incomplete response to his discovery. If respondent believes that the ultimate discovery response is incomplete and can support that belief, he can file another motion to compel at that time. Nonetheless, because we have not previously addressed the issue of computer-assisted review tools, we will address it here.” 143 T. C. 9, at p. 10.

And address it he does, and lets the predictivists go at it. There’s lots of buzz in the technology press, other courts have allowed it in the past, and IRS’ expert can’t contradict Dynamo’s expert that it can work. Dynamo is right to worry about handing everything over to IRS, clawback or no clawback, and the cost of doing any eyeball search is staggering. Tax Court Rule 1 is to secure a “just, speedy and inexpensive resolution of every case.”

So go ahead, Dynamo and IRS, predictivize away, and, IRS, if you’re unhappy at close of play, come back and make your motion to compel.

No, not Mick Jagger’s and Keith Richards’ 1965 Number One hit for the Stones. This is Judge Ruwe’s word to Greenoak Holdings Limited, Southbrook Properties Limited and Westlyn Properties Limited, in 143 T. C. 8, filed 9/16/14.

The late James Irwin’s personal representative got a NOD from Appeals, affirming NITL on certain nonprobate assets of the late James. The late James’ personal representative didn’t petition the NOD. Green, South and West, apparently owned by a Bahamas outfit called Karamia Settlement, to which the late James had transferred assets (and as to which the late James’ personal rep claimed there weren’t assets in the probate estate sufficient to stump up the $7 Mil in tax due), file their own petition, aided by a substitute personal rep for the late James.

Green, South and West want either to be substituted in for the personal rep as petitioner  (even though it’s too late for the personal rep to petition, the 30 days from NOD having run), or that they themselves be allowed to petition, as they never got notice of the amount of tax due, which is what they want to contest.

Ordinarily, when the taxpayer didn’t have a chance to petition from a SNOD, or otherwise contest the computation of the deficiency at Appeals, Section 6330(c)(2)(b) gives them a shot in Tax Court. And we’ve seen any number of such instances where the petitioner gets a whack at the numbers if they hadn’t either had a chance before, or self-reported the numbers. And Green, South and West certainly didn’t self-report, or have a chance to contest.

Since every Section 6330 before now has been brought by the taxpayer him/her/itself, this is a case of first impression. Green, South and West claim that the late James didn’t own their property (and IRS didn’t claim they did, or specify what nonprobate assets were involved in the levy).

Now Section 6330 uses the word “person” extensively, so Green, South and West want to tag along.

“Petitioners interpret ‘person’ broadly so as to include any third party claiming an ownership right in property that might be subject to levy to collect the unpaid taxes of another person. Thus, they claim all of the rights conferred in section 6330, including the right to appeal a notice of determination to this Court, even if the notice of determination was issued only to the person who owed tax.” 143 T. C. 8, at pp. 12-13.

Once again we slide down the slippery slope of statutory construction and interpretation, and Green, South and West land on the bottom with a thump.

“A comprehensive reading of section 6330 in its context demonstrates that ‘[t]he person’ contemplated within the statutory framework is the person who owes the unpaid tax and that the only property that is subject to levy is the property of the person who owes the tax.” 143 T. C. 8, at p. 13.

The whole idea of the notice and hearing protections is to protect the property of the taxpayer. Green, South and West aren’t taxpayers. So no jurisdiction in Tax Court.

And this attempt to bring in Green, South and West by way of petition is too late. Rule 41 prohibits any amendment to a petition that tries to confer jurisdiction on Tax Court after the statutory clock has run.

That said, Green, South and West can always bring a Section 7426 wrongful levy claim in USDC. For more about Section 7426, see my blogpost “Whose Money Is It, Anyway?”, 1/11,12.

No, not a reprise of The Byrds’ 1965 cover of Pete Seeger’s take on Ecclesiastes 3. This is a further rebuke of an attorney heretofore known as Mac, who wants Judge Halpern to reconsider the blast he laid upon the aforesaid Mac back in April. Moreover, out of time at that.

Remember Mac? No? Then see my blogpost “A Further Cautionary Tale”, 4/28/14, the tale of Leonard L. Best & Evelyn R. Best, Docket No. 26662-10L, filed 9/15/14.

Now, your recollection refreshed, L. L. and Eve are high school graduates whose frivolity got them a $5K Section 6673 chop from Judge Halpern back in April. Furthermore, their attorney, known to my readers as Mac, was ordered to show cause why he shouldn’t get a vexatious chop per Section 6673(a)(2) or maybe a you-signed-it Rule 33(b) chop.

Well, more than the magic 30 days for a Rule 161 reconsideration went by, but Mac wants to ask for reconsideration anyway.

No dice, Mac, says Judge Halpern.

“In support of the motion, petitioners argue: ‘In effort to expedite matters, rather than await the sanctions opinion, and thus await the decision of all issues for which a motion for reconsideration can be timely filed, Mac decided to move to file out of time a motion for reconsideration of the findings and opinion.’ In referring to the sanctions opinion, petitioners refer to the Court’s order dated April 28, 2014, ordering petitioners’ counsel to show cause why the Court should not require him to pay respondent’s excessive costs pursuant to I.R.C. section 6673(a)(2) or sanction him pursuant to Rule 33(b), Tax Court Rules of Practice and Procedure. We agree with respondent that the motion for leave does not state a compelling reason to grant the motion for leave. Like respondent, we have examined the motion for reconsideration and, like respondent, we do not find therein a compelling reason.” Order, at p. 1.

So show cause, Mac, take your lumps, if any, and then ask for reconsideration.

Yet another in my “misunderstanding” series  is the tale of Steven Yari, 143 T. C. 7, filed 9/15/14. And it merits a full-dress T. C. because Judge Wherry addresses for the first time whether the Section 6707A nondisclosure chop applies to the initial (non-disclosing) tax return, or to subsequent amendments thereof.

The issue comes up on a CDP, because the Section 6707A chop couldn’t be included in the deficiency proceeding that Steve and IRS settled. Tax Court had no jurisdiction to review a Section 6707A chop in a deficiency proceeding, but Judge Wherry finds that Tax Court does have jurisdiction in a CDP.

But while Steve was going through the CDP, Congress changed the method of calculating the Section 6707A chop.

Steve’s deliction giving rise to all this was an abusive Roth IRA. It’s the old story of putting stock from a Sub S in a Roth, having an operating entity (here an LLC) pay the Sub S for “management fees”, and funneling the deductible fees into the nontaxable Roth. See Notice 2004-8, 2004-1 C.B. 333, for more about this nefarious scheme.

Steve, an admitted non-discloser, was in the middle of the CDP when the change in method took place, so the CDP was put on hold while IRS (not Appeals) considered whether the old method or the new method should apply. And that depends upon whether the tax shown on original return or last amended return applies.

Judge Wherry: “The parties scarcely mention, much less substantively discuss, this midhearing ‘time-out’ and apparent referral to the IRS examination function. We therefore will not further comment on these events.” 143 T. C. 7, at p. 7, footnote 3. All I can say is, mighty strange.

Anyway, Steve had amended his return for the year at issue twice after the deficiency was settled, and the last amendment (which no one is fighting about), would give Steve a $5K penalty per the new method, while his return pre-amendments would hit him with a $100K chop.

“Petitioner urges us to use the amended returns to determine the decrease in tax, and respondent says we must look to the original return. These disparate positions stem from a fundamental disagreement as to what the phrase ‘decrease in tax shown on the return as a result of the transaction’ means.”” 143 T. C. 7, at p. 12. (Footnote omitted, but it says the Regs just parrot the statute)..

Tough luck, Steve, but Judge Wherry sees no basis in the plain language of 6707A to give you a bye. “We think the statute is clear and unambiguous: The penalty is calculated with reference to the ‘tax shown on the return’. Sec. 6707A(b). When we look to the penalty provision as a whole, it is clear that Congress has penalized the failure to disclose participation in a listed or otherwise reportable transaction on the return or other information statement giving rise to the disclosure obligation. If the taxpayer fails to report the transaction on that return or information statement, then the penalty is based on the tax shown on that return or information statement, not some other, later filed return or some hypothetical tax. Congress did not say that the penalty should be calculated by reference to tax shown on a return; it did not say to calculate the penalty using the tax required to be shown; and it did not say to calculate the penalty using the decrease in tax resulting from participation in the transaction. Congress very clearly linked the penalty to the tax shown on a particular return–the return giving rise to the reporting obligation.” 143 T. C. 7, at pp. 14-15 (emphasis by the Court).

Yes, it’s harsh. And yes, plain language isn’t always so plain, as Judge Wherry goes to some lengths to show.

“We observe that the process of divining the legislative intent underlying a statute’s language and structure, while subject to canons of construction and well-established methodologies, is hardly an exact science. Compare, e.g., Halbig v. Burwell, No. 14-5018, __ F.3d __, 2014 WL 3579745, at *13-*17 (D.C. Cir. July 22, 2014) (having found sec. 36B unambiguous, concluding that weight of legislative history, including overall congressional policy goals, did not override statute’s plain meaning, which was that tax credits were unavailable to participants in health insurance exchanges established by the Federal Government), vacated and rehearing en banc granted, __ F.3d __, 2014 WL __ (D.C. Cir. Sept. 4, 2014), with King v. Burwell, No. 14-1158, __ F.3d __, 2014 WL 3582800, at *9-*10 (4th Cir. July 22, 2014) (having found sec. 36B ambiguous, concluding that legislative history did not support either plausible interpretation, and deferring to agency’s determination that statute permitted tax credits for participants in Federal health insurance exchanges, as consistent with overall congressional policy goals).” 2014 T. C. 7, at p. 15, footnote 5.

Maybe grounds for appeal, Steve.

But for those similarly situated, better ‘fess up early,  or it will not go well with you.

Edited to add: Affirmed, Steven Yari v. Com’r, No. 14-73914, 10/13/16, 9 Cir.

The baseball season may be drawing to a close as I quote these words from E. L. Thayer’s immortal paean to what G. H. Ruth called “the only real game”, but the Tax Season is just beginning, with on-extension corporate returns due Monday.

And John (“Kosi”) Koskinen’s gang are revving up the Annual Filing Season Program, the volunteer replacement for the now-defunct RTRP (pronounced “retrep”, accent on first syllable) program, notwithstanding the lawsuit hereinafter more particularly bounded and described.

Anent the which, see my blogpost “Open Season”, 7/18/14.

Of course, the CPAs who are suing to blast AFSP (pronounced “afsip”, accent again on the first syllable) are nowise behindhand, as they are also suing, I’m told, to block the sixty-buck PTIN fee.

If you’re interested in AFSP, here’s a link: http://www.irs.gov/Tax-Professionals/Annual-Filing-Season-Program

As for the PTIN litigation, I’m as cheap as anybody, so if I can save the sixty bucks I’m all for it.

But if they’re unhappy with IRS reaching into their pockets, they might ask Congress to think about regulating preparers, not just attorneys-at-law, CPAs, EAs, EActs and ERPAs. And imposing a modest user fee.

On background, see my blogpost “The Phone Call”, 4/15/14.

For today’s lesson, we will assume the phone call was received. The recipient had more than one of those cold, clear liquids containing an olive or maybe two, and probably needed every one. She (or he) spent the next morning composing The Letter, the one that we never wish to send, to that august entity, hereinafter known as The Carrier. After receiving the Reservation (and no, it’s not for Caesar’s Palace) from The Carrier, s/he meets a battle-hardened, I’ve-heard-it-all type in a creased striped suit with a rather outré tie (whom s/he will learn to love, eventually), hereinafter known as Claims Counsel. Claims Counsel may be my friend Mark, my other friend Mark, or my friend Marian. Whoever they may be, they’ve heard it all.

After depositions, document exchanges, and that heart-wrenching moment when s/he signs The Stipulation and the General Release, today’s lesson can begin.

And if, Dear Reader, all this is meaningless gibberish to you, thank whatever Higher Power you acknowledge. But be aware–before every storm, there is a calm. They were having drinks on the Titanic before the iceberg.

Judge Chiechi takes up the story of Garey A. Cosentino and Jo-Ann Cosentino, 2014 T. C. Memo. 186, filed 9/11/14, completing today’s hat-trick for me.

Gar and Jo wanted to provide for disabled daughter by hanging onto income-producing real estate. To prevent Uncle Samuel from laying hold of same to daughter’s detriment, Gar and Jo turn to the Section 1031 like-kindness. This they do several times, but each time bootless.

You’ll remember 1031s defer tax, but not if unlike property is involved (known as “boot”). Boot is taxable.

So when their trusted tax adviser suggests a basis-builder to allow Gar and Jo to take out some reduced-tax boot from a booted-up 1031, they jump at the chance.

Until IRS descends, and Gar and Jo discover they participated (unwittingly and unknowingly) in an abusive tax shelter, whereupon tax, interest and penalties fall from Federal and State.

Gar and Jo make The Phone Call. The scenario above set forth is played out, and Gar and Jo have a solatium to the tune of $375K.

Are their problems over? Hardly. IRS claims it’s taxable.

No, says Judge Chiechi. “Where the recovery represents damages for lost profits or other items taxed as ordinary income, it is taxable as ordinary income. Where the recovery represents a replacement of capital destroyed or damaged, it generally does not constitute taxable income to the extent that it does not exceed the basis of the destroyed or damaged property.” 2014 T. C. Memo. 186, at p. 19 (Citations omitted).

IRS argues that recoveries like Gar and Jo got were in cases where the taxpayers overpaid, the SOL ran, and they got back what they overpaid from the unhappy preparer. Gar and Jo underpaid.

“…an amount paid to a taxpayer in order to compensate the taxpayer for a loss that the taxpayer suffered because of the erroneous advice of the taxpayer’s tax consultant generally is a return of capital and is not includible in the taxpayer’s income.” 2014 T. C. Memo. 186, at p. 31. (Citations omitted).

You saw the magic word? “Generally”. Here’s the rest.

“That exception is that, under the so-called tax benefit rule, an amount paid to a taxpayer in order to compensate the taxpayer for a loss that the taxpayer suffered because of the erroneous advice of the taxpayer’s tax consultant is includible in the taxpayer’s income to the extent that it compensates the taxpayer for amounts that the taxpayer had deducted.” 2014 T. C. Memo. 186, at pp. 31-32. (Citation omitted).

And Gar and Jo got some of that $375K because they claimed amounts greater than what they could prove that they lost.  I’m sure The Carrier didn’t care, as long as they got out of the case. But Judge Chiechi cares.

So there will be an extensive Section 155 beancount, with taxable and non-taxable portions of the $375K chopped up pro rata.

STJ Daniel A. (“Yuda”) Guy has bad news for Michael P. Woods, Docket No. 28807-13, filed 9/11/14. Mike may be deficient, but he can’t claim he’s innocent. Not in this case, anyway.

While Mike and his loved-once Annie were hitched, their tax return triggered a SNOD. Now divorced, Mike petitions the SNOD. Annie doesn’t, but files a Form 8857 innocent-spousery. Mike, however, includes in his petition a request that he and loved-once Annie be declared jointly and severally liable for whatever slings and arrows IRS may bestow upon them.

IRS grants loved-once Annie preliminary innocent-spousehood.

IRS moves for partial summary judgment that Judge Yuda is without jurisdiction to decide loved-once Annie innocent-spousehood.

Judge Yuda says IRS is right, but summary judgment isn’t how you get there.

“Section 6015(h)(2) provides that a non-requesting spouse is entitled to notice of, and the opportunity to participate in, administrative proceedings addressing a requesting spouse’s election to claim relief from joint and several liability. The record shows that petitioner was notified of Ms. Woods’ claim for spousal relief and that he submitted information to respondent in respect of that claim. Although petitioner may be dissatisfied with respondent’s preliminary administrative determination to grant Ms. Woods relief, section 6015 does not provide the Court with jurisdiction to review that matter in this case. … the Court’s jurisdiction under section 6015(e) may only be invoked by an individual who elects relief under that section–and petitioner has not asserted that he is entitled to spousal relief.” Order, at p. 2. (Citations omitted).

All Judge Yuda can do for now is redetermine the deficiency.

Assuming Mike properly intervened in loved-once Annie’s innocent-spousery, when IRS renders a NOD in loved-once Annie’s favor, Mike can petition that.

Judge Gale Blows the Whistle

Looks like it’s a case of another good ploy shot down. And maybe, just maybe, somebody in the glasshouse at 400 Second Street, NW, reads this blog. See my blogpost “Delay of the Game”, 7/12/13 for more. As I said a year ago, “And now for a really cool taxpayer tactic. You really wouldn’t notice it if you didn’t read between the lines of a couple of recent Tax Court orders.”

I’ll let whistleblowing Judge Gale call the play dead.

“This case is calendared for trial at the New York, New York trial session….Petitioners filed with their petition a Request for Place of Trial designating New York City as the place of trial. However, the address petitioners listed as their mailing address in the petition and the address given for them in the notice of deficiency is one in Pacific Palisades, California. The record in this case does not appear to contain any indication of a connection between New York City and the issues in petitioners’ case.” Order, at p. 1.

Maybe they just wanted, in the words of the immortal Ol’ Blue Eyes, to “wake up, in the City that Never Sleeps.”

For whatever reason they wanted the Big Apple, Judge Gale tells them to let him know why. Before the end of the month.

I again quote my blogpost from last year, abovecited. “Maybe Tax Court needs a rule that those seeking to lay venue need to show some nexus to the desired place of trial.” Maybe in the Request for Place of Trial, ya think?

Oh yes, the order is Frank Pierri & Neva Pierri, Docket No. 27981-13, filed 9/11/14.