Riding the Dawn Patrol out of New York Penn Station to the Capital of the Confederacy, I remembered to blog an opinion from what is now yesterday, 8/15/13, Staffmore, LLC, 2013 T. C. Memo 187.

Again the mantra: the SNOD is the ticket to Tax Court.

Does any reader remember Karl E. Cross and his travails before His Honor Big Julie, a/k/a Judge Julian Jacobs (hereinafter HHBJJJJ)? No? Not surprised; the same are more particularly bounded and described in my blogpost “Got Your Ticket?”, 12/13/12.

Well, Staffmore’s problems are different to Karl E.’s, inasmuch as Karl E.’s SNOD, dodgy as it was, was still a SNOD. Staffmore never had one, so its attempt to appeal the employee reclassification of the pseudonymous SH, and stay IRS from making public the SS-8 letter so holding until its appeal is decided, fails.

By the way, Staffmore’s business is to provide personnel to providers of mental and behavioral health services. Good training for Tax Court and the Internal Revenue Code generally.

HHBJJJJ gets this one, and he kicks Staffmore to the curb.

Background, per HHBJJJJ: “…petitioner’s attorney… mailed a letter to respondent objecting to respondent’s employment status determination and stating: ‘We are requesting that this redacted determination letter be deleted and not published at all during the review and appeal period as we plan to petition the Tax Court on both issues. It is our understanding that the release of this letter is prohibited pending reconsideration and appeal of the SS-8 determination.’” 2013 T. C. Memo 187, at p. 5. (Name omitted).

Following the obligatory incantation that Tax Court’s jurisdiction is limited, and only by express Congressional grant can Tax Court live, move and have its being, HHBJJJJ goes straight to Section 7436(a): “…in connection with an audit of any person, there is an actual controversy involving a determination by the Secretary as part of an examination”, 2013 T. C. Memo. 187, at p. 7.

Staffmore’s counsel, hereinafter Johnny T., says that the SS-8 notification letter was a determination (maybe he read the whistleblower cases).

IRS says it wasn’t a Section 7436(a) determination, and in any case there’s no audit.

Johnny T.’s not done, though: “Finally, petitioner asserts that if respondent’s motion is granted because of what petitioner refers to as ‘hyper-technical arguments’, the Court would be wasting judicial resources because the employment status of SH would eventually be resolved by the Court after respondent issues petitioner a notice of deficiency.” 2013 T. C. Memo. 187, at p. 8.

While to the legal mind judicial economy is a prime desideratum, it doesn’t go in Tax Court. Absent examination (audit) and SNOD, Tax Court can’t go there.

“Petitioner’s submission of Form SS-8 is in essence a request that the IRS make a determination as to a worker’s employment classification for a taxable period or periods separate and apart from the IRS’ normal audit and examination procedures. See Rev. Proc. 2005-32, sec. 4.03(2), 2005-1 C.B. 1206, 1207. The submission of Form SS-8 is analogous to a taxpayer’s request for a private letter ruling.” 2013 T. C. Memo. 187, at p. 8, footnote 3.

Wait for the audit and the SNOD, then go to Tax Court.

Now Section 6110(f)(3) gives Tax Court jurisdiction to determine disputes about what should be published in the IRS Electronic Reading Room. But that doesn’t help Johnny T., because he wanted publication of the entire SS-8 suspended “pending appeal”, and Tax Court has no jurisdiction to hear said appeal, so Johnny T.’s request for what amounts to an injunction pendente lite, as the high-priced lawyers say, is moot, because there will be no lite. Not yet.

So HHBJJJJ doesn’t need to do the “we ain’t got no general equitable jurisdiction either” foxtrot.

I don’t want to be misunderstood here. A critic of my blog claims I make fun of litigants, lawyers and judges, and calls down Divine wrath upon my balding head (I won’t send the bears after him; see 2 Kings 2:23-25).

Maybe I have gotten a trifle acerbic at times, but not here. My sympathies are with Johnny T. He is another lawyer who spins out in the chicane that is Tax Court and its labyrinthine anfractuosities. It’s not his fault. Obviously he is used to courts of general jurisdiction, where judges deal with matters head-on, generally.

But that isn’t Tax Court. Hyper-technical distinctions are where it’s at. So, as to Staffmore and the pseudonymous SH, in the immortal words of the late great Charles Dillon Stengel, you could look it up.

Or both of your clients’ petitions in one envelope. CSTJ Panuthos unravels this one in a designated hitter, Desiree Broadnax, Docket No. 6179-13, filed 8/15/13.

Des’ petition gets tossed for late filing (no jurisdiction). Des’ counsel replies that the petition that IRS claims was late-filed was a duplicate of an earlier petition he sent, together with a petition for an unrelated client, both of which were timely. He put them both in the same USPS Express Mail envelope.

CSTJ Panuthos: “The record–which includes the Supplemental Response filed by petitioner on July 3, 2013, and the sworn Affidavit attached thereto–reveals that on March 4, 2013, a member of petitioner’s counsel’s staff went to the U.S. Post Office and mailed two petitions–one for petitioner and one for a different taxpayer–in the same envelope. Attached to petitioner’s Response was a receipt from the U.S. Postal Service dated March 4, 2013, showing that an envelope weighing 14.40 oz was sent to the Court on that date. The envelope bearing the same tracking number as that listed on the receipt was received by the Court on March 5, 2013, but the Court has record only of having received the other taxpayer’s petition. In addition, the petition that was received weighed approximately half of the weight indicated on the U.S. Postal Service receipt. Further, the Court’s own records show that accompanying the other petition was a check for $120: twice the Court’s $60 filing fee.” Order, p. 1.

Because of these “unusual circumstances”, Judge Panuthos treats Des’ petition as timely, and orders IRS to file and serve an answer.

A personal note: Years ago, doing bank servicing, we sent off two loan payoff checks and documents in the same envelope. The envelope was lost. A total disaster. Separate envelopes ever after.

Takeaway–Separate envelopes, separate checks.

No, not the 1975 Fred Ebb-John Kander song from “Chicago”, nor yet the 1979 Bob Fosse film, but rather the small-claimer from Thomas Allen Gullion, 2013 T. C. Sum. Op. 65, filed 8/14/13, with Judge Kerrigan on the bench and Tommy the Taxpayer on sax.

Tommy was a musician. “Petitioner began performing on the saxophone at the age of eight. He has played professionally since the age of 16. He attended Indiana University, where he studied under David Baker, a distinguished professor of music and jazz education. He also toured with J. J. Johnson, a master of bebop trombone.” 2013 T. C. Sum. Op. 65, at p. 3.

Tommy’s musical efforts yielded far less than his specialized design activities for the years at issue. In fact, over a seven-year span, he took in $13K from his Driftwood Jazz Festival in Southwestern Wisconsin and four CDs, but lost $130K.

IRS says “no” to two years’ worth of losses.

Now the Section 183 hobby-loss mambo is facts-and-circumstances, no single factor determinative and a mere head-count is necessary but not sufficient.

Tommy was regular and continuous: he blew that horn wherever and whenever. But did he want to, and try to, make a profit?

But instead of going through all the factors, Judge Kerrigan cuts to the chase. Tommy was certainly trained to be a musician and did play with J. J. Johnson, of J. J. and Kai fame, as those of us who staggered into our high school classes sleep-deprived from listening to Symphony Sid remember fondly.

“Petitioner was dedicated to his music career. He organized a jazz festival in Wisconsin and recorded four CDs, including ‘Carswell’ in 2009. Petitioner’s testimony was credible concerning the time he spent on his music career. We have recognized that a taxpayer may engage in more than one trade or business at any one time. It is also well settled that the term ‘trade or business’ includes the arts.”  2013 T. C. Sum. Op. 65, at p. 8. (Citations omitted).

I’m sure the shades of Da Vinci, Michelangelo, Rembrandt, El Greco, Velasquez and Van Gogh are pleased to be recognized as having practiced a “trade or business”, at least as far as Tax Court is concerned.

Moreover, “(P)etitioner testified that the music industry has undergone changes over the years and that it is now difficult to make a profit. He testified that many of the jazz clubs closed in Chicago and that there were not that many opportunities. He further testified that less money is made when a musician plays another artist’s music. Petitioner contends that he made changes so he can become profitable. Petitioner moved to Wisconsin in part because the cost of living was lower and because he could continue to travel to Chicago and elsewhere. For instance he will embark on a tour in Spain in summer 2013. He referred to his time in Wisconsin as rebuilding years and stated that he would like to be able to leave the software industry and pursue music full time. In addition petitioner wanted to change the course of his career, placing more emphasis on his own music and focusing on composing. He wants to leave behind a legacy of work.” 2013 T. C. Sum. Op. 65, at pp. 9-10.

It’s true Tommy lost a bundle, but Judge Kerrigan understands. “We have found that ‘a history of losses is less persuasive in the art field than it might be in other fields’, as economic success in the arts, frequently takes longer to achieve than success in other fields. We believe that the arts include music.” 2013 T. C. Sum. Op. 65, at p. 10. (Citations omitted).

I’m sure the shades of J. S. Bach, G. F. Handel, W. A. Mozart, L. van Beethoven, and J. Brahms are pleased that music is included among the arts, and is therefore a “trade or business”, according to Tax Court..

IRS says that a $600 profit in a year not at issue, based on Tommy’s CD “Catharsis”, doesn’t erase $130K of losses over a seven-year stretch.

But Tommy, echoing the more successful songwriter Robert Alan Zimmerman, says “the times they are a-changin’”. “The music industry changed, and petitioner’s focus moved from performance to original composition and other aspects of music. Petitioner contends that he made adjustments and retooled his career and that he was profitable in 2011. A result of this retooling was the CD ‘Catharsis’, which includes his original compositions.” 2013 T. C. Sum. Op. 65, at p. 10.

Judge Kerrigan says Tommy didn’t have a lot of income from other sources. But he did pretty well at his software designing, $103K in one of the years at issue, and $130K in the next. So maybe Judge Kerrigan thinks that a six-figure income is modest, after her years in a white-shoe Washington, D.C. law firm.

And though Tommy loved to blow his horn, that element of personal pleasure doesn’t negate a profit motive. You can have fun and make money.

Tommy gets nailed for some minor deductions, but he went to a fellow musician who is also a CPA and gave him all the records to do his taxes, so Judge Kerrigan knocks out all penalties.

Takeaway– If you represent artists, you can catch a break if the hits don’t just keep on comin’.

No, not the way the universe will end when, according to some theorists, the universe will have expanded such that all heat will be so evenly distributed that none is left to do any work and everything stops.

No, this is the story of Dr. Woody and Dr. Kumar, two battling oncologist radiologists, and how Judge Vasquez decides Dr. Kumar’s tax fate, in Ramesh T. Kumar and Pushparani V. Kumar , 2013 T. C. Memo. 184, filed 8/13/13.

Woody and Ram were shareholders, 60-40, in a sub S. As is not unusual among partners, a dispute arose and Woody froze Ram out, told him nothing, and gave him nothing except a K-1 for $215K in ordinary business income and $2k in interest.

Of course Woody gave Ram no cash. So Ram sued, got an accounting, and settled by selling his stock to the sub S in complete redemption of his interest.

Ram never reports the business or interest income from the K-1, and IRS issues a deficiency, but following my blogpost “Don’t Get Yourself Into A State”, 5/11/11, IRS concedes the penalty.

But Ram owes the tax.

Judge Vasquez: “Petitioners argue that they are not liable for tax on [the S Corp’s] income because Dr. Kumar was not the beneficial owner of his [S Corp] shares in 2005. When the record owner of S corporation stock holds that stock for the benefit of another, such as a nominee, an agent, or a passthrough entity, then income, losses, deductions, and credits of the corporation are passed through not to the record owner but to the beneficial owner of the stock. A taxpayer is the beneficial owner of property if the taxpayer controls the property or has the economic benefit of ownership of the property. We have previously noted that cases applying the beneficial ownership test involve an arrangement between parties who had some agreement or understanding regarding their relationship with each other.” “ 2013 T. C. Memo. 184, at p. 6. (Citations and name omitted).

Ram argues that because Woody froze him out, Woody grabbed his beneficial ownership.

No go, says Judge Vasquez: “However, petitioners have not cited any cases, nor are we aware of any, where one shareholder was able to take beneficial ownership of stock away from another shareholder absent an agreement between the two shareholders or a provision in the corporation’s governing articles to that effect. On the contrary, we have held that when one shareholder merely interferes with another shareholder’s participation in the corporation as a result of a poor relationship between the shareholders, such interference does not amount to a deprivation of the economic benefit of the shares.” 2013 T. C.Memo. 184, at p. 7. (Citation omitted).

Ram and Woody never agreed. So Ram is on the hook for the tax and interest. And since he stipulated when he settled with Woody that each would bear his own tax consequences, he’s out there by himself.

If IRS gives you a Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing, you have thirty (count ‘em, 30) days to file your petition with Tax Court. If you miss the cut-off, even if IRS later on gives you a second Letter 1058 covering the same tax(es) and same year(s), you don’t get a second chance.

But if the second Letter 1058 has new tax(es) or new year(s), your petition may be timely for those if you hit the thirty-day cut-off.

That’s the lesson Judge Vasquez teaches B. Gordon LaForge, in 2013 T. C. Memo. 183, filed 8/12/13.

And he does it in a footnote. “…a taxpayer must request a CDP hearing within 30 days of receiving the notice of intent to levy. Sec. 6330(a) and (b). Once the Secretary issues a notice of intent to levy and notice of right to a sec. 6330 hearing, a subsequent notice, more than 30 days later, that the IRS intends to levy on property of the taxpayer for the same tax and tax period as in the initial notice does not entitle the taxpayer to a sec. 6330 hearing. Sec. 301.6330-1(b)(2), Q&A-B2, Proced. & Admin. Regs.” 2013 T. C. Memo. 183, at pp. 6-7, footnote 3.

So a bunch of years are off the table. And anyway, B. Gordo doesn’t contest the tax liability, so abuse of discretion is the only test for the couple of years for which his petition was timely. Since B. Gordo’s 433-A wasn’t complete, the SO was not arbitrary in rejecting B. Gordo’s OIC or installment agreement. IRS need not keep the administrative record open indefinitely, or go hunting for what the petitioner should provide.

Takeaway–The first Letter 1058 is the hardest, but also the one you need to address–fully.

No, not William Empson’s 1930 classic of literary criticism; literary excellence is rarely found in the Internal Revenue Code or the regulations thereunder. Today we consider two varieties of dismissal, one from a SNOD redetermination and the other from a CDP.

First up, Jazmine M. Valte, Docket No. 8662-13S, filed 8/9/13, Ch J Thornton on deck. Jaz sends the Ch J a billet doux, stating “she wishes ‘to drop the case’ and requesting the Court to ‘discontinue everything.’” Order, at p. 1. Ch J Thornton, a stickler for proper form: “The Court will retitle petitioner’s Letter as a Motion To Dismiss.” Order, at p. 1.

Now our old friend Settles comes into the picture. See my blogpost “Dismissed!”, 5/8/12. Now Settles involved a CDP, not a SNOD, so the holding in Settles will apply to the CDP case I’ll discuss next.

But Ch J Thornton likes Judge Wells’ dicta in Settles enough to quote it: “In the deficiency context, once a taxpayer has filed a petition with the Tax Court, the taxpayer cannot withdraw that petition. See Estate of Ming v. Commissioner, 62 T.C. 519 (1974). When the Tax Court dismisses a deficiency case for a reason other than lack of jurisdiction, we generally are required by section 7459(d) to enter a decision for the Commissioner for the amount of tax determined against the taxpayer in the notice of deficiency. Id. at 522. Rule 123(d) requires that a decision entered pursuant to a dismissal on a ground other than lack of jurisdiction operate as an adjudication on the merits of the taxpayer’s case. [Fn. ref. omitted.]” Order, at p. 1.

So rather than treat Jaz’s note as consent to entry of decision, Ch J Thornton titles it as her motion to dismiss, and denies it. Now Jaz and IRS can do the entry of decision dance.

Next up, Geoffrey Weglarz, Docket No.11416-12SL, filed 8/9/13. Geoff petitioned from a NOD and IRS moved for summary judgment. Geoff moved for a continuance (that’s an adjournment), and IRS said “Okay”.

CSTJ Panuthos: “Petitioner did not file a separate objection to respondent’s [IRS’] motion for summary judgment, but it appears to the Court that petitioner’s motion for continuance contains his objections to respondent’s motion for summary judgment. The Court has not yet ruled on respondent’s motion for summary judgment.” Order, at p. 1.

Then Geoff files a motion to dismiss, stating he is unable to pay his taxes. Confused? So is CSTJ Panuthos.

“Granting petitioner’s motion to dismiss would have the effect of treating petitioner’s case as if it had never been filed. See Wagner v. Commissioner, 118 T.C. 330 (2002). Additionally, the statutory period under section 6330(d)(1) has expired in which petitioner may file (or refile) a Tax Court petition based on the Notice of Determination…. Consequently, should we grant petitioner’s motion, respondent will be able to take all appropriate collection action as provided by law.

“It is not clear to the Court that petitioner is aware of the consequences of filing a motion to dismiss, or that petitioner even intended the document he filed… to dismiss the case and allow respondent to take all appropriate collection action as provided by law. If petitioner indicates to the Court that he intended to proceed to trial rather than dismiss the case, the Court will rule on respondent’s motion for summary judgment. If the Court denies respondent’s motion for summary judgment, this case will be set for trial at a future trial session of the Court….” Order, at p. 2.

So CSTJ Panuthos tells Geoff to let him know soon whether he really intended to have his case dismissed as if it had never been filed, and let IRS levy, and if he says he doesn’t so intend, then it’s summary judgment time. But if Geoff says nothing or says he really wants the case dismissed, then IRS must tell CSTJ Panuthos if they object.

Clear? Thought not.

No, not the 1943 hit by the King Cole Trio, as written by the late great Nat King Cole and Irving Mills, but rather Judge Chiechi’s admonition to an attorney (who shall here be nameless) who appears to be following in the footsteps of Freddie; see my blogposts “How Not To Do It”, 11/21/12, and “Utterly Helpful”, 1/18/13.

Here’s the story, ripped from the text of the order in Farrokh E. & Minoo S. Pourmirzaie, Docket No. 12894-12, filed 8/8/13.

IRS moved to toss Farrokh & Minoo and enter decision. Judge Chiechi did, so Farrokh & Minoo move to vacate.

Judge Chiechi: “The thrust of petitioners’ motion and petitioners’ reply is that petitioners were not aware of the (1) negligence of their counsel of record (counsel), including counsel’s negligence in not appearing at the call of this case from the calendar at the Court’s May 14, 2013 trial session in San Francisco, California, and not informing petitioners until after that session concluded that this case was calendared for trial at that trial session, and (2) counsel’s lack of cooperation with respondent. Petitioners are now aware of counsel’s negligence and lack of cooperation. They should also be aware, as the Court is aware, that their counsel continues to be negligent in other ways in representing them in this case. For example, petitioners’ counsel attempted twice to file electronically petitioners’ reply. In the first such attempt, their counsel did not comply in all respects with the Court’s Order dated July 9, 2013. In the second such attempt, the document that counsel attempted to file electronically contained careless mistakes. The Court rejected each of those attempted electronic filings and required counsel to comply with the Court’s Order dated July 9, 2013, and to correct the careless mistakes contained in the second attempted electronic filing. The Court admonishes petitioners that they as well as their counsel will bear the consequences of any future negligent, uncooperative, or otherwise irresponsible and unprofessional conduct by their counsel.” Order, at p. 1.

So dismissal and decision are vacated, and get ready for trial, guys; but first, straighten up and fly right.

Yes, there were T. C. Memos today, but one of them was a disability income case with nothing new in it, and the other was a discussion of material participation in bull breeding. I’m not going there.

That’s the lesson from STJ Armen, the Judge With A Heart (see my blogpost “A Judge With A Heart”, 6/6/13), in James Cecil & Anne-Marie Swank, Docket No. 20448-12S, filed 8/7/13, today’s designated hitter.

IRS says the issues in this case are “whether petitioners are entitled to claim tax credits under I.R.C. § 901(a) for two specific taxes paid to the French government, the contribution sociale généralisée (“CSG” ) and the contribution pour le remboursement de la dette sociale (“CRDS”).” Order, at p. 1.

Now I have no idea what these “contributions” might be, much less whether either or both are foreign taxes creditable under Section 901.

But IRS doesn’t want those questions decided in a small-claimer, which is non-appealable and non-citable as precedent. So IRS asks to remove the small case designation and to continue the trial, because a full-dress Tax Court case is pending where the same French “contributions” are at issue, and that case has been fully briefed and submitted for summary judgment (decision as a matter of law, as no facts are disputed).

Jimmy and Anne-Marie object to IRS’ motions, but STJ Armen finds merit as to continuing (adjourning) their trial until the full-dress is decided.

“It would appear that the issue whether the CSG and the CRDS are creditable taxes under I.R.C. section 901(a) is a legal issue of first impression. It is contrary to the Court’s practice to decide legal issues of first impression in the context of small tax cases, which cases are non-appealable and non-precedential. See I.R.C. sec. 7463(b). This is particularly so when the same legal issue is pending in a regular case, which case is potentially appealable and precedential and where the issue therein has already been briefed by the lawyers for both the taxpayer and the Commissioner and is under consideration by the Court.” Order, at p. 2.

Besides, the decision in the full-dress might resolve Jimmy’s and Anne-Marie’s case without the need for any more paperwork.

And STJ Armen denies IRS’ motion to drop the small-claims designation in Jimmy’s and Anne-Marie’s case without prejudice to renewal, if later circumstances warrant (like if the full-dress case gets dropped or settled before a decision, so Jimmy and Anne-Marie can go play in the big leagues).

Tax Court doesn’t sweat the small stuff.

No, not Karl Marx’s 1867 assault on Truth, Justice and The American Way, but rather a couple of designated hitters by The Great Dissenter, Judge Mark V. Holmes, a/k/a The Judge Who Writes Like a Human Being, who sets out a schema for determining when a contract right is a capital asset (and therefore favorably taxed at capital gains rates when sold) or merely a funnel for ordinary income (in which case it is taxed as such when sold).

This useful refresher is found in Greenteam Materials Recovery Facility PN; Greenwaste Recovery, Inc., Tax Matters Partner, et al., Docket No. 21946-09, and its companion Greenwaste Of Tehama, PN, Zanker Road Resource Management, Ltd., A California Limited Partnership, Tax Matters Partner, Docket No 423-11, both filed 8/6/13.

The Greens sold their assets, which mostly consisted of service contracts to deal with various California municipalities’ waste, to unrelated third parties, and claimed the contracts were capital assets. IRS said no, served FPAAs, and the Greens move for summary judgment.

Of course, the Greens’ tax returns for the year in question never made it into the record, but the Greens claimed in their motion the numbers on the returns were wrong anyway, and supplied new ones. And the contracts never made it into the record either.

So there are enough fact questions to deny summary judgment off the bat, but Judge Holmes has something to say about capital assets.

“When does a sale of rights under a contract create capital gain and when does it create only ordinary income? The Code tells us that capital gain is derived from the sale or exchange of a capital asset. Section 1221 defines a capital asset as ‘property held by the taxpayer.’ (There are exceptions, but none apply here.) But caselaw has made clear that the list of statutory exceptions is not exhaustive, and there are scores, perhaps hundreds, of cases that try to draw clear lines in this especially fuzzy area — none of which petitioner cites. Still, our own research in the area cannot improve on Judge Friendly’s summary of the problem a half century ago:

[I]t has long been settled that a taxpayer does not bring himself within the capital gains provision merely by fulfilling the simple syllogism that a contract normally constitutes ‘property,’ that he held a contract, and that his contract does not fall within a specified exclusion * * *

[I]t would be hard to think of a contract more ‘naked’ than a debenture, yet no one doubts that is a ‘capital asset’ if held by an investor. Efforts to frame a universal negative, e.g., that a transaction can never qualify if the taxpayer has merely collapsed anticipation of future income, are equally fruitless; a lessor’s sale of his interest in a 999 year net lease and an investor’s sale of a perpetual bond sufficiently illustrate why * * *

* * * * * * *

One common characteristic of the group held to come within the capital gain provision is that the taxpayer had either what might be called an ‘estate’ in * * *, or an ‘encumbrance’ on * * *, or an option to acquire an interest in * * *, property which, if itself held, would be a capital asset. In all these cases the taxpayer had something more than an opportunity, afforded by contract, to obtain periodic receipts of income, by dealing with another * * *Commissioner v. Ferrer, 304 F.2d 125, 129-30 (2d Cir. 1962) (emphasis added) (citations omitted), rev’g 35 T.C. 617 (1961).” Order in Docket No. 21946-09, at pp. 3-4.

Judge Holmes goes on: “The lines are not bright in this area. In a very similar case, Foy v. Commissioner,84 T.C. 50, 69-70 (1985), we held that in determining whether the taxpayer’s contract rights that were transferred constituted a capital asset, courts generally consider all aspects of the bundle of rights and responsibilities of the taxpayer that were transferred, specifically including the following six factors:

(1) How the contract rights originated;

(2) How the contract rights were acquired;

(3) Whether the contract rights represented an equitable interest in property which itself constituted a capital asset;

(4) Whether the transfer of contract rights merely substituted the source from which the taxpayer otherwise would have received ordinary mcome;

(5) Whether significant investment risks were associated with the contract rights and, if so, whether they were included in the transfer; and

(6) Whether the contract rights primarily represented compensation for personal services.” Order in Docket No. 21946-09, at p. 5-6.

All the Greens claim is that revenue under the contracts wasn’t guaranteed, but that doesn’t make them capital assets, any more than any of us has capital gains on the pittances we finally collect, because it’s not certain that our clients will pay us (and you can say that again!).

And in Docket No. 423-11, the Greens argue that their allocation of items in the contract of sale must be respected, but that’s a total nonstarter. “The Court also agrees with the Commissioner that Greenwaste of Tehama’s seems to argue that the Commissioner must respect the allocation of the purchase price that it and Waste Connections may have agreed to. We rejected this very proposition years ago. (And both parties must be prepared, if they do not settle this case, to become conversant in the numerous conflicting lines of caselaw on this question.).” Order at Docket No. 423-11, at p. 3. (Citations omitted, but read them. And see my blogpost “Buying Trouble”, 1/18/12, for another look at the allocation question).

So guys, hit the books, or the internet, and do your homework.

No, not Stobie Creek, but John Hancock Life Insurance Company (U.S.A.), as Successor in Interest to John Hancock Life Insurance Company (f.k.a. John Hancock Mutual Life Insurance Company) and Subsidiaries, et al., is up a different creek, leading off 141 T.C. in 141 T. C. 1, filed 8/5/13.

And the reason this blogpost is a day late (but hopefully not a dollar short) is that I wanted to reflect on the 244 pages of Judge Haines’ prose before leaping onto the internet.

Remember the “synthetic leases” of the 1980s? No? Take a look at FAS 13, the accounting guide to leveraged leases and off-balance-sheet finagling. The idea was to put up 20% of the deal, borrow 80% nonrecourse, lease and lease back (later buy and lease back, when IRS blew up the lease and lease back deals (called LILOs) under Section 467) from a tax-indifferent, take heavy depreciation and interest deductions, when in fact all the cash you were going to owe was put in secure accounts, so that all payments were made out of those accounts. Your transaction costs were the broker’s commission and the tax-indifferent’s vigorish for doing the deal.

And the nonrecourse debt was off-balance-sheet per FAS 13.

I remember a CLE program given at that time, run by a now-defunct abstract company, where these were extolled. I denounced them publicly as a fraud. As usual, nobody listened.

The American Jobs Creation Act of 2004 put paid to the whole game, but prospectively only; those deals then in place, to the extent compliant with pre-existing law, were unaffected.

John Hancock, needing to offset investment gains, found itself besieged by various brokers peddling this dodge. So it did deals with the Austrian State Railways, the Belgian State Railways, the City of Dortmund in Germany, and some Austrian and German public utilities.

IRS first claims that these aren’t leases at all but financing arrangements, so John Hancock’s depreciation and loan interest deductions are out, but they do get some other interest income and minor deductions. None of the other deductions IRS gives John Hancock comes close to the roughly $560 million in deficiencies, not counting interest and penalties (which Judge Haines doesn’t discuss, but which will surely surface after the Rule 155 beancount he orders).

So we have the trial. “The Court held a five-week special trial session in Boston, Massachusetts. The record in these cases includes the testimony of 53 witnesses, over 3,600 exhibits, over 4,000 pages of trial transcripts, and over 1,000 pages of briefing.” 141 T. C. 1, at p. 76.

Bottom line is that IRS wins. If international wheeling-dealing  sings your song, you can read all about it.

But the point I want to make here is why IRS wins. IRS’ initial attack is substance over form: John Hancock never had benefits and burdens of a net lessor or of an owner. It only had cash at risk in two deals, and even those were financing deals, not leases. For the rest, it was a roundy-round with the cash, with John Hancock getting the write-offs, and, though it wasn’t 100% certain that the indifferents would buy out of the leases at the bail-out date, it was probable enough to satisfy Judge Haines that John Hancock would not be buying electric power in Austria or running high-speed expresses from Brussels to Paris. And that’s what carries the day.

Now IRS got cute at the pre-trial memorandum stage. IRS wild-carded in an economic substance argument, that they hadn’t raised in the SNODs or in their answer.

John Hancock moved to preclude any evidence IRS might offer on that score from the 53 witnesses or the 3600 exhibits, but Judge Haines let it all in. However, IRS had the burden of proof, and the Health Care Reform Act codification plays no part.

IRS relies on its expert, Dr. Thomas Lys, who, Judge Haines notes, “has previously testified for the Government in other Federal leasing cases.” 141 T. C. 1, at p. 82. Professional witness, maybe?

But the Prof lets the IRS down, and IRS loses on economic substance, because IRS can’t carry the burden of proof.

“Having found that a net present value analysis may be useful in these cases, we turn to respondent’s argument that the ABC reports do not provide reliable pretax economic returns and thus that Dr. Lys’ net present value calculations should control. We disagree. If, as Dr. Lys opined, the proper test of profitability requires an investor to accumulate a return on an investment and discount the return back at the same rate and over the same period, any investment with transaction costs would always produce a pretax loss. In fact, Dr. Lys stated at trial that the actual pretax cashflows from the test transactions were ‘irrelevant’.

“At trial petitioners presented Dr. Lys with a simple example to illustrate this point.

“Q:            So my simple example is: Assume that you walk into your stockbroker and you have $101,000 in your pocket.

“A:            Uh-huh.

“Q:            And you buy a $100,000 bond – –

“A:            101 or –

“Q:            A $100,000 bond, because there are going to be some transaction costs.

“A:            Okay.

“Q:            The broker is going to charge you $1,000 for that transaction.

“A:            That’s correct.

“Q:            Using your methodology, assume my bond is 4 percent – – you would calculate the present value today of that bond at maturity, you would take the $100,000 and accumulate it forward at 4 percent, and then you would discount it back at 4 percent. Am I right?

“A:            Correct.

“Q:            So on a present-value basis, the value of my investment is [$]100,000.

“A:            That’s correct.

“Q:            But I have [$]101,000 invested.

“A:            That’s correct.

“Q:            Is that a value-destroying investment?

“A:            Yeah. But may I specify, Your Honor? But I get a service. What the broker did is – – I had a problem. I had $100,000 today, and I didn’t want to have $100,000 today, I wanted to have $100,000 tomorrow, or whenever that period is. The $1,000 transaction fee is something that I voluntarily paid for getting $100,000 tomorrow.” 141 T. C.1, at pp. 136-137.

Judge Haines isn’t buying. “Neither Dr. Lys nor respondent [IRS] has provided a logical explanation to support a real world application of his method and calculations. As a result, the record does not include a credible net present value calculation.” 141 T. C. 1, at p. 139.

There’s more, enough to knock Dr. Lys completely out of the box, but this is enough.

Let’s go back to my blogpost “Woodshedding Your Experts – Stobie Creek Part Deux”, 1/10/11, wherein I said “(T)he takeaway for counsel? As with currency trades, every litigated case has a ‘sweet spot’, the one disputed point your side must prove to win.  Before choosing experts, ask what you want your experts to establish to hit the ‘sweet spot’. Work with them. Learn their craft, so far as possible. And sweat them good, both in preparation of their reports and in preparation for depositions. And if they can’t properly opine, it’s time for a major heart-to-heart with the taxpayer-client.”

I would add that if, after the time has run for you to amend your pleadings, you have a bright idea, make sure your expert is on board.

And that what your expert tells you and the judge bears some relation to reality, not just to what you want to hear.