OK, But Forget the Ten Dollars

If hypertechnical semantic gymnastics are what does it for you (and if so, only my innate courtesy prevents me from adding “in which event I most respectfully suggest you get a life”), take a peek at RP Golf, LLC, SB Golf, LLC, Tax Matters Partner, T. C. Memo. 2012-288, filed 10/3/12, Judge Paris reaching for her driver on this one.

It’s another scenic easement, involving acres of Platte County, Missouri, which a golf club operator deeded to an appropriate 501(c)(3) to protect, preserve and defend from any development, and incidentally to claim a $16.4 million tax break.

Once again, it all comes down to the famous Section 170(f)(8) substantiation requirement. No letters from the 501(c)(3), so let’s look at the deed.  Describes the property? Yes. Contemporaneous? Yes, both golf clubber and 501(c)(3) signed the deed. But the deed doesn’t say that no (emphasis by the Court) goods or services were furnished by the 501(c)(3) to the cheerful giver, although IRS and golf clubber agree that golf clubber got nothing from the 501(c)(3).

The deed does say “for and in consideration of the covenants and representations contained herein and for other good and valuable consideration, the receipt and legal sufficiency of which are hereby acknowledged, Grantor on behalf of itself and its heirs, successors and assigns, in consideration of the premises contained herein and other valuable consideration paid to its full satisfaction….” T. C. Memo. 2012-288, at p. 4.

Here’s the problem, of course, the boilerplate “other good and valuable consideration”. This is part of what sunk poor ol’ Randy Schrimsher, but its absence saved Gayle and Margaret Averyt and their pals. See my blogpost “Yes In Deed”, 7/16/12.

Randy’s deed had the ten dollar language, and even though in his case  Tax Court agreed it was boilerplate, there was no contemporaneous evidence to show there wasn’t “other good and valuable consideration,” and apparently no one thought to stipulate that there wasn’t. Gayle and Maggie, on the other hand, said nothing about anything but how they loved the environment.

Judge Paris hits the ball squarely between the bunker and the fairway. “Despite the veiled reference to ‘other good and valuable consideration’, neither party alleges that goods or services were exchanged for the easement contribution. In fact, the agreement indicates to the contrary–that there was no consideration exchanged. The most obvious indication is that the agreement does not recite any amount of consideration. Cf. Schrimsher v. Commissioner, T.C. Memo. 2011-71 (the deed conveying a conservation easement recited as consideration ‘the sum of TEN DOLLARS, plus other good and valuable consideration’). The absence of any statement regarding consideration is underscored by the agreement recitals, which state that the easement is ‘freely’ given. Therefore, the Court concludes that the ‘other good and valuable consideration’ recited in the agreement is boilerplate language and has no legal effect for purposes of sec. 170(f)(8).” T. C. Memo. 2012-288, at pp. 10-11, footnote 7.

Note the capital letters, in which are written the fatal sum that scuttled poor Randy Schrimsher. What if he had used lowercase letters instead?

Better still, scrivener, leave out the ten dollars. Whether in upper or lower case.

World Bank Gets It Right But Employee Gets It Wrong

Yesterday I discussed how an IMF junior staffer was excused the 20% understatement penalty because her bosses didn’t warn her properly of her liability for SE tax; the case, you’ll remember, was Amy Yu-Wen Chien, T. C. Memo. 2012-277, filed 10/1/12.

But the World Bank does it better, so Judge Halpern isn’t in love with Amy or her decision, in Humberto S. Diaz and Clara D. Diaz, T. C. Memo. 2012-280, filed 10/2/12. Hummer is a Chilean ex-flyboy who transitioned to World Bank from the Chilean Air Force, and to US citizenship from Chilean.

But, unlike IMF, World Bank does a proper tax indoctrination when an employee either is, or becomes, a US citizen. “Because he was a U.S. citizen, the World Bank switched from paying him on a net basis (no additional compensation to cover estimated U.S. tax obligations) to paying him on a gross basis (compensation includes additional amounts to cover estimated U.S. tax obligations).”  T. C. Memo. 2012-280, at p. 3 (footnote omitted).

Hummer’s employment agreements (he signed several during his tenure at World Bank) stated: “The fee [compensation] is based on the understanding that you will assume any tax obligation which may be imposed on your the [sic] World Bank income. United States citizens working in the United States with international organizations are covered for Social Security under the U.S. Social Security Act and are liable for Social Security at the “self-employed” rate.” T. C. Memo. 2012-280, at p. 4.

Moreover, for one of the years at issue “…Mr. Diaz received from the World Bank a form (bank form) containing images of his Form W-2, Wage and Tax Statement, for tax year 2006 (2006 Form W-2). The 2006 Form W-2 identified his employer as the World Bank, and it identified him as the employee. Box 1, labeled ‘Wages, tips, other compensation’, showed $53,230; boxes 2 through 6, labeled, respectively, ‘Federal Income tax withheld’, ‘Social Security wages’, ‘Social Security tax withheld’, ‘Medicare wages and tips’, and ‘Medicare tax withheld’, were blank. The bank form, in space outside the images of the 2006 Form W-2, contained the following instruction:

‘Schedule SE (Self-Employment Tax) must be attached to your Form 1040. U.S. Staff must pay social security and medicare tax at the selfemployment rate on wages for services performed inside the U.S. Please refer to Instructions for Schedule SE, “U.S. Citizens Employed by Foreign Governments or International Organizations,” at www.irs.gov.” T. C. Memo. 2012-280, at p. 5.

And if that wasn’t enough, before Hummer’s tax return was due “… approximately 200 World Bank employees attended a two-hour presentation by the Internal Revenue Service (IRS) concerning World Bank employee tax obligations. The presentation took place in the World Bank’s auditorium, and handouts were provided to attendees. The presentation was simulcast to World Bank employees’ individual desktop computers. At that meeting, the IRS explained that all World Bank employees who are U.S. citizens are required to prepare and submit, with their Federal tax returns, a Schedule SE, Self- Employment Tax, and pay self-employment tax because the World Bank does not withhold the employee’s share and does not pay the employer’s share of Social Security and Medicare taxes.” T. C. Memo. 2012-280, at pp. 5-6.

So after all that, Hummer runs to an AARP volunteer Tax-Aide program, devoted to tax prep for the low-income elderly. Given that Hummer’s pay was $53,320, what by AARP standards is “low income”? Anyway, the AARP volunteers can’t decide if Hummer has to pay SE. That’s easy, because Hummer has carefully cut out of the W-2 he shows the AARP Vols the instructions that say he has to file a 1040-SE and pay the tax. So after a confab, the AARP Vols decide Hummer doesn’t owe SE, and fill out his return accordingly.

Judge Halpern is not amused, even though Hummer shows up with five (count ‘em, five) attorneys to contest the substantial understatement penalty IRS bestows upon him. Hummer of course claims reliance on the AARP Vols, even though he doesn’t know their names, can’t say what expertise they have (if any), and none of them testifies on the trial.

Hummer and IRS did stipulate that the only information necessary to compute Hummer’s taxes accurately was a complete copy of Hummer’s W-2 and the fact that Hummer is a US citizen. Hummer says he gave the AARP Vols the W-2 and told them he was a US citizen.

Now the AARP Vols are trained and IRS certified, but they work mostly with low-income types and are not necessarily experts in the finer points of the taxation of employees of embassies and international organizations.

“Moreover, Mr. Diaz went to some trouble to separate copies of his 2006 Form W-2 from the portion of the bank form including the instructions advising that U.S. citizen employees are required to file a Schedule SE. While we are cognizant of his testimony that he told the volunteer that he worked for the World Bank and paid self-employment tax, we do not dismiss the possibility that he intentionally withheld those instructions from the volunteer.” T. C. Memo. 2012-280, at p. 20.

And Hummer admitted on the trial that he had his doubts about his SE liability, but didn’t have time to check them out. Of course, that didn’t fly, and gave Judge Halpern the hook he needed to distinguish Hummer from Amy Yu-Wen Chien. Amy was an innocent; Hummer was something less.

My colleague Jean Mammen, EA, has written a book on the US tax posture of foreign embassy and international organization employees, entitled “1040 or 1040NR? International Organization and Foreign Embassy Employees”. I haven’t read it, so I can’t criticize it, but those who represent taxpayer-employees in that area might wish to do so.

See my blogposts ”Not An Employee for Tax Purposes?”, 5/24/11 and “Another Argument”, 6/7/12.

Now Judge Morrison reviews the problems of a rather naïve young employee, fresh out of the Peace Corps and into the International Monetary Fund at the staff assistant level. The case is Amy Yu-Wen Chien, T. C. Memo. 2012-277, filed 10/1/12.

Amy went from college (during which time her papa prepared whatever tax returns she needed) to the Peace Corps (no taxable income) to a temp agency (filled out her returns using IRS online instructions) to the International Monetary Fund as a staff assistant (clearly not top-level managerial).

Judge Morrison: “Shortly after joining the IMF, Chien met with J. Carter Magill, an employee of the IMF who was conversant in taxation. The meeting lasted five minutes. Magill explained to Chien that she had to make an estimated-tax payment every quarter. Shortly after the meeting, Magill emailed Chien a spreadsheet that calculated her next estimated-tax payment. Because an estimated-tax payment is based on the taxpayer’s tax liability for the year, see sec. 6654(b)(1), (d)(1)(A) and (B), (f)(1), the spreadsheet was based on Magill’s calculation of Chien’s tax liability for 2005. The amount of liability, as calculated on the spreadsheet, included the income tax imposed by section 1, see sec. 6654(f)(1), and the selfemployment tax imposed by section 1401, see sec. 6654(f)(2), with Chien’s 2005 IMF wages included in self-employment income. Had Chien understood that her estimated-tax payment was based on her liability for the income tax imposed by section 1 and the self-employment tax imposed by section 1401, she would presumably have inferred from the spreadsheet that she would be liable for the selfemployment tax. However, Chien had no such understanding of the estimated-tax regime. So she made no such inference from the spreadsheet. Other than the spreadsheet, Chien did not receive any other information from the IMF informing her that she was considered self-employed or that she was liable for the selfemployment tax.” T. C. Memo. 2012-277, at pp. 3-4.

If Alex Pope was right, and “a little learning is a dangerous thing”, then Amy had less and that was more dangerous, because she never filed a 1040-SE, paid the SE tax or took the one-half adjustment for SE tax on her 1040, for any of the three years she worked for IMF.

At least she knew she owed some income tax, unlike another employee of an international organization who forgot to pay tax on nearly $80K of salary from the World Bank.

IRS gave a lecture on-site for IMF employees, but attendance wasn’t mandatory, and Amy arrived at the very end. She claims the handout she got, which seems to have been limited to the PowerPoint slides, was unenlightening. She thought she’d be in compliance if she followed the 1040 instructions.

Judge Morrison gives Amy a bye on the substantial understatement penalties. She followed the 1040 instructions, and what guidance she got was less than effective.

Takeaway–International organizations need to provide better intake orientations for their employees. If you’re a US citizen, you owe both income tax and self-employment tax, because the US can’t collect from your exempt employer. Give the new hire a copy of a 1040, a 1040-ES, and something more than a five minute off-the-cuff from your resident tax guru who probably just spouts numbers and letters like the rest of us, and drops an email that only a tax professional would understand.  And if IRS sends somebody around, tell your employees they cut this class at their peril.

The few  who  read this blog may remember Steve and Lori Esrig, who featured in my blogpost “Whose Line Is It, Anyway?”, 2/8/12. They were finalists in my Best Excuse For Late Filing sweepstakes. Steve claimed his accountant, who was supposed to prepare the returns for the years at issue, failed to do so “because she had to serve a very long prison sentence for murdering her husband, and the person in her office who took over their account made a slew of mistakes.” T. C. Memo. 2012-28, at p. 18.

But Judge Holmes, The Great Dissenter (The Judge Who Writes Like A Human Being), wasn’t buying it, as Steve adduced no proof of this outré assertion.

Not so Special Trial Judge Armen, The Judge With A Heart, dealing with Andrew M. Ross, Docket No. 19691-10S, filed 9/28/12.

Andy’s on for trial October 10, 2012, and needs a continuance of the trial date to get needed documents. IRS says they’ll make available to Andy and counsel “’a large amount of documentation that petitioner produced during the original audit’ and suggests that this documentation should suffice for trial next month in Peoria. Yet in his pre-trial memorandum respondent states that ‘To date, petitioner has not provided sufficient documentation to support the disallowed deductions under either the Cohan rule or I.R.C. sec. 274 [and that] Petitioner’s failure to maintain adequate records and fully substantiate the deductions claimed for the 2006, 2007, and 2008 taxable years constitutes negligence under I.R.C. sec. 6662.’” Order, at pp. 1-2.

But IRS doesn’t say that the missing documents Andy seeks wouldn’t help his cause. And that won’t play, even in Peoria.

Oh, where are the missing documents? Andy says “the Department of Justice seized all of the tax records that I had pertaining to the case on 4-12-11 [and that] after multiple attempts via my attorney all requests [for the return of such records] have been ignored at this time.” Order, p.1.

And, says STJ Armen: “As exhibits to his motion petitioner attached, inter alia, a copy of a Search And Seizure Warrant dated April 11, 2011, issued by a magistrate judge of the United Stated District Court for the Central District of Illinois that authorized the search of a building owned and/or used by petitioner in Springfield, Illinois and the seizure of, inter alia, all business records (specifically including all tax and client records), all computers and computer-related equipment, and all computer hardware and software (specifically including all internal and peripheral storage devices). Also attached as an exhibit to the motion was a 4-page inventory prepared by agents of the Federal Bureau of Investigation of items seized from petitioner’s premises on April 12, 2011, pursuant to the search and seizure warrant.” Order, p. 1.

Best excuse yet for inability to go to trial. Andy, you’re in the sweepstakes.

Ex parte communication between Appeals and IRS is a no-no, per Rev. Proc. 2000-43, 2000-2 C.B. 404, which provides Q&As to flesh out the 1998 IRS reorganization act. But when the IRC specifically requires Appeals to talk to IRS, specifically Area Counsel per Section 7122(b), all bets are off. So we learn from Norman Hinerfeld, 139 T. C. 10, filed 9/27/12, Judge Gale writing for Tax Court.

Norm was looking at $471K in TFRPs, which he didn’t contest, from his former corporation Thermacon Industries, Inc. Norm made an OIC of $10K based on collectibility, but when the SO determined his RCP was $74K, he upped the ante accordingly (and he got a second chance, unlike the hapless B.M. Vanmali and Bhari Vanmali; see my blogpost “Give It Your Best Number”, 4/9/12). The kindhearted SO was ready to buy it, but had to get clearance from Area Counsel.

Area Counsel, a nosy sort, discovered that Norm and his loving wife Ruth were being sued by a creditor of Thermacon for having sold substantially all Thermacon’s assets, alleged to have an equity of $2.2 million, to a corporation owned by the aforesaid Ruth and the Hinerfeld offspring, purchase price to be paid in worthless paper.

The SO asks Norm about this, but his answers contradict the answer he filed in the litigation, so the SO suggests the matter be placed in “currently not collectible” status pending the outcome of the lawsuit. Norman doesn’t agree, so the SO’s boss, the Appeals Team Manager (ATM, but the kind who takes money, not gives it), who’s got to approve an OIC, bounces Norm’s proposed OIC and approves a levy.

Norm claims Area Counsel had a prohibited ex parte communication with Appeals. No, says Judge Gale: “Rev. Proc. 2000-43, Q&A-11, 2000-2 C.B. at 406, specifically addresses communications between Appeals and the Office of Chief Counsel. Acknowledging the need for Appeals employees to obtain legal advice from the Office of Chief Counsel, A-11 provides three limitations on communications between Appeals employees and Office of Chief Counsel attorneys: (1) Appeals employees must not communicate with Chief Counsel attorneys who have previously provided advice to the IRS employees who made the determination Appeals is reviewing; (2) requests for legal advice where the answer is uncertain should be referred to the Chief Counsel’s National Office and handled as requests for field service advice or technical advice; and (3) although Appeals employees may obtain legal advice from the Office of Chief Counsel, they remain responsible for making independent evaluations and judgments concerning the cases appealed to them, and Counsel attorneys are prohibited from offering advice that includes settlement ranges for any issue in an appealed case.

“There is no evidence that the Area Counsel attorneys with whom Appeals conferred in this case had previously advised any employee who made the determination under Appeals review; that is, any employee of the Collection Division who made the determination to levy on petitioner’s property. In addition, the administrative record establishes that while SO X disagreed with Area Counsel’s recommendation to reject petitioner’s amended OIC, the decision to reject the OIC was made by ATM Y who, rather than SO X, had the authority to do so. Unlike SO X, ATM Y agreed with Area Counsel’s recommendation to reject. Given the substantial evidence that Area Counsel had marshaled to support the conclusion that petitioner had made a fraudulent conveyance, we are satisfied that ATM Y exercised independent judgment as contemplated in Rev. Proc. 2000-43, supra, when he agreed with Area Counsel’s recommendation.” 139 T. C. 10, at pp. 14-15. (Footnotes omitted).

But Judge Gale points out he isn’t deciding that Norm in fact made a fraudulent conveyance, only that ATM Y had sufficient evidence to bounce Norm’s proposed OIC.

Anyway, IRC 7122(b) requires a letter from Chief Counsel (or delegate, and Area Counsel is a delegate) to be in any file approving an OIC where the amount at issue is more than $50K. So Appeals must consult with Area Counsel and get an OK letter.

And kindhearted SO X’s opinion doesn’t matter, as ATM Y is the decider.

Now in an OIC, a nonliable spouse is not considered, unless a party to a fraudulent conveyance. And while Area Counsel should not reconsider facts determined by Appeals, Area Counsel is charged by the IRM to consider fraudulent conveyance issues.

Judge Gale:  “If anything, this case illustrates not an abuse of discretion by IRS employees but instead the wisdom of requiring the Office of Chief Counsel’s review of fraudulent conveyance issues.” 139 T. C. 10, at p. 23.

Takeaway–When you make a big OIC, Chief Counsel (or delegate) will be watching you.

No, this blogpost is not about Jules Pfeiffer, cartoonist, whose long-running Village Voice strip was so entitled. It concerns an SO whose disregard of the medical condition of A. DeeWayne Jones and his wife Shirley Jones (not to be confused with the Academy-Award winner of that name) earns a remand to Appeals from Judge Marvel in T. C. Memo. 2012-274, filed 9/26/12.

DeeWayne is a dentist for the county, working the local hoosegow. Shirley is retired. DeeWayne’s health is not good, he says, and Shirley’s is poor. DeeWayne has to keep working to pay his bills and the $51K of accumulated unpaid income taxes he owes, and which he doesn’t contest.

IRS levies on a bank account he has for $900, then gives him a CDP on the NFTL they want to file for the rest. DeeWayne wants a collection alternative, claiming he’s old, sick and broke, and Shirley is likewise.

There’s much back-and-forth about the worth of some real estate DeeWayne owns, but the house burned down and the SO included some insurance proceeds in DeeWayne’s RCP even though they were trust funds.

The point I’m making here is that the SO said that DeeWayne and Shirley were in good health, denied any OIC, and demanded payment in full. To the NOD denying any collection alternative, “The Appeals Office attached a statement prepared by Settlement Officer X and a copy of her worksheet. In the statement Settlement Officer X stated that Dr. Jones is ‘in apparent good health’ and that Mrs. Jones has ‘no known health problems.’” T. C. Memo. 2012-274, at p. 11. (Name omitted).

After deconstructing the real estate valuation arguments, with a sideswipe at Zillow.com as a source for real property valuations, Judge Marvel goes on: “Additionally, the notice of determination does not disclose that Settlement Officer X gave any consideration to the impact petitioners’ advanced age and asserted poor health might have on petitioners’ ability to pay, as required by IRM pt. 5.8.4.4. In fact, the statement attached to the notice of determination appears to confirm that Settlement Officer X gave no consideration to petitioners’ age or claims of poor health. There is no documentation in the administrative record showing that Settlement Officer X ever asked for documentation of or disputed petitioners’ asserted poor health, and respondent has offered no explanation for Settlement Officer X’s statement that Dr. Jones is ‘in apparent good health’ and that Mrs. Jones has ‘no known health problems.’ Although the Appeals Office does not have to list ‘every single fact that it considered in arriving at * * * [its] determination’, Barnes v. Commissioner, T.C. Memo. 2006-150, 92T.C.M. (CCH) 31, 35 (2006), aff’d in part, vacated in part sub nom. Keller v. Commissioner, 568 F.3d 710 (9th Cir. 2009), it cannot misstate or fail to address significant and obviously relevant facts.” T. C. Memo. 2012-274, at p. 23 (Footnote omitted, but read it. DeeWayne’ income comes from his profession, not investments; if he’s sick, he can’t work).

So remand to Appeals is appropriate, as IRS has too many gaps to fill to rescue SO X’s flawed analysis.

But isn’t this just another example of an overworked, under-resourced IRS, where the need to close cases becomes more important than closing them correctly? Congress, please copy.

And That’s An Understatement–Not!

Connoisseurs of the anfractuosities of, and travelers through the Byzantine labyrinth that is, Title 26 of the United States Code will appreciate BLAK Investments, Kyle W. Manroe Trust, Robert Manroe and Lori Manroe, Trustees, Tax Matters Partner, 2012 T. C. Memo. 273, filed 9/25/12. Judge Vasquez is our guide for this journey into the unexpected and counterintuitive.

To paraphrase Charles Dickens, the deal was dead to begin with. It was agreed by the parties, and “stipulated that ‘BLAK Investments was a sham, lacked economic substance, and was formed and/or availed of to claim deductions of artificial losses solely for tax purposes’ and conceded that a 20% accuracy-related penalty under section 6662(a) applies to the entire underpayment of tax resulting from the transaction. The sole issue remaining for decision is whether petitioner is liable for the higher 40% penalty rate for a gross valuation misstatement under section 6662(h).” 2012 T. C. Memo. 273, at p. 2.

Slam dunk for the IRS, no? BLAK is a son-of-BOSS, a mix-and-match of short sale of U. S. treasuries with an unliquidated liability to cover, using the old Section 752 dodge, pre-amendment. See my blogpost “Woodshedding Your Experts–Stobie Creek Part Deux”, 1/10/11. So a phony basis builder gets blown up, and a thumping capital gain gets laid on the Manroes.

Now what about the 40%? Judge Vasquez: “We have held that when the Commissioner asserts a ground unrelated to value or basis of property for totally disallowing a deduction or credit and a taxpayer concedes the deduction or credit on that unrelated ground, any underpayment resulting from the concession is not attributable to a gross valuation misstatement. See McCrary v. Commissioner, 92 T.C. 827, 851-856 (1989). Petitioner conceded the deductions on the grounds that BLAK Investments is a sham and lacks economic substance–grounds unrelated to the value or basis of the Treasury notes, foreign currency, or any other property in the transaction.” 2012 T. C. Memo. 273, at p. 6.

Game over for IRS? Not quite. “Nonetheless, it has long been the Court’s view that the gross valuation misstatement penalty does apply when the Court determines that an underpayment stems from deductions or credits that are disallowed because a transaction lacks economic substance or a participant is a sham.” 2012 T. C. Memo. 273, at p. 7 (Citations omitted, but one of them is the celebrated Petaluma case; see my blogposts “The Great Dissenter – Part Deux”, 2/15/12, and “Judge, He Didn’t Mean It”, 9/17/12).

So which is it, 20% or 40%? The answer is ambiguous. The Courts of Appeal are all over the lot. Ninth Circuit, where these California taxpayers could appeal, felt constrained by stare decisis to follow an earlier decision that said that a sham is not an understatement (cf. Home Concrete v. US , and my blogpost “Colony Lives”, 4/26/12).

Judge Vasquez: “We have similarly stated that stare decisis ‘generally requires that we follow the holding of a previously decided case, absent special justification. This doctrine is of particular importance when the antecedent case involves statutory construction’. Therefore, respondent bears the heavy burden of persuading us that we should overrule our established precedent.” 2012 T. C. Memo. 273, at p. 10 (Citations omitted).

IRS doesn’t bear the heavy burden, so stare decisis carries the day.

But IRS has one last round in its magazine. IRS claims its amended regulation under Section 6662(h) deserves Mayo Clinic deference (see my blogpost “Carpenter, Colony, Chevron and Mayo”, 4/26/11).

Judge Vasquez nails that one: “The Court of Appeals was well aware of the regulation when it decided Keller. We believe the Court of Appeals saw no need to address the regulation as the taxpayer there did not contest the amount of the overvaluation; he instead argued that section 6662(h) is not ‘applicable in the first instance’ because ‘his tax underpayment is not “attributable to” the valuation overstatement’. Keller v. Commissioner, 556 F.3d at 1059.

“The Court of Appeals agreed with the taxpayer and held that ‘When a depreciation deduction is disallowed in total, any overvaluation is subsumed in that disallowance, and an associated tax underpayment is “attributable to” the invalid deduction, not the  overvaluation of the asset.’ Id. at 1061. Because the Court of Appeals found that section 6662(h) was inapplicable, the regulation interpreting section 6662(h) would have been equally inapplicable.” 2012 T. C. Memo. 273, at p. 12 (Footnote omitted).

So the taxpayer’s sham transaction draws only a 20% penalty. At least in California, it’s better to create phony basis when you’re doing a completely phony deal, rather than creating phony basis in an economically substantial but nevertheless phony deal.

Don’t you just love this stuff?

Gross receipts, that is, when reckoning Average Annual Gross Receipts (AAGR) for Section 41 research tax credits.

That’s the lesson for Hewlett-Packard Company and Consolidated Subsidiaries, 139 T.C. 8, filed 9/24/12, Judge Goeke teaching the lesson.

This is not a replay of Foppingadreef and the Netherlands-US flimflam (see my blogpost “We Don’t Need No Stinkin’ Factors”, 5/15/12, Judge Goeke’s previous shootdown of a H-P ploy). No doubt H-P did research, but AAGR is a threshold that the researchers must cross before they can take the credit. Because the aim is to reward research that H-P otherwise wouldn’t have undertaken, the AAGR tries to exclude research that would have been undertaken, credit or no credit. The theory is that entities budget for research as a function of gross receipts, so by basing credit for new research on a threshold set at a function of gross receipts, the credit applies only to the new research, not the “anyway” research. This method also ties research into sales growth.

H-P tries to lower the threshold by not taking into account intercompany distributions (OK, says IRS, and so stipulates), and excluding nonsales income, like dividends, interest, rent, and other income, in computing AAGR (not OK with IRS or Judge Goeke).

H-P argues that only income from sales should be included in AAGR. “HP submits that by specifically excluding ‘returns and allowances’, a phrase connoting a merchant business association, Congress evinced a clear intention to limit gross receipts to solely sales receipts. Similarly, citing a Black’s Law Dictionary entry, HP asserts that the generally accepted definition of “gross receipts” focuses on sales or services income. See Black’s Law Dictionary 772 (9th ed. 2009) (defining ‘gross receipts’ as ‘The total amount of money or other consideration received by a business taxpayer for goods sold or services performed in a taxable year, before deductions. * * * [Sec.] 448; * * * [sec.] 1.448-1T(f)(2)(iv) [Temporary Income Tax Regs., 52 Fed. Reg. 22764 (June 16, 1987)].’).

“We are unpersuaded by HP’s contentions. Nowhere in the Code has the isolated term ‘gross receipts’ been construed as narrowly as HP suggests. On the contrary, an examination of the Federal income tax laws reveals that Congress widely embraces the notion of a broad, inclusive definition for the term. See, e.g., secs. 165(g)(3)(B), 993(f), 1244(c)(1)(C). Indeed, when adopting that term in a provision, Congress often qualifies the term’s comprehensive definition through specific exclusions or limitations to accommodate the relevant statutory scheme. See, e.g., secs. 448(c)(3)(C), 509(a)(2)(A)(ii), 1362(d)(3)(B) and (C).14 If, as proffered by HP, Congress intended to further limit the definition of ‘gross receipts’ in section 41, it undoubtedly recognized the constructional convention by which it had traditionally done so in numerous provisions.

“Further, HP’s attempt to equate the common meaning of ‘gross receipts’ with the narrow definition Black’s Law Dictionary is unavailing. Specifically, the definition provided in Black’s Law Dictionary is undermined by the cited authorities, section 448 and section 1.448-1T(f)(2)(iv), Temporary Income Tax Regs., supra, from which the definition was purportedly derived.” 139 T. C. 8, at pp. 17-18. (Footnotes omitted).

So Black strikes out. And so does H-P.

Some few of my older readers may remember, in the dim recollection of a long-ago time, an advertising tune that began thus. But Pepsico, successor-in-interest to the ancient hawker of “twice as much for a nickel, too”, definitely gets twice as much, both from Judge Goeke in Pepsico Puerto Rico, Inc., T. C. Memo. 2012-269, filed 9/20/12 (and the reason it took me so long to blog this case is that the decision is 100 pages of tightly-written corporate finagling of the highest order, with five lawyers for Pepsi and four for IRS).

Pepsi wants to expand into emerging markets during the 1990s, but doesn’t want to export any US cash, so it uses cash flow from notes issued by Frito-Lay to Pepsi’s Netherlands Antilles subs that are taxed at a minimal rate in the Netherlands Antilles, and are exempt from US tax. This works until the Netherlands Antilles preference in the Netherlands treaty with the US expires, and Pepsico has to restructure.

So Pepsico transfers some of its high-risk overseas subsidiaries from N.V.s to B.V.s, Dutch corporations. The notes get restructured, and finally are sold to an indirect Pepsi sub in exchange for advance agreements.

Now it gets amusing. For Dutch tax purposes, these advance agreements have to be debt, so that interest paid by the Dutch subs to its parent are deductible for Dutch tax purposes, but must be equity for the Pepsi subs that hold them.

IRS calls a halt and hits the convoluted Pepsi corporate structure with about $370 million in deficiencies, claiming the advance agreements are debt, Pepsi got taxable interest, and substance controls form.

Not so fast, says Judge Goeke. “Respondent asks this Court to disregard the objective form of the advance agreements and examine the substance of the transactions in discerning their proper characterization for Federal income tax purposes. It is axiomatic that the substance of a transaction governs for tax purposes. This principle is equally applicable in debt-versus-equity inquiries.

“While cognizant that the substance-over-form doctrine permeates tax law jurisprudence, we believe it prudent to emphasize that the form of a transaction often informs its substance. See e.g., Hewlett Packard Co. v. Commissioner, T.C. Memo. 2012-135 (dismissing the labels afforded to transactional instruments, but examining their terms to discern the true substance of the economic arrangement). An analysis focused myopically on the ‘substance’ of a transaction, but devoid of any consideration of the obligations engendered by the terms of the governing instruments, would typically result in deficient, or wholly flawed, determinations.” T. C. Memo. 2012-269, at pp. 49-50 (Some citations omitted).

However, see my blogpost, “We Don’t Need No Stinkin’ Factors”, 5/15/12, wherein I discuss the Hewlett-Packard case.

Since all the parties to the deal are related and are under common control, Tax Court must take a hard look at the documents, because fudging is so easy when you’re on both (or all) sides of the table.

But Judge Goeke gives Pepsi a bye. “However, notwithstanding the greater scrutiny afforded to related-party transactions, we believe that disregarding petitioners’ international corporate structure based solely on the entities’ interrelatedness is, without more, unjustified.” T. C. Memo. 2012-269, at p. 52.

So we have a voyage through the papers, with testimony concerning how Pepsi’s lawyers got what amounts to a PLR from the Dutch Revenooers saying the advance agreements were debt for Dutch purposes.

At the end, after an exhaustive review of the terms of the advance agreements, Judge Goeke finds them to be equity. Pepsi has indeed hit the spot.

This case has to go to Second Circuit, and I’ll bet we get interesting learning there. Follow.

I take the title of this blogpost from the English band of that name, but it isn’t only Dylan Moody who will be blue. He’s blue enough, when his dependents’ exemptions and child tax credits are disallowed, despite Judge Goeke’s sympathetic declaration, in 2012 T. C. Memo. 268, filed 9/19/12.

It’s the usual Section 152(e)(2) story. This time Dylan has a divorce decree that gives Dylan the exemptions (doesn’t mention the credit, but that’s not at issue) and states that Tammy Jean, his loved-once, shall sign Form 8332 each year by January 10, so long as Dylan pays the child support. Tammy Jean is custodial parent, of course.

Dylan pays. Dylan attaches a Form 8332 for each of their two children, but neither is signed by Tammy Jean. He subsequently submits the divorce decree, but Tammy Jean didn’t sign that either. Besides, says Judge Goeke, it isn’t IRS’ function to police or enforce divorce decrees.

Of course, signature by the custodial parent is the essential element of Section 152(e)(2), so game over for Dylan.

But I’ve suggested before that the matrimonial Bar should make sure that 8332s are prepared, signed and filed at the point the divorce decree is issued. If the non-custodial spouse welshes on the child support, any tax refunds, among other monies, are attachable. And there’s jail time as well.

Some lawyers could get in trouble if the payor doesn’t get what she or he expected.