And so the Biblical encomium of Genesis 32:28 is bestowed upon Michael J. Dale, in the eponymous T. C. Mem. 2012-146, filed 5/22/12. Except for $71, that is; he loses that one.

Mike said he was an innocent spouse. His loved-once, Big Ellen, invested in a cattle shelter run by one Hoyt. IRS blew up the shelter, and SNODs rained on the heads of the non-cowboys caught in Hoyt’s stampede. IRS said Mike was no innocent, but on the eve of trial IRS conceded Mike satisfied Section 6015(c)’s version of blamelessness.

Mike wanted a Section 7430 prevailing-party expense allowance of $4998.50; IRS agreed to $4927.50, but objects to $71 for “secretarial and clerical work performed by a secretary ($37.50), an assistant ($23) and a ‘staff’ member ($10.50).” 2012 T. C. Mem. 146, at p. 3.

So Mike goes to Tax Court for the $71. You gotta like a guy that fights as a matter of principle. And his counsel: one has to ask if she was getting paid.

But Mike loses. Section 7430(c)(1) reimburses for lawyer’s work, and the cost of secretarial and like services (lawyer’s overhead) is usually built into the lawyer’s fee.

Judge Kroupa: “Here, the titles of the persons who performed the services are immaterial. Rather, the nature of the services performed is relevant. The fees at issue relate to routine administrative tasks (e.g., editing or scheduling) and not to the performance of legal services (e.g., drafting legal documents). Petitioner did not demonstrate that the fees at issue were for work akin to that of an attorney. Accordingly, petitioner is not entitled to recover the fees at issue.” 2012 T.C. Mem. 146, at pp. 4-5.

But fighting for $71 definitely puts Mike in the premier litigants’ division.

A new treatise on Tax Court law and practice has been written by Prof. Danshera Cords, of Albany Law School. I haven’t read the book, so I can neither review it nor recommend it, but I am glad that someone has written about the minefield that is Tax Court practice. Too many litigants and practitioners, even those with decades of litigation experience and a list of high-profile successes (cf. F. Lee Bailey, Esq., 2012 T.C. Mem. 96, filed 4/2/12), have taken some nasty falls there.

Now I’ve said more than once, this is not a political blog; I grind no axes here. But on a non-partisan note, I must say that the Tax Court system is broken and needs repair. Prof. Cords has taken a step, but there is much more ground to cover.

Far too often practitioners are unaware of the Byzantine, not to say labyrinthine, limitations on Tax Court jurisdiction, scattered in various IRC sections in a masterpiece of counterintuitive logic. Even employees of IRS misinform taxpayers, mistakenly sending them to Court of Federal Claims or United States District Court, where they encounter a Sargasso Sea of procedural doldrums until the SOL runs on their meritorious claims (cf. Murray S. Friedland, 2011 T.C. Mem. 90, filed 4/25/11).

Finally, and most importantly, any attorney who has been “admitted to practice before and is a member in good standing of the Bar of the Supreme Court of the United States, or of the highest or appropriate court of any State or of the District of Columbia, or any commonwealth, territory, or possession of the United States”, (Tax Court Rule 200(a)(2)) is eligible to be automatically admitted to practice before Tax Court. The attorney need show no proficiency in Federal practice (to say nothing of Tax Court practice), or even the vaguest acquaintance with the IRC.

All other applicants for admission (and IRC Section 7452 permits anyone to apply for admission) must take an immensely complex examination, the pass rate for which is well below that of any State’s bar examination. Its complexity and scope, as to the years for which questions were available, certainly outdid the Special Enrollment Examination, which I passed.

But when I applied to take the Tax Court admissions examination, after months of study, my application was rejected, Judge Whelan informing me that as an attorney I could not take the examination, but for payment of a modest fee I could be admitted.

Hence the number of pro se litigants before Tax Court. Attorneys are expensive; there is no meaningful competition, as all but the infinitesimally chosen few are precluded from appearing, notwithstanding the brave language of IRC Section 7452: “No qualified person shall be denied admission to practice before the Tax Court because of his failure to be a member of any profession or calling.” Yeah, right.

So Congress and Tax Court, I have no doubt that between the two of you there lies a solution to providing less expensive and more competent representation to Tax Court litigants.

Or, Last Known Address

I wouldn’t waste my time, or my readers’ time (both of them), on a case like Sean Devlin, 2012 T. C. Mem. 145, filed 5/21/12. It’s the usual tax protester’s cocktail of frivolity, but Sean gets a boost from IRS’ failure to build a good trial record.

Sean didn’t bother to file five years’ worth of returns. IRS prepared SFRs and sent Sean a SNOD for the first of the five years, by certified mail, to a Long Island, New York address. This was returned as undeliverable. Two years later, IRS sent SNODs for the other four years to an address in Reno, Nevada, by certified mail, and those were not returned.

Sean never petitions Tax Court to contest his liabilities as stated in the five SNODs, so IRS sends Sean Letter 3172, a Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320. Apparently this got to Sean’s current address, and Sean seeks a face-to-face.

The usual charade follows. Sean makes frivolous arguments, Appeals demands Form 433-A, Sean doesn’t send it but repeats his frivolous arguments after claiming he’s withdrawing them, and Appeals issues a NOD denying Sean’s appeal and sustaining the lien.

Sean petitions Tax Court, claiming he never had a chance to contest liability. He’s right as to Year One, as IRS concedes the Long Island, New York address was not Sean’s last known address, but the Reno, Nevada letters were duly mailed (and IRS has Forms 3877 to prove it), and Sean never petitioned or appealed.

Ordinarily, the presumption of regularity would sink Sean despite his protestations of non-receipt. But the trial record is not of the best. Judge Vasquez: “We find nothing in the record that connects petitioner with 6110 Plumas [Reno]. As late as December 6, 2004, the IRS was mailing correspondence to petitioner at 3 Huskel Lane, Smith Town, New York[Long Island]. Although it is possible that after that date and before February 2, 2005, the date the IRS mailed the notices of deficiency for 2000 and 2002, the IRS received an information return or other document showing petitioner’s address to be 6110 Plumas, there is no evidence of this. Additionally, nowhere in Settlement Officer X’s declaration, respondent’s pretrial memorandum, or respondent’s posttrial brief is there anything to show that 6110 Plumas was petitioner’s correct address during 2005 and 2007. Accordingly, the presumption of proper mailing is not raised, and there is insufficient evidence to show that petitioner received the notices of deficiency for 2000, 2001, 2002, and 2004. We therefore allow petitioner to challenge his underlying tax liabilities for the years at issue.” 2102 T. C. Mem. 145, at pp. 8-9 (Footnotes and name omitted).

If IRS prepared the SFRs from 1099s or W-2s or K-1s, and had put those in evidence, then the address shown on those would substantiate the “last known address” of the elusive Sean. But none of those are in evidence.

Likewise, “In a number of recent cases the Court has found a taxpayer to have received a notice of deficiency despite a claim to the contrary. In these cases, however, the taxpayer either did not argue that the notice of deficiency was mailed to an improper address or did not unequivocally deny under oath receiving a notice of deficiency, or the evidence showed that the notice of deficiency was mailed to the correct address. See, e.g.,  Diamond v. Commissioner, T.C. Memo. 2012-90 (properly completed Form 3877 showing taxpayer’s correct address raised the presumption of proper mailing and allowed the Court to find that the taxpayer received the notice of deficiency after he refused to deny receipt under oath); Kamps v. Commissioner, T.C. Memo. 2011-287 (taxpayer argued only that he did not receive the notice of deficiency, not that it was mailed to the improper address); Clark v. Commissioner, T.C. Memo. 2008-155 (taxpayer presented no evidence that he did not receive the notices of deficiency and did not contest that the notices of deficiency were mailed to his correct address); Bailey v. Commissioner, T.C. Memo. 2005-241 (‘[p]etitioner does not dispute that the notice of deficiency was mailed to his last known address, and he does not unequivocally deny that he received it’). None of these scenarios is present in the matter before us.” 2012 T. C. Mem. 145, at p. 9, footnote 8.

So Sean gets a chance to disprove IRS’s asserted liabilities. But Sean just goes frivolous again. So Judge Vasquez sustains IRS, and shows Sean the Section 6673 yellow card. Further frivolity will cause the wrath of Tax Court to descend upon Sean heavily.

But IRS trial counsel, a word to the wise. When you get the SNODs, get the back-ups as well and put it all in at trial.

And an LLC is No Different

So paraphrases Judge Kroupa in Jack Trugman and Joan E. Trugman, 138 T.C. 22, filed 5/21/12; Gertrude Stein would be pleased.

Jack and Joan had a Sub S for their various rental properties, and had filed 1120s for the 19 years of the Sub S’s existence, during which time they dwelt in rented premises. Seeking to avail themselves of Congressional largesse in the form of the Section 36 FTHBTC2, they bought a dwelling in a State with no state income tax, contributing $7500 of their own cash while their Sub S graciously chipped in $319,500 and took title. Jack and Joan claimed the Section 36 credit, and the Sub S did not.

But pass-through entities are not individuals, and even though Jack and Joan might have qualified if they took title themselves, Congress meant for their largesse to be sufficiently guided so as to fall into the laps of individuals only.

Judge Kroupa: “We hold that S corporations are not individuals for purposes of section 36. A corporation, at its core, is a business entity organized under State or Federal law, whether an association, a company or another recognized form. A corporation that satisfies certain criteria may elect small business status for Federal income tax purposes. An S election does not alter the corporation’s corporate status; it merely alters the corporation’s Federal tax implications.  Items of income, deduction, loss and credit generally pass through to the shareholders. S corporations remain freestanding entities ‘independently recognizable’ from their shareholders.” 138 T. C. 22, at p. 4-5 (Citations omitted).

Section 36 mentions “individuals” 36 times, corporations zero times, says Judge Kroupa (huzza for the “global search” function!). Corps do not have principal residences, they have principal places of business. Individuals have their own Title in the IRC, and corps have their own as well. Never the twain shall meet.

Jack and Joan claim an IRS employee told them they could do it. Too bad, says Judge Kroupa, but the law is the law. “Petitioners seek leniency by arguing that IRS representatives indicated that they could claim the tax credit if the property was purchased through the S corporation. It is unfortunate when a taxpayer receives inaccurate information. We have recognized, however, that incorrect legal advice from an IRS employee does not have the force of law and cannot bind the Commissioner or this Court. Ultimately, statutes, regulations and judicial decisions govern a taxpayer’s tax liability. “ 138 T. C. 22, at p. 7 (Citations omitted).

So Jack and Joan are thrown out at home.

And so are Felix Rospond and Loretta Rospond, 2012 T. C. Sum. Op. 47, filed 5/21/12, a “not for nuthin’” Section 7463. Felix and Lorie formed a New Jersey LLC to hold family assets, bought their house in the aforesaid LLC (which had the fetching name of Jacco Associates, LLC) , and claimed the FTHBTC2.

Same result from Judge Wells, who doesn’t cite Judge Kroupa’s decision in Trugman, supra, but has a bushel basket full of cases and rulings wherewith to beat up Felix and Lorie. Pass-through or disregarded, if it isn’t an individual taxpayer’s principal residence, no Section 36 credit.

So holds Judge Gustafson in Bilal Salahuddin and Monique Salahuddin, 2012 T. C. Mem. 141, filed 5/17/12. Bil and Monique owe taxes based on their filed returns, but can’t pay, so when they get the Final Intent letter, they ask for a CDP and proffer a Form 433-A. The SO asks for supporting documents and offers a phonecall CDP hearing; Monique asks for time to gather documents in support of her already-submitted Form 433-A, and this is granted.

Before the due date, Monique calls the Appeals Team Manager (ATM). ATM tells her the file has sufficient information, so Monique need not send any more, and enters the conversation in the case activity file. Monique confirms this phone conversation by letter to the SO, which letter is also in the file.

Finally, three months later, having never told Monique or Bil anything or held a phone hearing, the SO shoots down the proposed installment agreement, and sends a NOD, which gets the facts wrong, claiming Bil and Monique didn’t submit the supporting documents and dodged a phone hearing. Unhappily, based on their own, ultimately unsupported figures, Bil and Monique’s offer is way low.

IRS moves for summary judgment. And loses.

Judge Gustafson: “The Commissioner argues that because the Salahuddins offered an amount ($900 to $1,000 per month) that was less than their own reckoning of their surplus monthly income (about $5,800 more income than living expenses), it could not be an abuse of discretion for Appeals to reject such an offer. This might be a winning argument, except for two problems that arise under the facts as we are required to assume them for purposes of deciding a motion for summary judgment.” 2012 T. C. Mem. 141, at pp. 14-15.

IRS said that what Bil and Monique had submitted was “sufficient.” So Appeals could not deny Bil and Monique on the ground they had not submitted information, when Appeals told them they didn’t need to. And the NOD didn’t discuss the low-ball with sufficient particularity to constitute an independent ground for the denial.

While IRS might have tossed Bil and Monique based on the low-ball offer (see my blogpost “Give It Your Best Number”, 4/9/12) Judge Gustafson finds IRS didn’t: “We can easily imagine a denial of an installment agreement based on two clear alternative grounds–i.e., (1) that the taxpayer failed to provide documentation to substantiate his financial information, and separately (2) that the amount offered by the taxpayer was inadequate even assuming accurate the taxpayer’s unsupported financial information. If the notice of determination stated such grounds, then the Commissioner could well argue that the first was harmless error, because the second was independent and sufficient. However, our role under section 6330(d) is to review actions that the IRS took, not actions that it could have taken. As the Supreme Court stated in SEC v. Chenery Corp., 318 U.S. 80, 93-95 (1943):

“[The agency’s] action must be measured by what the * * *[agency] did, not by what it might have done. * * * The * * *[agency’s] action cannot be upheld merely because findings might have been made and considerations disclosed which would justify its order as an appropriate safeguard for the interests protected by the Act.

“There must be such a responsible finding. * * *” 2012 T. C. Mem.141, at p. 16.

Judge Gustafson does take pains not to go too far; Bil and Monique don’t get a free pass: “We do not by any means hold that a notice of determination must be error-free in order to be sustained. However, in this circumstance, the error suggesting that the Salahuddins had failed to respond to Appeals’ letter has an unfortunate resonance with the unfair determination that they had failed to provide supporting information; and the error suggesting that a telephone conference had been scheduled raises the question whether the SO was confusing two different cases–the Salahuddins case and another case in which other taxpayers had made a material failure to produce information that was requested. Under Rule 121 we cannot hold that there is no genuine issue as to the reason for Appeals’ determination to deny an installment agreement and the absence of an abuse of discretion in that determination.” 2012 T. C. Mem. 141, at pp. 17-18.

Judge Gustafson goes even further,  warning Bil and Monique to get serious: “We do not hold that these facts constitute offer (by the Salahuddins) and acceptance (by Appeals), giving rise to a contract. Nor do we hold that Appeals was barred in any way from rejecting the proposal and demanding more. We hold rather that there is a genuine issue of material fact as to whether Appeals induced the Salahuddins to believe that their information was “sufficient” and that their proposal would be accepted–i.e., whether Appeals thus misled the Salahuddins by inducing them to leave their proposal pending and unrevised–and whether it was an abuse of discretion for Appeals to terminate the CDP hearing by rejecting that proposal, rather than soliciting a satisfactory substitute proposal.” 2012 T. C. Mem. 141, at p. 18.

In short, as I said in my earlier blogpost, Give It Your Best Number. That goes for both taxpayer and IRS.

Judge Holmes, The Great Dissenter, really rattled the D.C. Circuit’s cage when he dissented in Tigers Eye Trading, LLC, Sentinel Advisors, LLC, Tax Matters Partner, 138 T. C. 6, filed 2/13/12 (see my blogpost “The Great Dissenter – Part Deux,” 2/15/12). DC Circuit remands Petaluma III to Tax Court, asking whether Tax Court overruled Petaluma III and requesting Tax Court to report the current status of Petaluma III, in Petaluma FX Partners, LLC, Ronald Scott Vanderbeek, A Partner Other Than The Tax Matters Partner, 2012 T. C. Mem. 142, filed 5/17/12.

Apparently D. C. Circuit was concerned that Tax Court exceeded its limited statutory jurisdiction. Oh no no no, says Judge Goeke, and he takes 16 pages to say so.

Judge Goeke declares Tax Court has hewn at all times to the line established by the Supremes 120 years ago for lower courts when they get a remand from on high: “That [lower] court cannot vary it, or examine it for any other purpose than execution; or give any other or further relief; or review it, even for apparent error, upon any matter decided upon appeal; or intermeddle with it, further than to settle so much as has been remanded. [In re Sanford Fork & Tool Co., 160 U.S. 247, 255 (1895).]” 2012 T. C. Mem. 142, at p.11, footnote 9.

Moreover, Judge Goeke raps Judge Holmes’ metaphorical knuckles. “In its remand order, the D.C. Circuit quotes a sentence from a dissent in Tigers Eye. See Petaluma FX Partners, LLC v. Commissioner, 2012 U.S. App. LEXIS 4011 (citing Tigers Eye Trading, LLC v. Commissioner, 138 T.C. at ___, (slip op. at 205) (Holmes, J., dissenting) (‘Our decision today overrules Petaluma III.’)). The cited passage does not represent the position of this Court. No other Judge of the Court agreed with the part of the dissent from which the quoted sentence was taken. As noted supra, no part of any of the opinions by the Judges of this Court in Tigers Eye purported to explicitly alter or overrule the decision in this case or to revise the language of the Court’s Opinion in Petaluma III. To the extent the remand order was intended to provide this Court with the opportunity to alter or amend any aspects of Petaluma III, we respectfully decline to do so.

“In summation, we hold that the Court’s Opinion in Tigers Eye did not overrule or alter Petaluma III and that the current status of Petaluma III is unchanged.” 2012 T. C. Mem. 142, at pp. 15-16.

So there, D. C. Circuit, we’re good kids, really we are. And Great Dissenter Holmes, go stand in the corner.

Equal Opportunity in Tax Court

The $500K/$50K limitations on Section 168(h) largesse (home acquisition indebtedness deduction and home equity indebtedness deduction) receive yet another full dress Tax Court opinion in Faina Bronstein, 138 T.C. 21, filed 5/17/12.

Faina and father-in-law buy a residence. It’s Faina’s principal residence; while  Faina’s husband lived there, he was never in title, never signed either note or mortgage, and never paid a cent of debt service (nor was he ever legally obligated to do so). Faina paid every cent of debt service on the $1.35 million mortgage. Faina files “married filing separately” and tries to take interest on the full $1.1 million that Section 168(h) allows, claiming the $500K/$50K limitation for marrieds filing separately is only there to keep two marrieds from each taking deductions for interest on $1.1 million. Cf. Charles J. Sophy, 138 T. C. 8, filed 3/5/12, and my blogpost “Sophy’s Choice” 3/6/12.

Interestingly, Sophy isn’t cited in Faina. Maybe Judge Goeke doesn’t read Judge Cohen’s decisions. For sure no Tax Court Judges read my blogposts.

Anyway, as with Sophy, the decision goes against Faina on plain language. Judge Goeke: “We believe section 163(h)(3)(B)(ii) clearly states that a married individual filing a separate return is limited to a deduction for interest paid on  $500,000 of home acquisition indebtedness. Similarly, we believe section 163(h)(3)(C)(ii) clearly states that a married individual filing a separate return is limited to a deduction for interest paid on $50,000 of home equity indebtedness.

“Petitioner has not offered any unequivocal evidence of legislative purpose which would allow us to override the plain language of section 163(h)(3)(B)(ii) and (C)(ii).7 As a result, we agree with respondent that petitioner is not entitled to a deduction for the interest paid on the entire $1 million of acquisition indebtedness incurred in purchasing the property. Rather, petitioner is entitled to deduct interest paid on only $550,000 of the mortgage indebtedness.” 138 T.C. 21, at pp. 8-9.

And what’s more, the statutory language is so unambiguous that Faina gets a 20% accuracy-related (understatement) penalty.

That’s Tax Court for you: Equal treatment for both married and unmarried couples, same-sex or opposite-sex; all are $500K/$50K limited.

And a new Circular 230 person?

Although abuse-of-discretion in CDPs is rare, here’s one filed today, Shawn Michael Lewis, 2012 T.C. Mem. 138, filed 5/16/12. Shawn was hit with SNODs, but filed Chapter 11. He and IRS jousted about the deficiencies in Bankruptcy Court, but eventually IRS’ second amended proof of claim carried the day, after Shawn signed a Form 4549, Income Tax Examination Changes.

IRS proceeds to levy, and Shawn asks for a CDP. It takes a year for his request to get assigned to a SO. He asks for a face-to-face, which is granted, so he gets sent from one SO to another. The second SO asks for documents Shawn says he sent but the SO says he never got, so he issues a NOD sustaining the levy for failure to furnish documents.

Shawn can’t challenge the underlying liability, of course. Judge Paris: “Where a taxpayer has filed a bankruptcy action and the Commissioner has submitted a proof of claim for unpaid Federal tax liabilities, the taxpayer has had the opportunity to challenge the underlying tax liability for the purposes of section 6330(c)(2)(b). See Kendricks v. Commissioner, 124 T.C. 69, 77-79 (2005). Additionally, a taxpayer who consents to additional assessments by signing Form 4549 is also deemed to have had the opportunity to dispute his or her tax liability for the years included in the Form 4549. Aguirre v. Commissioner, 117 T.C. 324, 327 (2001).” 2012 T.C. Mem. 138, at p. 8. Incidentally, it’s a proceeding in Bankruptcy Court, not an action, but that doesn’t help Shawn, he’s barred from contesting the liability.

But the second SO dropped the ball. He never gave Shawn a face-to-face, and Shawn had only one phonecall with the SO before the SO issued the NOD. Judge Paris:  “During the call petitioner reasserted his desire for a face-to-face conference on the basis of the complexity of his bankruptcy issues, asked for a total of his liabilities, and restated his desire to explore collection alternatives. SO X advised petitioner that he would have to submit the financial documentation requested in his previous letter in order to be eligible for collection alternatives. At no point did SO X indicate that the phone call would constitute petitioner’s CDP hearing. SO X had no further contact with petitioner until the issuance of the notice of determination….” 2012 T. C. Mem. 138, at p. 11 (Name and date omitted).

Judge Paris throws out the NOD. “In reviewing the administrative record, it is difficult to conclude that SO X dedicated much effort to a meaningful review of the issues presented by petitioner’s CDP hearing request.

“Respondent does a commendable job of attempting to argue that each individual defect in SO X’s administrative review can be rebutted to show that said defect was not an abuse of discretion. However, respondent’s argument seeks to quilt together a string of exceptions to account for SO X’s deviation from what one would consider a thorough review of petitioner’s case. While each individual defect on its own may be insufficient to support a holding that respondent abused his discretion, the cumulative effect of such defects demonstrates that SO X acted both arbitrarily and capriciously in rendering his determination. Accordingly, the Court holds that respondent abused his discretion in sustaining the proposed levy.” 2012 T. C. Mem. 138, at pp. 12-13 (Name omitted).

An also-ran among the Tax Court Memoranda filed May 16 is Gabriel S. Garcia and Maria Garcia, 2012 T. C. Mem. 139. This is another unsubstantiated deduction case, not worth commenting on, except for one interesting remark by Judge Cohen: “Petitioners’ tax returns for 2007 and 2008 were prepared by petitioner’s brother, Richard Garcia. Richard Garcia is not an accountant or an enrolled return preparer.” 2012 T.C. Mem. 139, at p. 3.

Was there such a thing as an “enrolled return preparer” in 2008 and 2009 (when presumably the 2007 and 2008 returns, respectively, were filed)? There certainly were enrolled agents, enrolled actuaries, and enrolled retirement plan agents in those years, and unenrolled return preparers abounded (and probably still do, notwithstanding the latest Circular 230), but Registered Tax Return Preparers only came into existence this year, and so far as I know the candidates are still being tested and screened for registration.

Never heard of an “enrolled return preparer” before 2009, or since. Anybody know who or what they were?

If the Deal Has No Economic Substance

This is a Hewlett-Packard disaster you can’t blame on Carly Fiorina, as Lewis Platt OK’d this one (right way to spell “Lewis”, though). It’s Hewlett-Packard Company and Consolidated Subsidiaries, 2012 T.C. Mem. 135, filed 5/14/12. And Judge Goeke has to wade through 82 pages to reach a simple conclusion.

Some tax wits at AIG concocted a Netherlands Guilder-USD shellgame, using an allowance of deductible contingent interest asymmetry between the IRC and the Dutch tax code. Essentially, AIG was going to lend ABN (that’s Algemene Bank Nederland) multiple millions and ABN was going to pay nominal real interest but a ton of contingent interest (currently taxable by Dutch law but not US law), disguised as “preferred stock dividends”,  via a stooge intermediary with the obviously stooge name Foppingadreef.

All of the interest, real and contingent, would be characterized for Dutch law as preferred dividends, and would be taxed, setting up a huge foreign tax credit for HP, which had tons of foreign income but no available foreign tax credits.

ABN’s ethics committee blesses the deal, the Dutch tax authorities give the equivalent of a PLR based on Dutch law, and various high-priced law firms sign off.

AIG flogs this unexploded ordnance to HP for a mere $15 million.

Cutting through the wheeling and dealing, Judge Goeke finds that the “dividends” weren’t; they were interest on a debt from ABN, Foppy being disregarded. HP got a minority interest in Foppy, but had stranglehold rights to bail out and get paid if the tax laws changed or the majority shareholder (ABN) tried to invest in anything but ABN notes. The actual interest HP got was less than 2%, at a time when US government bonds were paying over 6%, but when the foreign tax credits were factored in, HP got better than 9%, with ABN, one of the strongest banks in the Netherlands, essentially guaranteeing the deal.

HP wanted to deduct as a capital loss the upfront $15 million they paid AIG for the deal. No, says Judge Goeke. HP didn’t pay a commission to buy preferred stock, they paid a fee to AIG to facilitate a tax shelter. And that’s a non-starter first class.

Judge Goeke doesn’t have to get to economic substance, he says, but after reading the 82 pages, I couldn’t find any economic substance.

When You Get a Piece of Their Disability Pension

Shannon Fernandez finds this out the hard way in the eponymous Tax Court full-dress opinion, 138 T.C. 20, filed 5/14/12. Judge Wherry is the bearer of the bad news in this case of first impression.

Shannon’s loved-once, Mr. Fernandez, was another disabled L. A. County Sheriff, like Jay Sewards (see my blogpost “Service Trumps Sickness”, posted 4/2/12), but unlike Jay, Mr. took the disability option because he didn’t have the 20 years of service he needed for full benefits. He and Shannon split, and Shannon gets a piece of Mr.’s pension.

L.A. gives Shannon a 1099-R but Shannon doesn’t report the income, replying on Section 402(e)(1)(A) as placing her in the shoes of Mr. as regards any distribution from an exempt trust, like the L.A. Sheriff’s retirement fund.

That’s fine, except neither Section 402 nor Section 72 (the annuity section) talks about Section 104 bodily injury payments. Judge Wherry: “Nowhere in section 402(a) or section 72 is section 104(a) mentioned. Section 402(e)(1)(A) explicitly provides: ‘For purposes of subsection (a) [of section 402] and section 72, an alternate payee who is the spouse or former spouse of the participant shall be treated as the distributee of any distribution or payment made to the alternate payee under a qualified domestic relations order ‘. If Congress had included section 104 in this portion of the statute, the result in this case might be different. However, without congressional approval we decline to expand the reach of section 402(e)(1)(A) beyond the sections specifically referred to in its text.” 138 T.C. 20, at pp. 6-7.

Going back to the earliest days of the income tax, the prehistoric, pre-IRC, Revenue Act days, Judge Wherry finds: “A version of section 104(a)(1) allowing an injured person to exclude disability income from his or her taxable income has been in the Code since the Revenue Act of 1918 when it was added because ‘Under the present law it is doubtful whether amounts received* * * as compensation for personal injury or sickness * * * are required to be included in gross income.’ H.R. Rept. No. 65-767 (1918), 1939-1 C.B. (Part 2) 86, 92. In all of the years since, to our knowledge, petitioner’s particular issue has not been before the Court. We note that petitioner did not suffer an injury, and the Senate explicitly stated ‘as compensation for personal injury’. In the case at hand the compensation was not for petitioner’s personal injury, but that of her former husband.” 138 T. C. 20, at pp. 7-8.

There’s no caselaw that anybody can find, so Shannon gets nailed. But “(T)his outcome should come as no surprise to petitioner. Although not controlling on this Court, we note that the order and stipulated division of retirement benefits stated that ‘[d]istribution under this Order shall be taxable to the Nonmember [petitioner] and not the Member [her former spouse].’ We further note that the State court did not decrease petitioner’s share of the disability payments because it believed that she would receive the money tax free.” 138 T. C. 20, at p.8, footnote 5.

But would the result been different had the State court in fact decreased Shannon’s share? I doubt it.