At Least for Section 131

That’s Judge Colvin’s pick-up from a case tried by The Great Dissenter, Judge Holmes, Jonathan E. Stromme and Marylou Stromme, 138 T.C. 9, filed 3/13/12.

Marylou’s disabled brother Danny was the impetus for her and Jonathan to use their Emil Avenue house (originally bought for investment) as a residence for developmentally disabled adults. Jonathan acted as general contractor to remodel and upgrade the Emil Avenue house to county standards, and four disabled persons lived there. Marylou and Jonathan started a business, got licensed and paid by the county for caring for their inmates, hired additional staff (some family, some not) to help, and excluded the payments under Section 131.

But Marylou and Jonathan also owned other houses, one on Mound Avenue that they later sold and one on LaCasse Drive. “It was at the LaCasse Drive house that the Strommes held family get-togethers and celebrated the safe return of another son from service in Iraq. The LaCasse Drive house was also where they celebrated Thanksgiving and Christmas. Ms. Stromme found it a more restful place to recover from foot surgery. This was in part because the LaCasse Drive house was much larger than the one on Emil Avenue. Excluding the basement, the LaCasse Drive house had 2,808 square feet, in contrast to the 1,168 square feet of the Emil Avenue house–and it was large enough to accommodate the Strommes’ extended family and everyday life. Its six bedrooms often housed not only the Strommes and their two children, but also two other children from Ms. Stromme’s first marriage, plus Ms. Stromme’s brother, a niece, and two grandchildren. It also was large enough for the Strommes to bring their clients over for outings.” 138 T.C. 9, at pp. 5-6.

Marylou and Jonathan claimed they owed no tax on the county payments (about $500K), because they cared for the disabled persons in their home. But was Emil Avenue their “home”?

Section 131 excludes from income “…payments if they were:

• made pursuant to a foster care program of a State;
• paid by a State or political subdivision thereof, or a qualified agency; and
• paid to a foster care provider for the care of ‘a qualified foster individual in the foster care provider’s home.’

“See sec. 131(b)(1). The parties disagree about the third requirement. Does the phrase ‘foster care provider’s home’ merely require ownership, as petitioners contend; or does it mean the foster care must be provided in a taxpayer’s residence, as respondent contends? We conclude that it means the foster care must be provided in a taxpayer’s residence.” 138 T.C. 9, at pp. 8-9.

Briefly, home is where you live. Ownership is not enough. And Marylou and Jonathan couldn’t prove that they lived, as distinct from worked, at Emil Avenue.

Judge Colvin: “The only case on the meaning of ‘home’ in section 131 is Dobra v. Commissioner, 111 T.C. 339 (1998). In Dobra, the taxpayers owned four houses where they cared for developmentally disabled people, but conceded that only one house was their ‘personal family residence.’ Id. at 340. The Dobras nevertheless argued that because they owned each house, they could exclude payments tied to the individuals in all four. Id. at 342. We held, however, that under section 131 a person’s ‘home’ is where he resides. ‘Put more plainly, in order for a ‘house’ to constitute * * * [a home], petitioners must live in that house.’ Id. at 345. Precedent fences us in: The Strommes’ mere ownership of the Emil Avenue house is insufficient to make it their home.” 138 T. C.  9, at p. 10.

So no exclusion.

There is much judicial fencing about whether “home” means “principal residence” for Section 131 exclusion, which would disqualify even a secondary residence, and whether Tax Court needs to decide that now. Judge Holmes has a concurrence that deals with those points, although Judge Gustafson doesn’t agree with him.

But Marylou and Jonathan escape the negligence penalty. The law is ambiguous, they did report receipts even though they claimed they weren’t taxable, and even the IRS publications dealing with the issue don’t try to define what is a “home” for Section 131 purposes.

Judge Holmes Deconstructs an Apartment Building

And How to be a Tax Fraud

Two for the price of one today.

Judge Holmes, the Judge who writes like a human being, has written another advanced tax accounting text in Amerisouth XXXII, Ltd., Amerisouth Texas III, LLC, Tax Matters Partner, 2012 T.C. Mem. 67, filed 3/12/12. Judge Holmes has ridden this range before (see my blogpost “Basis for Dummies,” 11/24/11), and this time he sprinkles his prose with cowboyisms (the property at issue is in Mesquite, Texas, although the parties shuffle off to Buffalo, New York, to try the case), and a few groaner puns.

Amerisouth XXXII (hereinafter “32”) is one of a string of apartment house tax shelter deals run by old-time Texas real estate operator Ruel Hamilton, who disappears after trial, so no post-trial brief is filed, and 32’s attorney are relieved (in more ways than one).

Ruel decides to use the component approach to depreciation (see my blogpost “Buying Trouble”, 1/18/12), trying to take MACRIS class lives for every single piece of 366 apartments in more than 40 buildings on 16 acres of Texas.

Ruel tries to get out of the 27.5 year residential realty life by deconstructing the entire building, via an analysis by MS Consultants, to accelerate depreciation deductions. He’s literally throwing in the kitchen sink (or sinks: there are hundreds of them).

I remember seeing this gambit played before the Tax Reform Act of 1986, and even after that by a few hardy souls. Like auto racing, it can be fun, but dangerous.

I won’t quote, much less try to paraphrase, Judge Holmes’ 61 pages of analysis, beginning with a property description that beats any broker’s set-up I ever saw, and marches resolutely through the maze of regulations, statutes both current and repealed, and a maze of decided cases. But any tax professional, who has to deal with what is a structural component and what is personal property, and the various class lives of the latter, should read and heed.

Another gem this date is Michael A. Scott, 2012 T.C. Mem. 65, filed 3/12/12. Mike is a dentist who claims he made no money for the years at issue. When IRS challenges this assertion, Mike fires off letters to banks, threatens to sue bank employees, tries to quash IRS subpoenas, and is less than credible on the witness stand, according to Judge Halpern.

I’ll digest the 50 pages of this decision thus: if you want a blueprint for how to be adjudged a tax fraud and subject to the Section 6663(a) 75% solution, just follow Mike’s example. Better yet, don’t.

No decisions out of Tax Court on 3/9/12, so a couple of orders caught my wide unwinking eye.

First is William Craig Soucy, Docket No. 596-12. It’s a short tale, told by Judge Colvin, thus: “On March 6, 2012, respondent filed a Motion To Dismiss for Lack of Jurisdiction on the ground the notice of deficiency was issued after the expiration of the period for assessment and collection provided under I.R.C. section 6501(a). Respondent states in the motion to dismiss that petitioner does not object to the granting of the motion.

“It is well settled that an allegation concerning the expiration of the period of assessment and collection is an affirmative defense and not a plea to the jurisdiction of this Court. Badger Materials, Inc. v. Commissioner, 40 T.C. 1061 (1963); see also Robinson v. Commissioner, 57 T.C. 735 (1972).” Order, at p. 1.

No reason why petitioner should object, the SOL has run and IRS is literally Sans Soucy (sorry, guys). But SOL, as Judge Colvin points out, is an affirmative defense. It has to be pled and proven. So he tells IRS and Sans to file a status report, or better still, submit decision documents.

Next is Albert Bront and Victoria Y. Pavlenko, Docket No. 16198-10S. Al was an IRS Grade 14 Revenue Agent gone to the Dark Side. DOJ claimed he filed false tax returns, helped others to do so, and capped off his career by threatening to assault and murder a Federal law enforcement agent officer in violation of 18 U.S.C. section 115(a)(1)(B). Al pled guilty to a count of Section 7206(1) violation, and two counts of Section 7206(2) violations, all of which were either filing false returns himself, or assisting others in that nefarious practice.

Judge Wherry takes up the story at page 3 of the Order: “…Mr. Bront appeared with his criminal counsel in front of the Honorable Otis D. Wright and entered his plea of guilty to counts 4, 10, and 13 of the first Superceding Indictment [The Section 7206 violations.]. After an extended discussion with Mr. Bront, the court found that the plea was a knowing and voluntary plea supported by an independent basis in fact containing each of the essential elements of the offense and accepted Mr. Bront’s guilty plea.

“… the United States District Court for the Central District of California entered a judgment of guilty as to counts 4, 10, and 13 of the First Superceding  Indictment. Mr. Bront has appealed the judgment insofar as it relates to his sentencing and the computation of tax loss. Mr. Bront has taken no action in the United States District Court or on appeal to withdraw his guilty plea.” Order, at  p.3.

Now Al wants to dispute certain adjustments to his tax return for one year at issue, and incidentally the Section 6663 civil fraud penalty IRS wants to tag him with.

IRS says “collateral estoppel. You pled guilty to fraud, so you can’t try to undo the effects.”

Judge Wherry gives the short course on issue preclusion, a/k/a collateral estoppel: “Statements made by a taxpayer in a prior case, whether written or oral, are judicial admissions and bind the taxpayer in future actions.

“Collateral estoppel precludes a party to a prior suit from relitigating in a later suit issues of fact and law that were actually and necessarily decided by the prior court in reaching judgment in the prior suit. It exists for ‘the dual purpose of protecting litigants from the burden of relitigating an identical issue and of promoting judicial economy by preventing unnecessary or redundant litigation.’ There is no difference between a judgment of conviction based on a guilty plea and one rendered after a trial on the merits.

“For Federal tax litigation, collateral estoppel applies when (1) the issues of law and fact in the second suit are the same as the issues in the first suit; (2) a court of competent jurisdiction has rendered a final judgment; (3) the parties in the second suit are the same or in privity with the parties in the first suit; (4) the issues were actually litigated in the first suit; and (5) the controlling facts and legal principles are unchanged.” Order, at pp. 3-4. (Citations omitted.)

Al claims he’s going to bring a habeas corpus proceeding, and therefore his conviction isn’t final, but he hasn’t done so, and even if he did, the conviction is still a conviction until overturned. Even then, his admissions are admissible in a civil proceeding.

OK, Al is estopped, right? Not quite, says Judge Wherry: “The problem is that Mr. Bront never agreed to the specific factual allegations contained in the First Superceding Indictment regarding his 2006 tax year and the ones respondent argues he should be estopped from contesting. We agree with respondent that ‘a guilty plea is an admission of all the elements of a formal criminal charge.’ But establishing specific tax liabilities is not an element of section 7206(1) and consequently none need to be determined.” Order, at pp. 5-6 (Citations and footnote omitted).

So even though Al hasn’t formally petitioned, he asked in a status report to prove his return was in fact correct, and Judge Wherry will give him a shot.

Even better, Al isn’t estopped to challenge the Section 6663 fraud penalty. He did say in his Plea Agreement: “’[he] is liable for the fraud penalty imposed by the Internal Revenue Code, 26 U.S.C. § 6663, on the understatement of tax liability for tax years 2003, 2004, 2005, 2006, and 2007.’ But Mr. Bront was never found guilty of this by the District Court for the Central District of California nor was this issue fully litigated, and therefore Mr. Bront is not estopped from contesting his liability for the civil fraud penalty of section 6663.” Order, at p. 7 (footnote omitted, but read it, it’s more useful stuff about collateral estoppel).

And though Al’s statements might be construed as judicial admissions, those relate to facts, not law. A defendant’s admissions are not conclusive on a question of law.

Good learning here, even if it doesn’t make the Decisions page.

Spring is coming, so it’s time for baseball. And here’s an example of an old baseball phrase, courtesy of  Judge Wells, in Kenneth Melvin Pisetzner, 2012 T.C. Mem. 64, filed 3/8/12, a special date for a certain employee of Apple Corp.; happy birthday!

Back to K-Mel’s problem. He filed his return for the year at issue but didn’t pay the tax shown thereon. IRS assesses tax as shown,  sends Notice of Intent to Levy, and K-Mel asks for a CDP.

One tele-hearing is set, but K-Mel asks for adjournment. Granted, but K-Mel must file Form 433-A, the wage earner show-and-tell by the adjourned date.

K-Mel asks for second adjournment, as he needs his accountant’s help with “the form”, and said accountant is recuperating from surgery. Adjournment granted.

Next time the AO asks for adjournment, as she is on emergency leave. She adjourns CDP tele-hearing for approximately 60 days. In her letter, “(S)he wrote:  ‘Please be advised that we will make a determination in the Collection Due Process hearing you requested by reviewing the Collection administrative file and whatever information you have already provided. If you would like to provide information for our consideration, please do so within 13 days (August 17, 2011) from the date on this letter.’ On August 15, 2011, petitioner mailed [the AO] a letter requesting to reschedule the conference for after Labor Day because petitioner planned to be on vacation during the scheduled conference. [The AO] received petitioner’s letter on August 19, 2011, and she denied his request to reschedule the conference. Instead, she reviewed the information in the file and, on the basis of that information, issued a notice of determination sustaining the proposed collection action.” 2012 T.C. Mem. 64, at pp. 4-5.

Needless to say, there was no Form 433-A in the file, because K-Mel never sent one. He claims the AO never sent him the Form 433-A, but Judge Wells knocks that one out of the park. “Although petitioner does not dispute that he failed to submit a Form 433-A, he contends that the reason he failed to submit a completed Form 433-A is that [the AO] never sent him a Form 433-A. However, petitioner’s contention that [the AO] never sent him a Form 433-A is contradicted by his own letter to [the AO] dated May 31, 2011. In that letter, he referred to the ‘complex form’ sent to him by [the AO] and the ‘form and accompanying documents’ that he needed to submit to her. Accordingly, we conclude that petitioner did receive the Form 433-A from [the AO]. Although he had months to complete the Form 433-A and submit the accompanying documents, he failed to do so.” 2012 T.C. Mem. 64, at p. 5.

K-Mel had plenty of time to submit the Form 433-A. He didn’t. “Despite [the AO]’s warning in her August 4, 2011, letter that she would proceed with her review of petitioner’s case on the basis of the administrative file if petitioner failed to contact her at the scheduled time on August 17, 2011, petitioner failed to contact her at the scheduled time. His written request to reschedule the telephone conference was not timely. As we explained in Roman v. Commissioner, T.C. Memo. 2004-20: ‘The statute only requires that a taxpayer be given a reasonable chance to be heard prior to the issuance of a notice of determination.’ We conclude that petitioner was given a reasonable chance to be heard and that [the AO] did not prematurely conclude the hearing.” 2012 T.C. Mem. 64, at p. 7.

Judge Wells concludes that IRS was neither arbitrary nor capricious, and acted with a sound basis in law. K-Mel, yer out.

Takeaway: if you want an adjournment, request same timely.  File the show-and-tell form. And call before you write.

Judge Wherry, Of All People

Who says Tax Court cases, and Tax Court judges, can’t be whimsical? Judge Wherry struts his whimsical stuff in Tonda Lynn Dickerson, 2012 T.C. Mem. 60, filed 3/6/12.

Tonda was a Waffle House waitron whose dream came true. She hit the FL lottery for $10 million without even buying a ticket. While Tonda was table-hopping one fine day in her hometown, Grand Bay, AL, a Mr. Edward Seward, himself a whimsical gentleman who would go off to FL to buy fistfuls of lottery tickets and give them to his favored waitstaff (gambling being illegal in AL at the time), left her a ticket in a plain sealed envelope. Neither Mr. Seward nor anyone else knew the ticket was worth a lot more than I or the greatest number of my readers will ever see, in this world or the next. Like the aforesaid $10 million.

Tonda checked the number and had her Daddy confirm it: she was wealthy beyond the dreams of any but a Wall Street hedgefundie. Tonda claims she had an agreement with her family to split the proceeds of any such windfall, so she and Daddy, with the help of a local abogado, form an S Corp, hand out shares to the famiglia, and go off to FL to grab the booty.

Don’t be shocked, but Tonda’s fellow waitrons claim they had an agreement to split if ever Seward’s Folly hit, and try to enjoin FL from handing over anything to anybody. The waitrons win below, but ALSC (Alabama Supreme Court) tosses them, because contracts bottomed on gambling are illegal in Alabama, suh.

Then the inadvertent bestower of unguided largesse, Mr. Seward, demands a piece of the action, but he, too, is sent empty away, courtesy of ALSC.

So FL disgorges to Tonda et famille. Happy ending? Not so fast. Comes now Toya Sue Washington, Esq. Toya Sue, an attorney in the IRS Estate Tax Division, demands a 709 from Tonda. Tonda to Toya: no tax due. Toya to Tonda: wrong, bitsy, y’all owe Oncle Sam’l $771,570, plus interest. Gift tax, y’know.

Daddy files petition for Tonda, and we’re off to the races. Judge Wherry, under such delightful captions as “I. She’s Got a Ticket to Ride”, “II. Family Values”, “III. Inc.-ing the Deal”, “IV. Eye on the Booty” (good one, Judge!), “V. House of Waffling”, and “VI. Looking a Gift Horse in the Mouth”, unpacks the facts.

Now the humor ends. Tonda, while she may be a loyal child, can’t prove there was a contract to share. While the family were generous toward one another, there was no writing, no systematic chasing after lottery gold, and anyway the booty was split otherwise than equally this time, unlike the other times when there was joy to share.  And you did no business, so there was no partnership. In any case, the law of the Sovereign State of Alabama says it’s illegal to make contracts based on gambling, and that’s what got the Waffling Waitrons and the generous Mr. Seward tossed.

Pay up, Tonda.

And a Heavy Duty Penalty

Two Tax Court cases filed 3/5/12 each illustrate a point.

First is a “not-for-nuttin’” section 7463, Paul Michael Gritz and Janice Lee Gritz, 2012 T.C. Sum. Op. 20.

Paul’s story is the usual unsubstantiated employee business expenses and disallowed commuting costs. Paul was a pilot who flew from various airports, all in the general vicinity of his home. His employer reimbursed him for travel between airports, but Paul had to pick up the tab from home to whichever airport he was flying out of. He tried to deduct those expenses. No, says Judge Ruwe, commuting (homeplace to workplace and back) is personal. “It is well settled that, as a general rule, the expenses of traveling between one’s home and his place of business or employment constitute commuting expenses which are nondeductible personal expenses, while the costs associated with travel between work assignments are deductible. See Fausner v. Commissioner, 413 U.S. 838 (1973); Commissioner v. Flowers, 326 U.S. 465 (1946); Feistman v. Commissioner, 63 T.C. 129 (1974); Heuer v. Commissioner, 32 T.C. 947; see also secs. 1.162-2(e), 1.262-1(b)(5), Income Tax Regs.” 2012 T.C. Sum. Op 20, at p. 8.

Janice Lee’s story is more interesting. Schoolteacher Janet Lee bought a computer, manuals and similar items that she claimed she needed for her job, and expensed them. She could have claimed reimbursement from her school, but chose not to. Here’s her story: “…Mrs. Gritz consciously elected not to be reimbursed for her expenses, because if she were reimbursed, the items purchased would belong to the school district. Petitioners specifically indicated that they found reimbursement to be unappealing because Mrs. Gritz desired to amass a personal library of books and electronic devices. When an employee has a right to reimbursement for expenditures related to her status as an employee but fails to claim reimbursement, the expenses are not deductible because they are not “necessary”; i.e., it is not necessary for an employee to remain unreimbursed for expenses to the extent she could have been reimbursed. Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), aff’g T.C. Memo.1984-533; Lucas v. Commissioner, 79 T.C. 1, 7 (1982).” 2012 T.C. Sum. Op. 20, at p. 11.

Part Two is how to get a Section 6673(a) frivolity penalty equal to three-quarters of your gross income. Performing this feat is Dennis C. Jackson, 2012 T.C. Mem. 58. I’ll spare you the particulars. This tale goes back to 1999, but the year at issue here is 2002.

Judge Thornton: “Petitioner’s deemed admissions establish that in 2002 he received income of $21,179. This amount is made up of net gains from the sale of stock, interest, dividends, royalties, partnership gains, and retirement income from a pension fund, as reported to the IRS by third parties. Under the Code, these items are clearly taxable. See sec. 61(a)(3), (4), (6), (7), (11), (13). Petitioner has not expressly disputed receiving any of this income or presented any evidence or made any judicially cognizable argument to properly challenge his 2002 underlying liability. Instead, petitioner has espoused frivolous and groundless arguments, including, notably, the argument that he made in objecting to respondent’s request for admissions, that the amounts and sources of his 2002 income are ‘irrelevant’. This argument appears to emanate from his nonsensical contention, as appears repeatedly in his petition and in other materials filed with this Court, that he is not liable for Federal income taxes because he is not a ‘taxpayer’.” 2012 T. C. Mem. 58, at pp. 14-15.

Well, he mightn’t have been a taxpayer before, but he sure will be now, as Judge Thornton socks ol’ Denny with a $15,000 Section 6673(a) penalty.

He Can Split the Interest Deduction, But Can’t Double-Up

That’s Judge Cohen’s conclusion, based on the “plain, everyday” meaning of the language of Section 163(h), the qualified personal residence interest section. The cases are Charles J. Sophy and Bruce H. Voss, 138 T. C. 8, filed 3/5/12.

Sophy and Voss weren’t married during the years at issue, but were joint tenants (co-owners) of two different residences, one principal and one secondary, during those years, and mortgaged the residences up to the hilt, some $2.7 million worth. Each claimed the one-and-one interest deduction, one million acquisition and one hundred thousand equity. No, says IRS, you are limited to one-and-one split between you, in whatever proportion you want, even though marrieds filing separately are limited to $500K, per Section 163(h)(3)(B)(ii).

IRS relies on a Chief Counsel Advice, C.C.A. 200911007 (Mar. 13, 2009). This Chief Counsel Advice states: “[T]he $1,000,000 limitation on acquisition indebtedness under §163(h)(3)(B)(ii) is used to determine the portion [of] Taxpayer’s interest payments that may be deducted. In particular, the amount of interest Taxpayer may deduct is determined by multiplying the amount of interest actually paid by Taxpayer on Taxpayer’s qualified residence by a fraction the numerator of which is $1,000,000 and the denominator of which is * * * the average balance of the outstanding acquisition indebtedness during the years in question.” 138 T.C. 8, at pp. 5-6.

Sophy and Voss argue that the one-and-one for marrieds is a “marriage penalty”, but Judge Cohen isn’t going there. Judge Cohen: “We begin our analysis by looking closely at the definitions of acquisition indebtedness and home equity indebtedness in section 163(h)(3)(B)(i) and (C)(i). The acquisition indebtedness definition uses the phrase ‘any indebtedness which is incurred’ in conjunction with ‘acquiring, constructing, or substantially improving any qualified residence of the taxpayer and is secured by such residence.’ We note that the word ‘taxpayer’ in this context is used only in relation to the qualified residence, not the indebtedness. Similarly, the operative language in the definition of home equity indebtedness is ‘any indebtedness’ that is secured by a qualified residence (other than acquisition indebtedness). Sec. 163(h)(3)(C)(i). Once again, the phrase ‘any indebtedness’ is not qualified by language relating to an individual taxpayer.” 138 T. C. 8, at p. 11.

Judge Cohen goes on: “From Congress’ use of ‘any indebtedness’ in the definition of acquisition indebtedness, which is not qualified by language regarding an individual taxpayer, it appears that this phrase refers to the total amount of indebtedness with respect to a qualified residence and which is secured by that residence. The focus is on the entire amount of indebtedness with respect to the residence itself. Thus when the statute limits the amount that may be treated as acquisition indebtedness, it appears that what is being limited is the total amount of acquisition debt that may be claimed in relation to the qualified residence, rather than the amount of acquisition debt that may be claimed in relation to an individual taxpayer.” 138 T. C. 8, at p. 12.

Finally, “(A)lthough we have reached our conclusion by reviewing the language of the statute, nothing in the legislative history of the section 163(h)(3) indebtedness limitations suggests that Congress had any other intention than what we have determined from an examination of the language. We conclude that the limitations in section 163(h)(3)(B)(ii) and (C)(ii) on the amounts that may be treated as acquisition and home equity indebtedness with respect to a qualified residence are properly applied on a per-residence basis.” 138 T.C. 8, at p. 16.

Especially not since Sophy’s choice of interpretative language would give same-sex or other unmarried couples a better tax deal than married couples. But nice try, guys.

But Innocence Helps Too

Such is the story of Norma L. Slone, Transferee, et al, 2012 T.C. Mem. 57, filed 3/1/12. This is the story of the Slone Family and their encounter with the infamous Midcoast Credit Corp. (see my blogpost “A Good Day for Taxpayers”, 3/15/11). Like the taxpayers in Griffin and Starnes (both cases cited in Slone), the transferees, pure in heart, walk away clean.

It’s the same old story. Daddy Jim Slone was a DJ-turned-station-owner, and built the family broadcasting empire, all concentrated in a C Corp. Daddy sells to a local mogul; as usual,  basis zero, gain astronomical. The sale is an asset sale, and the C Corp pays the first installment of tax. While the sale is pending, C Corp’s accountant gets a feeler from a Midcoast stooge. The accountant does nothing until the closing is past. The C Corp makes no distribution of the sales proceeds post-closing.

Post-closing, the accountant and various lawyers check out the stooge, which is acknowledged to be a Mid-Coast entity, and, when the stooge appears legit, Norma and Daddy Jim agree to sell the stock of the C Corp to the stooge. The stooge has financing from Rabobank, and the deal closes, the stooge undertaking to assume the tax liability of the C Corp.

The rest is the usual story. The stooge does the mix-and-match with a phony tax loss to offset the gain, grabs the cash in the C Corp, and diddles around with IRS for as many years as it can get away with, finally collapsing under the weight of a $23 million deficiency.

Oh, did I mention the stooge never paid Penny One of the tax due?

IRS goes after Daddy Jim and Norma and their various trusts, as transferees. First Daddy Jim and Norma argue SOL, but that’s a nonstarter because of the stooge’s extensions of the SOL. Next Daddy Jim and Norma argue the stooge’s officer who signed the Form 872s extending the SOL had no authority, but Judge Haines finds “ostensible authority”, or what we called “apparent authority” in my young day, Far Above, etc.

First IRS claimed the deal was an “intermediary” transaction (a/k/a step transaction), but switched out of that theory because of the time lag between asset sale to local mogul and stock sale to stooge. Then IRS switches to substance over form: however the deal looked on paper, it was a sham, marrying a phony loss to a real gain. The stock “sale” was in fact a liquidating distribution from the C Corp, says IRS.

No, says Judge Haines: “We will respect the form of the transactions in this case. Respondent [IRS] has conceded that the asset sale was independent from the stock sale. The asset sale was negotiated by a media broker with Mr. Roberts providing accounting advice and Mr. Chandler legal advice. Mr. Roberts credibly testified that no tax strategies to offset the potential gain arising from the asset sale were discussed before the closing of the asset sale. The asset sale closed on July 2, 2001, more than five months before the closing of the stock sale. Slone Broadcasting’s [the C Corp] first installment of $3,100,000 of Federal income tax attributable to the asset sale was paid. There is no evidence that Fortrend, Midcoast, or Berlinetta [the three stooges] was involved in any way in the asset sale, nor is there any evidence that a sale of stock was anticipated at the time that the asset sale was negotiated and closed.” 2012 T. C. Mem. 57, at pp. 22-23.

Moreover: “Due diligence confirmed that Midcoast was a legitimate player in the debt collection industry and Fortrend and Midcoast had reputable law and accounting firms representing them. The purchaser of the stock, Berlinetta, was capable of closing by using funds provided by loans from Rabobank and other assets it owned. Berlinetta agreed that it would not use the assets of Slone Broadcasting for 10 days after the closing of the stock sale.” 2012 T.C. Mem. 57, at p. 23.

In fact, Daddy Jim, Norma and their advisers asked about Midcoast’s tax strategy, and got the brush-off from the Midcoast stooge. “Petitioners had no reason to believe that Fortrend’s methods were illegal or inappropriate. When Mr. Roberts and Mr. Phillips asked Fortrend for more information about how Berlinetta planned to offset the gains from the asset sale, they were told that Fortrend’s methods were ‘proprietary’. Petitioners did not have a duty to inquire further and are not responsible for any tax strategies Berlinetta used after the closing of the stock sale.” 2012 T.C. Mem. 57, at p. 24.

In a footnote, Judge Haines catalogs all the Midcoast cases, with the won-loss record, and it’s worth reading (2012 T. C. Mem. 57, footnote 9 at page 25).

Takeaway: Trust, verify–as far as reasonably possible. And don’t know too much.

To take a leaf from Stephen Sondheim’s and Leonard Bernstein’s song “When You’re a Jet” from the 1957 hit musical “West Side Story”. In this case, a 501(c)(3) exemption doesn’t disappear, even though the corporation did pay unrelated business income tax (UBIT) in three years of its hundred-year life, and unrelated debt-financed income tax (UDFIT) in two other years, when the corporation gets an employer reversion from a qualified retirement plan. That would ordinarily trigger a Section 4980(a) 20% excise tax.

But Research Corporation dodges the proverbial bullet in the eponymous case, Research Corporation, 138 T.C. 7, filed 2/29/12, a leap year bonus from Judge Haines. It’s a case of first impression.

Briefly, Research was a 501(c)(3) from the day 501(c)(3) first showed up in IRC 1954. Research was incorporated in 1912, and was exempt when the income tax was first inflicted in 1916. Research did have some UBIT to pay back in the 1950s, and some UDFIT in the early years of the current millennium.

Research had a defined benefit retirement plan for its employees from 1961 until 2003, which from inception through amendment always got favorable letters from IRS. In 2002, Research terminated the plan, setting up a $5.8 million reversion, but rolled 25% of that into a new plan, having gotten a favorable PLR that the reversion would not constitute UBTI to Research under Section 512(a)(1) (but interestingly, Research withdrew the part of its ruling request relating to Section 4980 treatment).

Research filed Form 5330 with respect to the reversion for 2003, but only paid the ratio that its lifetime UBIT and UDFIT bore to its entire income for three years, around $14K. IRS issued a SNOD for the whole enchilada, around $4.4 million, in 2010, claiming that by filing the Form 5330 and paying the $14K, Research conceded its liability for the Section 4980 excise tax.

Judge Haines blows off the concession argument in a footnote: “We do not view either the submission of Form 5330 or the statement as a concession. We note that all concessions are subject to the Court’s discretionary review and may be rejected in the interests of justice. If the submission of the Form 5330 and the statement contained therein can be viewed as a concession, we reject it. Petitioner has maintained throughout this proceeding in its petition and its briefs that it is not subject to excise tax.” 138 T.C. 7, at p. 6, footnote 2 (Citation omitted).

IRS conceded that Research never made any contributions to any of its employee plans to offset either UBIT or UDFIT whenever it owed any,  so no tax benefit inured to Research from any contributions.

Also of interest, Research never raised SOL, even though the SNOD was issued more than six years after the filing of the Form 5330, so Judge Haines deemed the argument waived. Possibly Research didn’t raise SOL because it also sought a refund of the $14K in the case (but it loses on that one on Section 6512(b)(3) grounds…too many years gone by since filed and paid, so no Tax Court jurisdiction to award a refund).

The whole case goes off on Section 4980(c)(1)(a). The excise tax applies to a “qualified plan”. IRS claims Research’s plan was qualified; Research says no. The magic language: “The term ‘qualified plan’ means any plan meeting the requirements of section 401(a) or 403(a), other than a plan maintained by an employer if such employer has, at all times, been exempt from tax under subtitle A. Sec. 4980(c)(1)(A).” 138 T.C. 7, at pp. 8-9. (Emphasis by the Court.)

But Research wasn’t “at all times” exempt, says IRS. They paid UBIT three times, and UDFIT twice, since 1954.  Those are both Subtitle A taxes, so Research wasn’t exempt at all times.

Judge Haines buries that argument with Section 501(b), as to the plain meaning of which he finds that, notwithstanding the UBIT and UDFIT, which Section 501(b) states does not disqualify a 501(c)(3) like Research, Research never lost its 501(c)(3) exemption.

IRS says it’s not seeking disqualification of Research as a tax-exempt, but to collect an excise tax, not an income tax. More magic language from Judge Haines: “Respondent [IRS] would like us to ignore the plain language of section 501(b), which provides that a section 501(c)(3) organization shall be subject to tax to the extent it has UBTI but, notwithstanding any unrelated business income tax paid, the organization ‘shall be considered an organization exempt from income taxes for the purpose of any law which refers to organizations exempt from income taxes’.” 138 T.C. 7, at p. 12. (Emphasis by the Court.)

Any law means any law. And the issue isn’t whether Research or any 501(c)(3) ever paid any tax. It’s whether Research was exempt under Subtitle A, because that’s what the plain language says.

IRS wants Tax Court to look at legislative history. Not necessary, says Judge Haines, because no ambiguity. But he’ll humor IRS. Here’s IRS’ last hope: “‘The agreement provides that the excise tax does not apply to a reversion to an employer that has at all times been tax-exempt. Of course, this exception does not apply to the extent that such employer has been subject to unrelated business income tax or has otherwise derived a tax benefit from the qualified plan.’ H.R. Conf. Rept. No. 99-841 (Vol. II), at II-483 (1986), 1986-3 C.B. (Vol. 4) 1, 483.” 138 T.C. 7, at p. 16. IRS says the sentence is disjunctive, and therefore either portion applies; so if Research ever paid UBIT, they must pay excise tax on the whole unrolled-over reversion.

No, says Judge Haines: “We do not agree with respondent’s argument. Respondent [IRS] ignores the phrase “to the extent”. That phrase limits the application of the legislative history to a specific set of facts. When coupled with the phrase “or has otherwise” the legislative history addresses a set of facts where the tax-exempt organization, whether it incurred unrelated business income tax or not, derived a tax benefit from the qualified plan. Respondent has conceded that petitioner did not derive a tax benefit from the plan.” 138 T.C. 7, at pp. 16-17.

So Research loses the $14K refund in Tax Court, but dodges the $4.4 million bullet. Not a bad swap.

When It Comes to SE Tax

 A net operating loss (NOL) from a trade or business, whether operated as a partnership or derived from from self-employment, whether carried forward or carried back, is generally a valid deduction. But where? Here’s the story of Joe Decrescenzo, or more properly, Joseph Decrescenzo, 2012 T.C. Mem. 51, filed 2/27/12, Judge Marvel at the helm.

Joe was a CPA who got a heavy-duty SNOD. After extensive negotiations between Joe and IRS, the only thing left for determination was where Joe could take a $51K NOL, on his Schedule C or on his 1040. If on his 1040 and not his Schedule C, he owes $15K in SE tax.

After Joe’s arguments about burden of proof are dismissed (there’s nothing to prove, as he and IRS stipulated everything but the one question of law), Judge Marvel goes to the magic language of Section 1402(a)(4): “'(E)arnings from self-employment’” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss–

* * * * * * *

(4) the deduction for net operating losses provided in section 172 shall not be allowed;” 2012 T.C. Mem. 51, at p. 8.

Joe argues that paragraph (4) applies only to partnerships, not individuals like him, since paragraph (5) begins with the word “if”, and goes on to discuss partnerships. Judge Marvel buries that one in a footnote: “Petitioner contends that para. (4) of sec. 1402(a) does not apply to individuals but instead applies only to partnerships. He contends that, because para. (5) of sec. 1402(a) begins with the word “if,” para. (4) of sec. 1402(a) is applicable only if the taxpayer meets the requirements of either subpar. (A) or (B) of sec.  1402(a)(5). Paragraphs (1)-(17) of sec. 1402(a) set forth specific rules for computing net earnings from self-employment. Each numbered paragraph contains a separate rule. Paragraph (4) of sec. 1402(a) operates independently of para. (5) of sec. 1402(a), and the application of para. (4) of sec. 1402(a) is not dependent on the taxpayer’s satisfaction of subpar. (A) or (B) of sec. 1402(a)(5).” 2012 T. C. Mem. 51, at p. 9, footnote 6.

There’s a bushelbasket of cases holding you can’t take NOL against SE. Joe tries to distinguish only one, and fails.

So Joe has the deduction on his 1040. But since he stipulated to the additions to tax if he lost on the SE, he owes those. He tries to get out of the stipulation, saying he suffers from acute anxiety disorder and couldn’t attend the trial, but Judge Marvel kicks that one to the footnotes again: “While petitioner argues that he was unable to appear at trial because of an acute anxiety disorder, he introduced no evidence that he was suffering from the acute anxiety disorder at the time he executed the stipulation. See King v. Commissioner, 121 T.C. 245, 252-253 (2003). Petitioner is bound by the stipulation of settled issues.” 2012 T. C. Mem. 51, at p. 11 (continuation of footnote 8 from p. 10).

I can understand anyone being acutely anxious about taxes, even a CPA like Joe.