And Tax Court Can’t Review Why IRS Didn’t Get

Is Section 7623(b) a toothless lion? Unless, of course, you’re a Swiss moneylaunderer and tax evasion facilitator, doing time for your peccadilloes.

Maybe. See Raymond Cohen, 139 T. C. 12, filed 10/9/12, Judge Kroupa laying down the law. And see my blogposts, “Qui Tam?”, 9/12/12, “Whistleblowers, Beware!”, 9/7/11, and “The Whistleblower Blows It”, 6/20/11.

Briefly, a whistleblower gets paid if, and only if, IRS gets paid based on info provided by whistleblower and not publicly available.

If IRS doesn’t get paid for any reason, including but without in any way limiting the generality of the foregoing (as the high-priced lawyers say), IRS doing nothing for any reason or for no reason, whistleblower doesn’t get paid.

IRS can refuse to proceed arbitrarily, capriciously or stupidly, and Tax Court has nothing to say. Tax Court has no jurisdiction to review IRS’ determination to proceed or not to proceed.

Ray blew the whistle on a bunch of uncashed dividend checks his wife found when she was administering a decedent’s estate, claiming they were unreported income. IRS’ Ogden whistleblowing crew looked at it and said “we didn’t get any money, so you’re out”. Ray asked for a reconsideration, and Ogden said “no, but this time we say no because you used publicly available information (like a class-action lawsuit and the State’s unclaimed property website).”

The arguments: “This case presents an issue of first impression in this Court. We are asked to decide whether any relief is available under section 7623(b) when a taxpayer alleges that the Commissioner denied a claim without initiating an administrative or judicial action or collecting proceeds. Petitioner contends that respondent abused his discretion by not acting on his information. Petitioner argues respondent must explain the reason he denied the claim and reopen the claim. Respondent contends we can provide relief under section 7623(b) only after the Commissioner initiates an administrative or judicial action and collects proceeds.” 139 T. C. 12, at p. 5.

Ray argues IRS will bounce his claim, take his info, grab the money and pay him nothing. That’s not fair. Maybe not, says Judge Kroupa, but: “This Court, however, is not a court of equity and section 7623 does not provide for equitable relief. See Commissioner v. McCoy, 484 U.S. 3, 7 (1987); Stovall v. Commissioner, 101 T.C. 140, 149-150 (1993). Section 7623(b) does not provide any relief before whistleblower information leads to an administrative or judicial action and the collection of proceeds.” 139 T. C. 12, at p. 9.

Of course, there is the usual “so sad, too bad” finale: “We can appreciate petitioner’s frustration that information that he believes is actionable was not pursued. Congress, however, has charged the Commissioner with resolving these claims and has not provided any remedies until after an administrative or judicial action and the collection of proceeds.” 139 T. C. 12, at p. 9.

Want to close the tax gap, Congress, without increasing IRS’ budget? How about a more user-friendly whistleblower statute?

That’s Judge David Gustafson; by way of illustration of the foregoing, as the high-priced lawyers say, see my blogpost “We’ll Come to You”, 9/18/12, where I describe how Judge G offered to conduct John Carter’s trial in the prison where John was a-servin’ of his time.

Tax Court is closed today, 10/8/12, so no decisions or orders issued. I was suffering from Tax Court withdrawal, so I found an order of Judge G’s from 10/5/12, Michael J. Sylvia III, Docket No. 23908-11. Judge G helps Mike out by answering four questions Mike poses in his pre-trial brief, and incidentally showing what frivolous arguments are and the consequences thereof.

Candidates for the RTRP qualification  won’t be asked questions like these on their exam, although maybe they should be.

Judge G: “1. ‘Is the notice of deficiency valid?’ The apparent answer to his question is: yes. Mr. Sylvia’s point seems to be that the notice of deficiency is based on reports from third parties of amounts that they paid to Mr. Sylvia, and he challenges those reports. A taxpayer may indeed raise a ‘reasonable dispute’ about third-party reporting. See section 6201(d). However, it appears (though we cannot yet determine finally) that the nature of the challenge is that Mr. Sylvia contends that the amounts reported to do not constitute taxable income for various frivolous reasons. If, as he seems to admit, the payors on the reports really did pay money to Mr. Sylvia in exchange for his work or property, then the amounts are taxable, and the notices of deficiency would be upheld in that regard.

“2. ‘By what statute, if any, has the petitioner been made liable for a tax?’ The answer is: section 1 of the Internal Revenue Code (26 U.S.C.).

3. ‘Was the petitioner engaged in an activity that is subject to tax?’ The income tax is imposed not on activities but on ‘income from whatever source derived’, including ‘[c]ompensation for services’. I.R.C. sec. 61(a)(1). For example, if Mr. Sylvia was paid compensation for his labor, then that compensation is taxable income.

4. ‘Does the petitioner have zero basis in his labor? Yes. ‘The argument that a taxpayer has a basis in labor equal to its fair market value would effectively eliminate taxes on wages and is frivolous.’ Beard v. United States, 580 F.Supp. 881, 882 (E.D.Mich.1984).” Order, p. 1.

Then Judge G tells Sylvia all about it: “America is a free country, and citizens have the right to advocate for their views, to petition for redress of grievance, and to lobby Congress for the revision of our laws. However, no one has the right to make doomed, frivolous arguments in Tax Court litigation only to delay the inevitable assessment of their obvious tax liability.” Order, p. 2.

And Judge G tells Sylvia to play fair or expect a Section 6673 penalty if he doesn’t.

Can’t wait for the decision.

And,  “Lift Up Thy Voice”

Twofers from Tax Court today, 10/4/12, the tales of the two Bobbys.

First Bobby is Robert S. Yarish and Marsha M. Yarish, 139 T. C. 11, filed 10/4/12. It’s all Bobby’s problem, as his ESOP craters in 2004 retroactive to Day One (2000). Judge Kroupa, unraveller of tangled webs, has the floor: “Respondent (IRS) determined in the revocation letter that the Yarish ESOP did not meet the requirements under section 401(a) for failing to satisfy section 410(b) and that the trust under the Yarish ESOP was not exempt from tax under section 501(a). This Court sustained respondent’s determination to retroactively disqualify the Yarish ESOP for the 2000 to 2004 taxable years. See Yarish Consulting Inc. v. Commissioner, T.C. Memo. 2010-174.” 139 T. C. 11, at p. 4.

Apparently Bobby’s ESOP was a fable, because it was a Sub S holding corporation ESOP and disqualified. See my blogpost “The Unanswered Question”, 6/13/12, involving a Nonqualified Sub S ESOP that gets by when it dissolves.

So Bobby claims that, since 2004 is the only open year when he gets hit, he only need pay tax on the contributions made to his now-defunct ESOP for that year, relying on the “(other than the employee’s investment in the contract)” parenthetical in Section 402(b)(4)(A). This provision requires the disqualified beneficiary to pay tax on whatever he gets (in this case $2.43 million) less whatever he contributed or his employer, his captive Sub S, contributed for him.

OK, but does he pay tax on the whole enchilada or only what accretions there were in 2004, the only open year? Case of first impression, and no disputed facts, so Judge Kroupa has to parse the statute and grant summary judgment.

IRS argues that the only “employee’s investment in the contract” is what the employee actually paid tax on, and Bobby never paid tax from Dime One until now, so Bobby owes everything, whenever it accrued to his benefit, and as he was fully vested in the exploded ESOP from Day One, he owes tax from Dime One.

Bobby argues that the magic words, not defined in Section 402 but as defined in Section 72, are terms of art but Judge Kroupa isn’t buying: “First, petitioners argue that ‘investment in the contract’ as defined in section 72 is an established term of art that applies universally throughout the Code and thus we should look to section 72 for its definition. We recognize that where Congress uses a term of art that has had an established specific meaning over long periods, Congress presumably incorporates that meaning when it uses the term. We disagree, however, that the phrase ‘investment in the contract’ is an established term of art.

“While section 72 defines the phrase ‘investment in the contract,’ nowhere in that section or its accompanying regulations is there any indication that the definition applies outside the context of section 72. Moreover, the definition of ‘investment in the contract’ in section 72 that petitioners argue applies for purposes of section 402(b)(4)(A) is expressly limited in scope to specific subsections of section 72. See sec. 72(c)(1), (e)(6), (f). Thus, we are not convinced that the phrase ‘investment in the contract’ as defined in section 72 is an established term of art that applies throughout the Code.” 139 T. C. 11, at pp.11-12 (Citation omitted).

Neither is Section 72 of similar purpose and intent to Section 402 so as to make the definition in pari materia (that’s high-priced lawyer babble for “same same”), and thus applicable.

Finally, Bobby argues each year stands on its own, and the closed years are off the table (IRS isn’t arguing nonfiling, fraud or substantial overvaluation, so standard 3SOL applies). No, says Judge Kroupa, there are plenty of places where Congress has moved otherwise taxable events from one year to another, and here the aim is to hit the heavies when their deferral schemes blow up, to the extent they haven’t sooner “given at the office”. And Bobby hasn’t, so the whole nine yards are taxable.

Next is another Bobby, Robert G. Fielder and Deborah R. Fielder, T. C. Memo. 2012-284, filed 10/4/12. Bobby is fighting a levy, and there’s much back-and-forth about whether his 433-A was complete or not, what his farm was worth, and whether he disclosed Debby’s business income, when he offered a collection alternative that Appeals rejected and sustained the levy.

But for sure he never got a SNOD, and he did file the necessary return to be considered timely for collection alternative purposes. IRS wants summary judgment affirming Appeals’ rejection, but Judge Laro says no.

There are questions of fact. First, as Bobby never got a SNOD, he can contest the deficiency, and that includes additions to tax, interest and penalties. “Respondent (IRS) takes the position in his motion that petitioners did not properly assert they are not liable for the additions to tax because they did not raise the dispute in their Form 12153 hearing request. As respondent sees it, the record supports his assertion that petitioners were merely confirming the accuracy of the information given to them by the IRS and were not substantively disputing the existence or amount of the liability.” T. C. Memo. 2012-284, at p. 15.

But the SO’s case activity record says that Bobby said he thought the penalty was unfair, that his return was late because his accountant quit on him and he prepared the return as fast as he could, and the SO tried to explain to Bobby why the penalty was proper. And the SO’s determination didn’t consider Bobby’s objection to the additions and penalty, although Section 6330(c)(3)(B) required him to do so.

“Nor do we accept respondent’s position that petitioners were precluded from challenging the additions to tax because they did not raise the issue in their Form 12153 hearing request. Neither the statute nor our caselaw requires a taxpayer to raise the liability issue in the request for a CDP hearing for it to be considered properly at issue. The statute provides only that a taxpayer may raise the issue of underlying tax liability at the CDP hearing if the taxpayer did not receive a notice of deficiency or did not otherwise have an opportunity to dispute such tax liability, and the determination by an Appeals officer is subject to judicial review under section 6330(d). The statute does not speak to the timing for raising the issue. The issue of underlying liability will be considered properly raised if a taxpayer raises it at any time during a CDP hearing.” T. C. Memo. 2012-284, at pp. 16-17 (Citations omitted).

So Bobby will get a trial.

Takeaway–When at a CDP, if you didn’t get a SNOD, take your text from Isaiah, Ch. 40, verse 9: “Lift up thy voice with strength; lift it up, be not afraid” even if you left it out of your Form 12153.

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?