It always stings to see a fellow tax professional upended, even when it’s his or her own fault. But this case approaches the limits of tolerance for human frailty, because Linzy puts her own neck in the noose. I’m referring to Joyce Ann Linzy, 2011 T.C. Mem. 264, filed 11/7/11.

Linzy has her own tax preparation business. She claims she employs “contract labor”, but has no records of any value showing to whom she paid what. Judge Vasquez takes up the story: “Petitioner presented canceled checks, bank account statements, receipts, and invoices purporting to substantiate various items claimed as business expense deductions. These records are not well organized and have not been submitted to the Court in a fashion that allows for easy association with the portions of deductions that remain in dispute. Nevertheless, we make what sense we can with what we have to work with….” 2011 T.C. Mem 264, at p. 7.

It gets worse. “None of the numerous receipts petitioner offered in support of her claimed contract labor expense were for contract labor.[Footnote- For example, petitioner introduced receipts for blinds, carpet, repairs, and furniture.] However, some of the receipts were for valid business expenses properly deductible elsewhere on petitioner’s Schedule C. We permit those expenses to be deducted and discuss them below in the appropriate expense category.

“At trial petitioner attempted to claim a deduction for additional contract labor expenses. Petitioner introduced photocopies of checks and a few pages of someone’s handwritten timesheet. The checks are photocopied such that the dates are missing or incomplete, and the full amount cannot be determined for one of the checks. These records are incomplete, and there is not enough information to permit a reasonable estimate. Accordingly, respondent’s complete disallowance of petitioner’s $34,880 deduction for contract labor is sustained.” 2011 T.C. Mem. 264, at pp. 7-8.

Though Judge Vasquez throws Linzy a few dollars’ worth of deductions above what IRS would allow in the other categories referred to, the net result sustains IRS’s deficiency.

Finally, as to the Section 6662 penalty (negligence and substantial understatement), Judge Vasquez had this to say:  “Petitioner’s records were insufficient to substantiate several of her claimed deductions, and she failed to keep adequate books and records. Furthermore, petitioner, a tax return preparer with more than 15 years’ experience, improperly deducted the cost of numerous items instead of depreciating the items as required by law. Although petitioner credibly testified as to the business purpose for her claimed deductions, her underpayment was still attributable to her negligence.” 2011 T. C. Mem. 264, at pp. 18-19.

Apparently Linzy was an unenrolled preparer, a species about to become extinct with the advent of the new Registered Tax Preparer testing and CPE requirements, and Circular 230 regulation. It remains to be seen whether the proposed testing and CPE requirements, and the oversight of OPR, will improve the performance of Linzy and her colleagues–at least as to their own tax returns.

Didn’t Work the First Time, Either

If at first you don’t succeed, try, try again, but Esmiss Esmoore missed the first time and Jim fares no better in James F. Moore, 2011 T.C. Mem 265, filed 11/8/11. Readers of my blog, and followers of Tax Court decisions, will remember my blogpost “Essmiss Esmoore, Essmiss Esmoore”, 8/16/11, reporting James F. Moore, 2011 T.C. Mem. 200, filed 8/16/11. Jim missed out because the payment to Esmiss Esmoore, that Jim claimed was alimony but IRS said wasn’t, didn’t terminate at the death of Esmiss Esmoore, and Indiana law didn’t state that all alimony ceases automatically at death of recipient ex-spouse.

Jim tries again, but the case his counsel relies upon doesn’t say what counsel says it says, at least to Judge Vasquez’s satisfaction. So although Jim’s Rule 161 reconsideration motion is not supposed to serve as “the appropriate forum for rehashing previously rejected legal arguments or tendering new legal theories to reach the end result desired by the moving party.” 2011 T.C. Mem. 265, at p. 3 [citation omitted], Judge Vasquez goes the extra mile, analyzes the cited case, finds it’s still ambiguous, and holds that Jim is once again out of luck.

Takeaway- If you want to make a Rule 161 reconsideration motion, better have some heavy artillery, like a demonstrably serious error of law or fact, or evidence newly discovered that could not, by the exercise of due diligence, have been produced at the proceeding.

At least not to an IRS agent on an audit, is provided by the taxpayer-petitioner and his primary tax adviser and longtime accountant, Viggo (“Wiggy”) Carstensen, in Perry W. Browning, 2011 T.C. Mem. 261, filed 11/3/11.

Merry Perry was an electronics company CEO who needed to stash some cash against his impending old age and his company’s flagging sales. Wiggy put him in touch with some employee-leasing promoters, who put Merry Perry into a lease-and-sublease deal with an Irish corporation, a US shell, and a Bahamian bank (sounds like a joke, doesn’t it?).

Briefly, Merry Perry made a deal with the Irish to let the Irish lease him to a US corporation with no discernable business purpose except to sublease Merry Perry back to his company and help him stash the cash generated by the differential between the lease rent and what Merry Perry nominally got paid by the sublessor. Notwithstanding anything to the contrary elsewhere herein contained, as the high-priced lawyers say, Merry Perry continued to act, hold himself out, and generally carry on as if he still worked directly for his electronics company.

The deal was that the Irish would collect, via the US sublessor, Perry’s real salary as rent, stash what part he wanted in the Bahamas (“it’s better in the Bahamas”, as the tourist board slogan says), and give Merry Perry and Mrs. Merry Perry credit cards on a Bahamian bank, whereby they could use the stashed cash how they wanted.

Taxes were not a great concern. When Wiggy wanted a second opinion, he got one from a knowledgeable person (he thought), but one whose Circular 230 status was never made clear. The second opiner, McCarthy, was concerned that the personal service corporation cases wouldn’t fit, as Merry Perry wasn’t an athlete, an entertainer, or otherwise a personal services corporation type. Merry Perry had no PSC of his own, and, if audited, the whole deal would implode. Nevertheless, and notwithstanding et cetera, Wiggy told Merry Perry to go for it.

Merry Perry and Mrs. Merry went for it with a will, maxing the plastic and paying with the stashed cash, maintaining the fiction that the Irish controlled the expenditures. In fact, Wiggy checked the “no” box on line 7a of Schedule B to Merry Perry’s and Mrs. Merry’s joint 1040s, claiming they had no control over any financial account in a foreign country, such as a bank account, securities account, or other financial account. He later blames this on the default setting on his computer software, but Judge Halpern doesn’t buy it.

Comes now Bad Belinda Evans, IRS agent, and audits the Merry pair. No foreign accounts, the Merry pair aver, and hand Bad Belinda a credit report that doesn’t show the Bahama credit cards. Not for two months does the truth come out, when Bad Belinda grills Wiggy, telling him she knows about the hidden plastic, and Wiggy unbags the cat.

Bad enough, but Wiggy and Merry Perry wax humorous with Bad Belinda. Here’s the story, as told by Judge Halpern: “Ms. Evans’ testimony regarding her audit meeting with petitioner further indicates that petitioner intended to understate his income by hiding from respondent [IRS] his and Mrs. Browning’s 1998-2000 expenditures of unreported excess … payments by means of their personal charges to the Leadenhall Bank credit cards. That testimony was as follows:

“Q Okay. So, Ms. Evans, what was the nature of your conversation with Mr. Browning regarding his use of the Leadenhall credit card?

“A We had asked him if it was his intent to report the deferred compensation when he withdrew it as taxable income, then why didn’t he report the amounts of personal charges at that time on his tax return. Mr. Carstensen stated that —

“Q Mr. Carstensen or Mr. Browning?

“A Mr. Carstensen stated that everybody does it. Mr. Browning then stated that this is the standard way of using credit cards. Mr. Browning then went on to say it’s like running a red light or going the speed limit. You do things you shouldn’t while you can.” 2011 T.C. Mem 261, at p. 42.

Well, now Merry Perry can’t do it, as Judge Halpern finds enough badges of fraud to hang Merry Perry and Mrs. Merry (who’s bound by her husband’s fate per stipulation).

Takeaway–Do not, repeat do not, crack wise with an IRS agent, not now, not never.

 Fair or Foul,  it’s Gross Income Anyway

So we learn from Glenn R. Crane and Deborah A. Crane, 2011 T.C. Mem. 256, filed 11/1/11.

This is a sad story. Deb’s son dies of cancer two days before Christmas. Deb gets cancer. Then Deb’s co-worker Amie claims their mutual boss sexually harassed her (and he didn’t even have the excuses that he was nominated for the Supreme Court or running for President). Deb steps up for Amie, claiming the boss is a chauvinist hog.

Deb gets demoted, her employee lease gets canceled putting her out of a job, and when she posts for a replacement job with the employee-lessor, doesn’t get it. Deb demands arbitration on her claim that all this was retaliation for backing Amie against Boss Hog, and gets awarded $44K, plus another $25K for counsel fees and arbitration costs.

The arbitrator finds Deb suffered no economic harm. There were economic reasons to cancel the lease, the job shift was to keep Deb away from Boss Hog, and Deb testified at the arbitration that she wasn’t going to take the pay cut that the replacement job offered.

Nevertheless, the arbitrator awards Deb the $79K, in a masterpiece of illogic:

“Notwithstanding my prior findings, I do find that Crane [Deb] suffered non-economic damages as the result of____’s [Boss Hog’s] direct actions and _______’s [Deb’s employer-lessee’s] failure to do more to control ____’s [Boss Hog’s] actions during the time the investigation into ____’s [Amie] sexual harassment complaint was pending. I find that ______ [Boss Hog] purposely acted in a way to intimidate Crane’s testimony in that investigation. I also find that given little or no communication by _______ [Deb’s employer-lessee] during the time the investigation was pending to Crane as to how she was, if at all, being protected from ____’s [Boss Hog’s] intimidation, ________ [Deb’s employer-lessee] acquiesced in ____’s [Boss Hog’s] actions. This is especially true since some of ____’s [Boss Hog’s] acts of intimidation were directly contrary to instructions he was given by his superior.” 2011 T.C. Mem.256, at p. 6.[Names omitted.]

So it would seem that the $79K was either for hurt feelings or punitive damages. The arbitrator said nothing about physical injury.

Deb and Glenn never reported the $79K on their joint 1040. Glenn claims Deb’s trial attorney told her it wasn’t taxable, and he wanted to disagree, but Deb was in so fragile an emotional state that he did nothing, and never told their accountant-preparer about the $79K or his qualms.

Section 104(a)(2) specifically excludes from gross income monies received on account of “personal physical injuries or physical sickness”. And money for emotional distress doesn’t get excluded, except to the extent there are actual medical expenses as a result.

Judge Chiechi: “…the record is devoid of evidence establishing petitioners’ contention that Ms. Crane ‘suffered from a physical sickness or illness because of her treatment in the workplace’. Nor does the record contain evidence establishing petitioners’ contentions that as a result of the negligent conduct of ______ [Deb’s employer-lessee] Ms. Crane suffered ‘emotional distress’ that manifested ‘itself in the form of [Ms. Crane’s] definite and objective physical injury.’ The record is also devoid of evidence establishing that Ms. Crane’s claim against ________[Deb’s employer-lessee] was for, or that the arbitrator’s award in his final arbitration decision was made on account of, personal physical injuries or physical sickness of Ms. Crane.” 2011 T.C. Mem. 256, at pp. 15-16 [Footnotes and names omitted.]

To the contrary, the arbitrator’s award was apparently made on account of the arbitrator’s annoyance at the way Deb’s employer-lessee handled the investigation into Amie’s complaint, as same related to Deb.

Tax Court also finds that the entire $79K must be included in Deb and Glenn’s gross income, although they may have a deduction for their legal fees and arbitration costs, but leaves that to the Rule 155 horse-trade that will follow this decision.

Finally, Glenn’s qualms about the exclusion of the $79K despite trial counsel’s assurances, plus the fact that there’s no evidence what Deb told trial counsel to elicit the statement that the award wasn’t taxable; and finally, the fact Glenn never told his accountant-preparer about the $79K so as to get a second opinion, means that the Section 6662 accuracy penalty is sustained.

Takeaway–No hurt may be foul or no foul, but there’s income tax to pay.

  Especially when you’re mailing from overseas

So we learn from William J. Quarterman, 2011 T.C. Mem. 258, filed 11/1/11. Quarters was living in Germany when he got into a fracas with IRS over three years’ worth of deficiencies and accuracy penalties, so he gets 150 days to file a petition instead of the standard 90 days for in-country types.

IRS sent Quarters a SNOD to his Wiernsheim, Germany address, stating a last-day-to-respond as October 1, 150 days after the date of the notice, which was dated May 4. But IRS didn’t mail the notice until May 5, so Quarters would have had until October 2. As always with taxes, though, there’s an exception. This exception is that October 2 was a Saturday, so Quarters had until October 4 to file his petition.

Quarters sends his petition on September 27 via Deutsche Post registered mail. The envelope gets no US postmark, but is date-stamped by the intake clerk at Fier Hundert Zweite Strasse, Nord-West, at 8:04 a.m., October 5.

You’re a day late and nineteen thousand dollars short, says IRS, and moves to dismiss. Tax Court orders Quarters to reply; he says he did, but neither Tax Court nor IRS gets Quarters’ reply, so Tax Court dismisses.

Quarters moves to vacate, claiming his petition got to New York on September 29, entering the US Postal Services’ stream and therefore beating the October 4 clock. To supplement his motion, he sends in a letter from an official of  Deutsche Post stating that the petition got to the US September 29.

“Hearsay!” shouts IRS. Likewise caselaw says you must have USPS Track & Confirm data showing entry into the USPS stream if you don’t have a postmark, and Quarters has neither.

Special Trial Judge Armen takes up the story: “Although timely mailing is generally determined by the U.S. Postal Service postmark date, see sec. 7502(a); sec. 301.7502-1(c)(1), Proced. & Admin. Regs., extrinsic evidence is admissible if a U.S. Postal Service postmark date is either illegible or missing, see Mason v. Commissioner, 68 T.C. 354 (1977); Sylvan v. Commissioner, 65 T.C. 548 (1975).” 2011 T.C. Mem. 258, at p. 7.

But there’s no USPS postmark and no USPS Track & Confirm to prove when the petition got into the USPS’s stream, and the Deutsche Post letter is hearsay.

STJ Armen isn’t dismayed by such small details. “However, in view of the fact that the envelope was clocked in by the Court’s Intake Section at 8:04 a.m. on Tuesday, October 5, 2010, it follows perforce (and not by conjecture or through evidence aliunde) that the petition must have been deposited with the domestic mail service of the U.S. Postal Service no later than Monday, October 4, 2010. See Sylvan v. Commissioner, supra at 551 (“It is impossible for an item to arrive via mail early in the morning on the same day it is mailed”); cf. Lundy v. Commissioner, T.C. Memo. 1997-14.” 2011 T.C. Mem. 258, at p. 9 [Footnotes omitted.]

We can all vouch for the truth of the Sylvan statement.

So Quarters’ petition is reinstated, and he can try to prove IRS wrong.

Takeaway- Three cheers for the hard-working intake clerks at 400 Second Street, N.W., who are on the job and stamping away by dawn’s early light, to give ex-pats like Quarters and the rest of us local nationals our day in Court.

Mr. Donald Kieffer from IRS Employer Plans Determinations gave an interesting webinar today concerning qualification letters for ESOPs. I don’t do employee benefits work; my knowledge in the area is spotty, but one must have at least enough basic knowledge to be cognizant of pitfalls and issues. So I could justify spending the hour for an EA CPE credit-hour.

Mr. Kieffer’s PowerPoint slide and oral presentation included the possibility that IRS might consider promulgating model form ESOP plan documents, if a sufficient number of practitioners with volume practices in this area could agree that such would be a benefit.

I can advance several arguments for, and several against, the proposition. Of course, all these are my own and not anything Mr. Kieffer or his colleagues had to say.

For: It would simplify the review and determination process and help cut down the inventory of plans awaiting determination letters (currently IRS is years behind in the review and determination process, as plans, custom-tailored or not, must be individually reviewed; I understand that IRS is trying out a system of reviewing plans by batches, where the preparer certifies all are in the same form). It would open the door to more practitioners desirous of entering the field but overawed by the perceived complexity and lack of step-by-step guidance (IRS’ present guidance being directed to the seasoned practitioner). It would encourage businesses seeking to provide ESOPs for their employees, but deterred by the high cost and delays of the present system, to do so, enabling recruitment of qualified personnel and expansion of business. It would serve to alert even those practitioners not desirous of entering the field to the important issues, should they encounter a “one-off” situation in their usual practices.

Against: It would divert resources, scarce enough even with the recent personnel additions of which Mr. Kieffer spoke, from the review and determination process, with an uncertain result (the “monument in the desert” syndrome–they built it, and nobody came). Getting agreement from even a plurality of the regular practitioners would be a time-consuming process; being busy with revenue-generating work, knowledgeable preparer participation with the commitment required may be less than needed. If the taxpayers who are paying for the handcrafted plans discover that an off-the-shelf takes half the time for the same result, the diminution in compensation will hardly encourage volume preparer participation. Even if a model set of forms could be developed and accepted both by IRS and the preparer community, no one can guarantee that Congress won’t enact legislation making the model forms instantly obsolete (shades of Christy & Swan Profit-Sharing Plan, 2011 T.C. Mem.62, filed 3/15/11, and my blogpost “Maybe Not So Obvious”, 8/28/11). Finally, Mr. Kieffer and I agree upon H. G. Wells’ famous proposition: “There is no passion, neither love nor hate, equal to the passion for altering someone else’s draft.” Will the model, once adopted, be so quickly  revised by practitioners that very little of the original will be left?

I’d like to hear what practitioners in the employee benefits area have to say.

“Thoroughness settles the question in more cases than any other one thing as to whether or not a person will be successful. A lawyer needs to be thorough in the first place because it is only fair to the state which has given him his license to practice.” Thus spake Adelbert Moot, a leader of the Buffalo (N.Y.) Bar, at the first Irvine Foundation lecture at the Cornell Law School (my alma mater), on May 29, 1914 (and no, I was not in attendance).

This is yet another lesson to the trial attorneys for the IRS; see also my blogposts “Read the Law”, 9/12/11, and “Don’t Quote Me”, 3/30/11. Judge Haines passes over without comment yet another illustration of incomplete trial preparation in Denise Kilker, 2011 T.C. Mem. 250, filed 10/27/11.

Denise ran a printing business and provided printing in exchange for stock. She didn’t bother to file a return for the year she acquired $90K in taxable capital gains and $100K in compensation for services, via stock-for-services deals, nor did she trouble to pay estimated tax.

The details are simple. Denise never filed but got the stock and sold some. IRS conceded what she sold was long-term capital gains. What she got was compensation for services (barter), therefore ordinary. Of course, the issuer of the stock-for-services sent Denise a 1099-MISC showing the $100K, and her broker sent her a 1099-B for the $90K capital gains.

IRS very kindly prepared Denise’s return for her pursuant to Section 6020(b), and sent her a SNOD, both at no extra charge. Denise has no defense to the capital gains portion of the assessed tax. She claims the stock-for-services should be charged to her wholly-owned corporation and was used to pay corporate expenses. But the stock certificates were issued to her I/T/F her kids, never to her corporation; nor did she put in evidence any Form 1120 for her corporation showing the income or expenses.

So far IRS has had it all their own way. IRS gets the Section 6651(a)(1) failure to file addition to tax, as Denise never claimed she filed any personal return.

Now here IRS comes unglued. Judge Haines speaking: “Respondent also determined that petitioner is liable for the addition to tax imposed by section 6651(a)(2) for failure to pay the amounts of tax shown on her 2004 Federal income tax return. Respondent did not introduce the 2004 substitute for return filed on behalf of petitioner pursuant to section 6020(b), nor did respondent introduce a Form 4340, Certificate of Assessments, Payments, and Other Specified Matters, for 2004. See Cabirac v. Commissioner, 120 T.C. 163, 172-173 (2003). Thus, respondent has not produced sufficient evidence that petitioner is liable for the section 6651(a)(2) addition to tax for 2004.” 2011 T.C. Mem. 250, at pp. 9-10.

This is not a case where a sly attorney or Tax Court admittee comes up with a great argument or a blistering cross-examination, and stumps IRS trial counsel. This is a case where what should have gotten onto the document checklist, and into the trial notebook, never got to either, and thus never got into evidence.

Adelbert, thou should’st be living at this hour.

Even though there are no novel principles of law discussed, I can’t resist the title of this decision, Richard A. Nixon, 2011 T.C. Mem.249, filed 10/25/11. Of course, this isn’t the Richard Nixon (to quote the immortal words of Surgeon Commander Leonard McCoy to Starship Captain James T. Kirk, “He’s dead, Jim”).

This Richard Nixon is Poor Richard,  just a hard-working Dad, who’s entitled to some of the tax breaks for supporting his two kids by his now-divorced spouse, Lowdown Leslie, by virtue of a parenting plan and order of child support entered in Superior Court in Clark County, Washington State.

Unfortunately, though Poor Richard signed a Form 8832, Lowdown Leslie refused to sign, and grabbed for herself the exemptions and credits Poor Richard was supposed to get per plan and order, even though Poor Richard dutifully paid all that the plan and order required. IRS assessed tax by disallowing Poor Richard’s dependency exemptions and child credits.

Poor Richard can’t prove he provided half the children’s support. They lived more than half the year with Lowdown Leslie, and the Form 8832 that Lowdown Leslie refused to sign isn’t worth the paper it’s written on. Besides, the kids were the qualifying children of Lowdown Leslie, under the strict terms of Section 152(d)(1).

Although Poor Richard attached to his return letters concerning the plan and order and Lowdown Leslie’s disreputable tactics, they don’t satisfy the Section 152(e) reasonable equivalency to a Form 8832 test, because Lowdown Leslie didn’t sign them.

So Poor Richard loses.

Judge Vasquez tosses in the boilerplate “tough turkey” language we often see in these cases (see my blogpost “Supported Child, Unsupported Exemption” , 7/11/11): “We are not unsympathetic to petitioner’s position. We also realize that the statutory requirements may seem to work harsh results on taxpayers, such as petitioner, who are current in their child support obligations and who are entitled to claim the dependency exemption deductions or child tax credits under the terms of a child support order. However, we are bound by the statute as written and the accompanying regulations when consistent therewith. Michaels v. Commissioner, 87 T.C. 1412, 1417 (1986); Brissett v. Commissioner, T.C. Memo. 2003-310.” 2011 T.C. Mem. 249, at p. 7.

Maybe Poor Richard would feel Judge Vasquez’s sympathy more if the Judge didn’t use the same boilerplate phraseology as appears in all these cases. Anyway, sympathy or no, IRS and Lowdown Leslie still have Dick Nixon to kick around.

Back in 1962, a young novelist named Robert Gover wrote the cult classic “The $100 Misunderstanding”. The phrase has entered the common lectionary, and I, even I, used it for my blogpost “The $250 Misunderstanding”, 6/3/2011.

Now Congress has added the $500 misunderstanding, via Public Law 112-41, the United States-Korea Free Trade Agreement Implementation Act, which, besides implementing free trade, raises the Section 6695(g) $100 preparer penalty to $500 for each due diligence failure by a preparer on an EITC claim.

In short, one wrong answer out of the two dozen or so required on the Form 8867 due diligence checklist, which now must accompany the return as well as being retained by the RTP, is worth $500 out of the preparer’s pocket. This was touted as an offset to the revenue to be lost by freely trading with Korea. So IRS will be enforcing this, to make sure that those who trade with the Land of the Morning Calm will not unduly deplete our national treasury.

Now how much does the average RTP charge to prepare an EITC return? And who is eligible to request an EITC? Clearly neither preparer nor requester is one of the 1% who feels the ire of the Wall Street Occupiers. And I’ll wager a large sum that no one who requests an EITC is a major trading partner with Korea, or anywhere else.

Now this is a non-partisan blog. I grind no axes here. But who is kidding whom? What level of IRS resources will be deployed to crack down on the $50 per return solo preparer? And when they are driven out of business by the first two penalties (and there is no maximum penalty per preparer or per return under Section 6695(g)), who will prepare the returns? True, the statute makes the RTP’s employer liable, so maybe IRS will concentrate on the franchise operations, which may be good news for the solos. One can but wait and see. I do not even want to contemplate the impact on VITA and other not-for-profit volunteer preparers and their organizations.

We all know that IRS reckons somewhere between 23% and 28% of all EITC filings are improper. But when Congress decrees a 17-part test, accompanied by a mandatory cross-examination worthy of Clarence Darrow in his prime, to provide what is claimed to be tax relief for, but is really welfare to, (presumably) the poorest in our society, what did Congress expect?

In any case, there’s nothing like slipping a Draconian penalty, that hits the bottom of the food chain the hardest, into Section 501 of a massive trade bill. You have to admire a Congress capable of this sort of thing.

Or, Withholding Without Paying Isn’t Withholding

So Mark W. May learns, in Mark W. May and Cynthia R. May, 137 T. C. 11, filed 10/24/11. Mark W. and Cynthia R., supra, gets consolidated for trial with Cynthia R. May, Petitioner, and Mark W. May, Intervenor, but Cynthia gets let out after trial on Section 6015(b) grounds, so Mark W. is the last man standing, except he’s in jail for tax fraud when the petition is filed.

Mark W. owned a 100-employee financial services firm, that he ran with an iron hand and an outstretched arm. He personally controlled all bank accounts, although he signed all checks by electronic facsimile. Anyway, Judge Goeke finds Mark W. was an officer, director, shareholder and financial czar of the firm.

Payroll checks and paystubs were generated by Paychex, an independent data processing firm and payroll preparer. Nevertheless, no matter what Paychex put on the paychecks or paystubs, Mark W. signed the checks (including his own $260,000 annual salary checks). And no matter what the withholding (FICA, Medicare, FUTA, Federal, State or municipal income taxes or whatever) was supposed to be paid, Mark W. never paid any of them. He used the money to run the business.

The forces of righteousness caught up with Mark W., and he was sent to a Federal installation in Kentucky to worthily lament his sins; the record does not state whether Mark W. actually did so.

Mark W. defends against the deficiencies in his income taxes caused by the non-remittance of the required withholding of his own salary on the grounds that Tax Court has no jurisdiction over a deficiency caused by penalties for fraud. This Judge Goeke disposes of via Rice, 1999 T.C. Mem. 65: “Section 6665 provides that ‘additions to the tax, additional amounts, and penalties * * * shall be paid upon notice and demand and shall be assessed, collected, and paid in the same manner as taxes’. A deficiency in tax is assessed, collected, and paid only after respondent makes a determination and sends a notice of that determination in accordance with section 6213, which provides for the jurisdiction of this Court. Eck v. Commissioner, 16 T.C. 511, 515 (1951), affd. per curiam 202 F.2d 750 (2d Cir. 1953). Thus, respondent, in sending a notice determining petitioner was liable for a section 6663 penalty, was complying with the law that requires him to proceed in the same manner as if there were a deficiency. ‘The statute was intended to mean * * * that where such a notice was sent, the Tax Court has jurisdiction.’ Accordingly, a statutory notice from respondent, in which no deficiency is determined, advising the taxpayer that a penalty for fraud is due, is a valid basis for jurisdiction to this Court.” 137 T.C. 11, at pp. 7-8 (emphasis by the Court). Here there is a deficiency and there is fraud, so Mark W. loses that one.

Not to be so easily squelched, Mark W. argues that the amount of withholding of the taxes due, whether or not remitted to the Treasury, is properly to be credited to the taxpayer, namely him. How’s that for chutzpah? “In support of their position, petitioners cite section 1.31-1(a), Income Tax Regs., which states in part that ‘If the tax has actually been withheld at the source, credit or refund shall be made to the recipient of the income even though such tax has not been paid over to the Government by the employer.’” 137 T. C. 11, at p. 10.

In short, having diverted the trust funds, Mark W. wants credit for the funds he stole. Ol’ Mark W. is quite a lad, but Judge Goeke isn’t buying it. “In United States v. Blanchard, 618 F.3d 562, 576 (6th Cir. 2010), the defendant owned and operated his business and withheld taxes from his own paychecks but failed to remit those withholdings to the Government. In affirming the defendant’s conviction under 18 U.S.C. sec. 287 for making a false claim for a tax refund with regard to his personal taxes, the court stated: ‘Rather than creating an overly formalistic division between the personal and official capacities of an individual operating as both employer and employee, which would permit the corporate form to serve as a shield to individual liability, we find it more consonant with the purposes of §287 to conduct a functional inquiry into whether funds due the government left the defendant’s control and so may be deemed ‘actually withheld’ from his wages. * * *” 137 T.C. 11, at pp. 10-11.

So, being functional, Judge Goeke simply reviews the facts. Mark W. ran the show, owned the corporation, signed all the checks, was the responsible person for the withholding payments, was the only person who could make the payments but didn’t, and used the diverted trust funds to run the company (and incidentally pay himself). Though technically subject to withholding, what he really did was generate a phony W-2 for himself.

At the end of the day, Mark W. has fraud penalties, but is allowed a $772 deduction for local income taxes he paid the City of Xenia, Ohio, because he had a canceled personal check.

Takeaway- Withhold means withhold and pay.