This is so vexed a question that Patricia A. Flood and Donald J. Flood escape penalties for understating tax in the eponymous T.C. Memo. 2012-243, filed 8/27/12, Judge Morrison doing the vexing.

Don’s a day trader, and claims his real estate operation, which consists of buying and selling vacant lots, is just a sideline. But Don only makes from day trading, during the two years at issue, “$25,901 of gains in 2004 and $24,153 of gains in 2005.” T. C. Memo. 2012-243, at p. 10.

On the other hand, Don and Pat made from their land-grabbing well over $1.75 million. Don claims capital gains; IRS says “No, you’re a dealer, one who sells something in the ordinary course of a trade or business.”

Of course, Don and Pat are self-represented, although they are confronting nearly $600K in deficiency and over $100K in penalty. Pat defaults in Tax Court, neither showing up herself nor giving Don POA, and has judgment entered against her for whatever Don gets. Is Pat going to try for innocent spouse? Stay tuned.

Don fails to respond to IRS’ demand that a 75-paragraph stipulation be deemed admitted, so it is.

That sound you hear is Don’s case going down the drain.

So what is a dealer? That is, one who must report profits from the enterprise as ordinary income, as opposed to capital gains, which carries a preferential rate of tax. Judge Morrison: “The answer depends on whether the Floods held the property primarily for sale to customers in the ordinary course of business or held it, alternatively, as a capital asset.” T. C. Memo. 2012-243, at p. 7.

So here’s how we unpack to which category the lots belong: “Typically, the factors in making this determination include: (1) the taxpayer’s purpose in acquiring the property; (2) the purpose for which the property was subsequently held; (3) the taxpayer’s everyday business and the relationship of the income from the property to the taxpayer’s total income; (4) the frequency, continuity, and substantiality of sales of property; (5) the extent of developing and improving the property to increase the sales revenue; (6) the extent to which the taxpayer used advertising, promotion, or other activities to increase sales; (7) the use of a business office for sale of property; (8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property; and (9) the time and effort the taxpayer habitually devoted to sales of property. The frequency and substantiality of sales is especially probative.” T. C. Memo. 2012-243, at pp. 8-9 (Citations omitted).

Judge Morrison starts well here, but ends up with something that, if Don had a lawyer or a Tax Court admitted person, might have turned out differently: “Mr. Flood testified that the Floods bought the land for investment purposes. He asserts that the Floods sold lots only to pay real-estate taxes and that they sold only a few of the lots in 2004 and 2005. Although it appears that the Floods sold only some of the lots they owned during the two years at issue, the gains from these sales were spectacular. Even according to the Floods’ tax return for 2005, they sold properties in 2005 for $1,754,135 that they had originally purchased for $631,044. This is a gain of over $1 million. As we explain in parts 3 and 5 below, the actual gain was even greater than that. Furthermore, we surmise that the values of the remaining lots not sold by the Floods in 2004 and 2005 were relatively low compared to the values of the lots that were sold.” T. C. Memo. 2012-243, at p. 9. The parts 3 and 5 referred to are based on the 75-paragraph torpedo.

“Surmise”, Judge? Based on what? The only issue is the nature of the gain on the sale of the lots that were actually sold, not what lots might have been, or could have been, sold. If one accumulated 100 shares of APPL for five years, held all of them at least a year and a day, and yesterday sold 50, could one “surmise” that the value of the remaining 50 shares was “relatively low”?

But Don did sell 40 lots in the second of the two years at issue, although he sold only two in the first. Still, we have some more “surmise”: “(A)lthough many lots remained unsold, the record reveals little about the cost or value of the unsold lots. We surmise that the value was relatively insignificant.” T. C. Memo. 2012-243, at p. 10-11.

How the value of the unsold lots has anything to do with the nature of the lots is still unexplained. Perhaps that is the basis for the “surmise”.

True, Don devoted a lot of effort to his lottery (the selling of lots–sorry, guys), searching public records, sending out mass mailings, and scouring the byways and highways of the Sunshine State to find and harvest the low-hanging fruit. He used a lawyer to draft contracts and enforce them, used a broker whom he supervised to sell lots, advertised lots for sale, had a dedicated website to flog his lots and so is a dealer.

The 75-paragraph “deemed admitted” stipulation buries Don as regards basis in the lots, and torpedoes a number of his other claimed deductions. One can only “surmise” that Don didn’t bother to consult a lawyer or Tax Court admittee, or that he did, and was told that his case was DOA, so he saved the legal fee.

The good news: “We first find that the Floods had reasonable cause for reporting the lots in question as capital assets and that they did so in good faith. The lots are the types of assets that could conceivably be capital assets. Whether they are capital assets is close question.” T. C. Memo. 2012-243, at p. 19. But some of their other torpedoed tax positions are spurious, as Don produces no records, so it’s off to a Rule 155 to sort out the numbers.

I’m going to be a little slow in blogging the next few days, as I’m off to the IRS Nationwide Tax Forum, held this year in my hometown, to get those precious CPE hours. But I’ll be on board as fast as I can; I know all thirty of you are hanging on my every word. Yeah, right.

And, Dogged Persistence Doesn’t Always Win

Two for the price of one today, 8/23/12, from the hardworking Judges at 400 Second Street, N.W., in Our Nation’s Capital.

Leading off, a “not for nuthin’” from the pen of Judge Goeke, Ronald Webster Moore, T. C. Sum. Op. 2012-83, filed 8/23/12, and the taxpayer wins.

In his young days as a GI, Ron buys a whole life policy from The Company That’s On Your Side, Nationwide Insurance. Ron pays the twenty bucks a month premium for about two years, from 1975 to 1977, and stops. He reckons he’s surrendered whatever cash value accumulated (couldn’t have been much, he thought).

The policy says that if a premium isn’t paid for 31 days, policy is forfeited unless within 90 days the owner pays up with interest. Also, Ron elected the automatic premium loan; that means that cash surrender is used to pay premiums until exhausted. It’s a true loan, and if the payments are used to pay premiums, they are deemed distributed to the owner, and if not repaid by owner are income to owner at exhaustion of the cash surrender value. The excess of loan over premiums paid is taxable as ordinary income. Thus, IRS argues, the cash surrender value was enough to pay premiums through 2008, at which point Ron is deemed to get a distribution and to pay it back to Nationwide to satisfy the loan.

See my blogpost, “A Dangerous Thing,” 4/13/11.

But Ron says no, the policy is ambiguous, I cooperated with IRS, so IRS has burden of proof. Judge Goeke agrees.

Here’s Judge Goeke’s take: “The policy contract provides: (1) premium payments not paid on or before their due date ‘will be in default’; (2) after default, the policy will remain in effect for a 31-day grace period; and (3) the policy will terminate if premiums are unpaid by the end of the grace period. Furthermore, the policy contract goes on to explain that: (1) the policy may be reinstated within five years after the due date of the premium payment first in default upon Nationwide’s receipt of certain evidence from petitioner; (2) an automatic premium loan will automatically be granted to pay a premium in default when the policy has a net cash value; and (3) the policy will automatically be placed on extended term insurance if no payment is made by the end of the 31-day grace period.

“Several of the premium payments were made after the expiration of the grace period–the payments were not made in time to prevent the insurance policy from terminating.” T. C. Sum. Op. 2012, at p. 17.

Nationwide sent Ron letters about the premium loan, but he tossed them unread, thinking they were just sales pitches.

It gets better. “Moreover, all premium payments due beginning September 28, 1980 through 2007, were not made within the grace period. Automatic premium loans were issued to pay the premiums three months after their respective due dates. The automatic premium loan provision functions to pay premiums in default. If a premium was not paid by the end of the grace period, the policy terminated. After termination the policy had to be reinstated by certain affirmative actions by petitioner–the automatic premium loan provision could not reinstate the policy after it had terminated.

“The policy contract provided that the frequency of premium payments could be altered only by a written request to Nationwide; however, there is no evidence in the record that such request was made. Accordingly, by the very terms of the contract, the policy should have terminated at the expiration of the grace period for any of the aforementioned premium payment due dates.” T. C. Sum. Op. 2012-82, at p. 18.

Now for the good news for Ron: “We are not persuaded that petitioner’s life insurance policy terminated in 2008 resulting in a taxable deemed distribution. Respondent’s (IRS’) argument would have us construct a multitude of inferences in his favor and simultaneously turn a blind eye to several unexplained discrepancies in the record. This we will not do. We believe a plain reading of the terms in the life insurance contract signifies that the policy should have terminated and been converted to extended term insurance on several occasions before 2008.” T. C. Sum. Op. 2012-83, at p. 18.

No distribution in 2008, no deficiency, Ron wins it.

Now for the “dogged determination” subheading. That’s Ralph Galyean and Laraine Galyean, T. C. Memo. 2012-242, filed 8/23/12. Judge Foley has this sad tale and it ends badly for the taxpayers.

Ralph loses his job on an oil rig, gets a shore-based consultancy, and when that goes south, takes Social Security. Laraine had a job as an administrative assistant, but between the two of them that wasn’t enough to stave off bankruptcy.

Ralph and Laraine lose their house, and rent an apartment for themselves and their two dogs (breed and names not stated, except dogs are styled as “large dogs”). But the rent is over the famous IRS local housing and utility standards. See my blogpost “A Home Is Not a House”, 8/16/12.

Ralph and Laraine filed returns for the years at issue, but didn’t pay the tax. They seek CDP, claiming they should be in “not currently collectible” status, because they have nothing left after paying living expenses. IRS says “you’re over the schedule on house and utilities, so pay up”.

True, say Ralph and Laraine, but if we rent a cheaper pad, it would be on a higher floor, and the dogs would have to go. Or, put more lawyerly, “Petitioners acknowledge the availability of apartments at or below the local standard but assert that first floor apartments, which would allow them to keep their dogs, are more expensive. Respondent reasonably determined that these preferences did not justify a deviation from the local standard in determining petitioners’ reasonable basic living expenses.” T. C. Memo. 2012-242, at p. 5.

Unfortunately, Ralph and Laraine had other arguments, but they weren’t raised at the CDP, so they’re non-starters in Tax Court. Again, put more lawyerly, “Petitioners make two contentions that were not raised at their CDP hearing. They contend that respondent failed to consider vehicle expenses and the impact of petitioners’ bankruptcy. We reject both contentions because they were not raised at the hearing. See Murphy v. Commissioner, 125 T.C. 301, 315 (2005) (holding that in reviewing the Commissioner’s determination the Court generally only considers evidence that was brought to the attention of the Appeals officer), aff’d, 469 F.3d 27 (1st Cir. 2006).” T. C. Memo. 2012-242, at p. 5, footnote 4.

Use it or lose it, guys. And too bad for the dogs. They’ve either got to climb or go.

            And Save the Trial Subpoenas for Non-Parties

Judge Gustafson lectures both IRS and taxpayers in William Cavallaro, et al., Docket No. 3300-11, 8/22/12, a Designated Order, so not precedent but a good quick refresher on Tax Court discovery.

First, ask politely. Informal discovery is the rule, the magic words being “informal communication or consultation”, or, in other words, play nice and have show-and-tell, before you start with motions to compel.

Second, follow Tax Court’s scheduling order. The scheduling order is not what the Pirates of the Caribbean call “guidelines or aspirational goals”. Failure to do so might provoke judicial ire, even with so genteel a Judge as Judge Gustafson.

Third, don’t try to use trial subpoenas duces tecum to circumvent Rules 70 and 72. Judge Gustafson: “The parties now attempt to use a trial subpoena duces tecum served on a party (or his agent) to accomplish discovery that should ordinarily be conducted under Rules 70 and 72 (which, among other things, provide for a 30-day response time and provide cut-offs sufficiently in advance of the trial to enable deliberate action by the parties and deliberate decision-making by the Court). Ordinarily, discovery from a party should be conducted under the discovery rules, and trial subpoenas duces tecum should be used to obtain information from non-parties. Ordinarily, the use of a trial subpoenas duces tecum to obtain information from a party would involve an evasion of the discovery procedures that the Rules intend for parties. If there is an exceptional circumstance in which a subpoena duces tecum served on a party is proper, that circumstance is evidently not present here. ” Order, p. 2 (emphasis by the Court).

So the parties’ motions to compel production of documents, of the existence of which the parties were well aware weeks before, on the “brink of trial”, are both denied. But the parties should bring the documents with them to the trial, so Judge Gustafson can rule on them if he has to.

Just Not a First-Time Homebuyer Home

One more of the 2008 First Time Homebuyer Tax Credit “not for nuthin’”s, David Merritt Funk, T. C. Sum. Op. 2012-82, filed 8/22/12.

Dave and Amber J. Reeves enter into an Iowa land contract in 2007 to buy a home, move in and start paying taxes, but don’t get a deed until 2008.

I don’t see land contracts here in the East, but they’re common, I am told, out in the Great Wide-Open. Seller agrees to deed real estate to purchaser if purchaser makes all installment payments of purchase price and interest, pays all taxes and insurance when due, and makes all repairs. If you read the land contract, most of which is printed in Judge Chiechi’s decision, it looks like a purchase money mortgage, bar the warranty of title.

Dave argues he didn’t own the home until he got the deed, in 2008, when he got a conventional mortgage, paid off the seller, and got the deed. Dave alone claimed the FTHBC-1.

Of course, the FTHBC-1 fails, as the purchase took place too soon, in 2007, rather than in 2008. While the seller had legal title until 2008, Dave had equitable title under Iowa law in 2007, was in possession and treated the home as his principal residence, and had the benefits and burdens of ownership. And Dave deducted his mortgage interest and real estate taxes on the home for calendar 2007. So Dave was a first time homebuyer before the magic date for the credit.

I’m glad that both iterations of the FTHBC are gone. They did little or nothing to alleviate the housing crisis, and were invitations to game the system.

And Cut to the Chase

It’s the dog days of summer, and Tax Court is somnolent; nothing but unsubstantiated deductions and loss carryforwards, with the odd protester thrown in.

So I’m reduced to reading Undesignated Orders. Those mostly tell litigants to serve and file responses, sign their petitions, or report the status of their cases.

However, today, 8/21/12, we have two orders that go a little farther.

First is Charnae Mattrice Hester, Docket No. 10495-12. Charnae’s petition is bounced for late filing, even though she claims she did file timely under Section 7502. The bad news for Charnae is that she didn’t put enough postage on the envelope.

Chief Judge Thornton has a certain quantum of pity for hapless Charnae, but that won’t get her into Court: “Petitioner appears to rely on the ‘timely mailing is timely filing’ rule of I.R.C. section 7502, however, the benefits of that rule are unavailing here because when the petition was initially mailed, it did not bear proper postage. Accordingly, the date the petition was re-mailed with sufficient postage applied controls.

“The record establishes that the petition was not filed within the applicable statutory 90- day period. This Court has no authority to extend that period provided by law for filing a petition “whatever the equities of a particular case may be and regardless of the cause for its not being filed within the required period.” Axe v. Commissioner, 58 T.C. 256, 259 (1972). Accordingly, this Court lacks jurisdiction to redetermine the deficiency determined in the notice of deficiency for 2010.” Order, at p. 2. (Citations omitted.)

But of course Charnae can petition IRS for an audit redetermination (good luck with that, Charnae), or pay the tax and sue in District Court or Court of Federal Claims (supra).

Charnae, next time pay the postman; it’s cheaper than the filing fee in USDC.

Next up is Jane E. Zdunek, Docket No.27966-10S. Jane wants to introduce evidence on the trial that “… the correspondence examination did not properly handle the audit prior to the notice of deficiency and that the case could have been resolved at the examiner’s level with no adjustment to the interest expense and therefore no need to take the matter to Tax Court.” Order, at p. 1.

IRS files a Motion in Limine to forbid the introduction “of evidence relating to the communications between petitioner and respondent prior to the issuance of the notice of deficiency on the grounds that such evidence is neither relevant nor material and is an attempt by petitioner to go behind the notice of deficiency.” Order, at p. 1.

STJ Armen sets the motion down for hearing next week, rather than going on the papers, because Jane hadn’t stated what evidence she means to submit. But he reminds the parties to stick to the facts of the deficiency: “…unless the parties settle this case, the issue at trial for decision by the Court will be whether the amount claimed was interest expenses and, if so, whether it was paid. The issue will be decided based on the relevant facts as adduced at trial and the applicable law, i.e., Internal Revenue Code, applicable Treasury regulations, and prior judicial cases. Events that occurred during the administrative stage of this case are generally irrelevant, as such events have nothing to do whether petitioner is entitled to the deduction claimed. Further, the Court will decide the disputed issue de novo, i.e., without regard to a prior administrative proceeding, if any. [Emphasis added.]”. Order, at pp. 1-2 (Emphasis by the Court).

So, Jane, the past isn’t even prologue. Prove you paid a deductible expense, and you’re good to go.

Unless you can prove hardship, the schedules of national and local allowances govern housing expenses for figuring out collectibility. That’s the lesson Judge Goeke has for Wayne Clark, in T. C. Memo. 2012-238, filed 8/16/12.

Even though Wayne had only paid about $5K of the nearly $750K he owed in taxes for three years, he went and bought a house for $950K.  Judge Goeke describes this palazzo as having “at least 4,000 square feet of interior finished living space, is on a lot of approximately two acres in a gated ‘golf course community’, and has four bedrooms and five bathrooms.” T. C. Memo. 2012-238, at p. 4.

Wayne’s explanation is that he was a part-time consultant for Prince George’s County, MD, trying to entice business to locate there, using his wholly-owned LLC, Clarke & Company, LLC.

Wayne claims “that he ‘purchased his primary residence to help promote confidence among businesses that Prince George’s County is still a booming community’ and that he used his home ‘office to meet prospective clients and the location of his office allowed him to produce income. Petitioner further claims that without the home office ‘he would be forced to rent outside space which would not be a viable option considering the unpredictable nature of his income’.” T. C. Memo. 2012-238, at p. 13.

Wayne says that the SO assigned to his CDP abused his discretion by not allowing Wayne’s special circumstances to trump the national and local allowances.

Judge Goeke isn’t going there. “While respondent was generally aware of petitioner’s business, there was no evidence presented that petitioner made the Appeals Office aware of the fact that one of the rooms in his home was used as an office for Clarke & Associates. Indeed, each Form 433-A petitioner submitted listed an address for Clarke & Associates that was different from his personal address listed. There was no evidence presented that petitioner informed respondent’s Appeals Office or the SO that his housing expenses may have helped him (through Clarke & Associates) to produce income. Because petitioner failed to prove this information was provided to the SO, we find that he failed to prove the SO abused his discretion in using the local standard housing and utilities allowances instead of petitioner’s stated housing and utilities expenses.

“Even if petitioner had informed the SO of the facts regarding his business and home office, we would still rule that the SO did not abuse his discretion, as we find that petitioner’s home was not a necessary expense for production of his income and that no special circumstance exists which would allow him to deduct his stated housing and utilities expenses. Apart from vague testimony, petitioner offered no evidence that owning the home helped Clarke & Associates generate business. We also compare the size of the house as a whole (4,000 square feet on two acres of land with four bedrooms and five bathrooms) with the size of the areas used for business. Petitioner testified he used one room as an office but that he also “spread things out in the–off the kitchen. Sometimes we bring folks in, and they sit in the living room and downstairs”. Considering the cost of the house (nearly four times the local standard housing and utilities allowance) and the vague and unproven benefits to his business, we find that petitioner was not entitled to his claimed housing and utilities expenses of . . .and that the SO did not abuse his discretion in not allowing him this claimed monthly expense.” T. C. Memo. 2012-238, at pp. 15-16. (Footnotes omitted.)

A home is a house only if it fits the schedules, or you can show true hardship. Sorry, Wayne.

Isn’t Worth the Paper It’s Not Written On

Another uninteresting Tax Court case August 14 (unopposed summary judgment in a collection alternative where taxpayer wasn’t current with estimateds and current liabilities), so on to the Designated Hitters.

And who shows up (twice) but our old friend the Flying Dream Teamer F. Lee Bailey? See my blogposts “Service Trumps Sickness”, 4/2/12, and “A Victim of His Own Success”, 4/4/12.

You’ll remember F. Lee got rudely handled over the money he earned while safeguarding his client’s ill-gotten gains for the benefit of a U. S. civil forfeiture, based on a handshake. F. Lee again asserts a handshake over a pension distribution from his late wife Patricia, which IRS claims F. Lee got, but F. Lee claims he held in trust for Patricia’s mom, Mrs. McGovern, pursuant to an oral trust.

Judge Gustafson gets this gem on a motion for reconsideration, and issues a Designated Order, filed 8/14/12. Bottom line: F. Lee, you have to be more specific. F. Lee claims that Mrs. McG wanted a mortgage paid off on a condo if her daughter predeceased her, which in fact happened. But the mortgage never made it into the trial record, and Judge Gustafson can’t tell if F. Lee would have benefited from the payoff.

Now oral trusts can be enforced, but they need “strong proof”, and F. Lee hasn’t got it. Judge Gustafson: “Mr. Bailey’s position, if it succeeded, would therefore excuse the payee (himself) from tax on apparent income and would shift the liability to someone unknowable by the tax collector–i.e., the beneficiary of an oral trust. The law abhors such asymmetry or ‘whipsaw’. In the United States Court of Appeals for the First Circuit (to which an appeal in this case would be taken), that abhorrence reflects itself in a heavy evidentiary burden that is put on a party to a contract who seeks a tax treatment at odds with the terms of a contract. See Muskat v. United States, 554 F.3d 183, 188-189 (1st Cir. 2009) (to alter an allocation in a written agreement for tax purposes, ‘the proponent must adduce “strong proof” that, at the time of execution of the instrument, the contracting parties actually intended the payments to compensate for something different’). Here Mr. Bailey asks us to uphold a tax treatment at odds with the apparent terms of the pension contract, which named Mr. Bailey in his individual capacity (not as a trustee) as the death benefit beneficiary. If we treat this situation as analogous to Muskat and therefore look for ‘strong proof’ of an oral trust, that strong proof is certainly lacking.” Order, at p. 3.

So an oral trust had better be strong, or it’s not worth the paper it’s not written on.

Oh yes, the citation is F. Lee Bailey et al., Docket No. 3080-08, 3081-08.

That’s the advice I would give Big Jim Dempsey, the V.P. of Atlantic Coast Masonry, Inc., which corporation gets short shrift in T. C. Memo. 2012-233, filed 8/13/12, with Judge Jacobs cementing IRS’ position that the masons Big Jim hired were employees, not independent contractors, so FICA, FUTA and ITW (income tax withholding), plus penalties and interest, fall on Big Jim like a ton of metaphoricals.

Of course, Big Jim and Blanche (Mrs. Big Jim, President) kept no records except a cash ledger book, did everything in cash, and made deals on a handshake. Big Jim bought the materials and supplies, which by the terms of the subcontracts under which Atlantic was employed belonged to the general contractors (a standard provision in subcontracts); the masons furnished their own tape measures, trowels, levels and hand tools. And being skilled workers, the masons didn’t need much supervising: apparently you point them at a pile of bricks and a tub of mortar, and they’ll build you a wall where you want, as high as you want. McNally, apparently a friend of Big Jim’s, ran the shape-ups of the masons and did whatever minimal supervision was required.

Oh, of course Big Jim and Blanche never filed 940s, 941’s, 1065s for their Sub S Atlantic, 1040s for themselves, or 1099-MISCs for the supposedly independent contractor-masons.

Now why hire  a lawyer, when it looks like Big Jim, Blanche and Atlantic are toast? Here’s why. Atlantic appears by Big Jim, who is an officer, with nobody else. The issue is whether Big Jim controlled the masons’ work. Judge Jacobs:  “The examining revenue agent testified without objection by petitioner that in interviews some of the masons and laborers stated they would receive instructions relating to the masonry jobs from Mr. Dempsey. None of the masons, laborers, or supervisors other than Mr. McNally testified at trial.” T. C. Memo. 2012-233, at p.15, footnote 6.

How do you spell “hearsay”? And how, Judge Jacobs, do you expect a bricklayer like Big Jim to know to object when the examining agent proffers objectionable evidence? Or who to call as a witness?

Granted, even without the objectionable hearsay, Big Jim’s walls were about to come tumblin’ down.

But it’s just another example of how the unrepresented taxpayer in Tax Court is in the position of certain predecessors of Big Jim’s, who were on a job in the Middle East making bricks without straw.

See my blogpost “You’ve Got to Be More Specific”, 4/19/11.

Nothing new in Tax Court on Friday, 8/10/12, except a Designated Order from Judge Lewis (right way to spell “Lewis”, Judge) Carluzzo.

The Tax Court website instructs us that “(D)esignated orders may exclude routine, nonsubstantive orders such as scheduling orders or rulings on motions for extension of time. Designated orders are not a complete inventory of all orders of the Court nor are these versions official documents of record. Designation practices of Judges vary; some select more of their orders for posting here than others.” In short, Designated Orders are snapshots of a Judge’s life in Court. And the Judges select the snapshots.

This one is interesting because IRS could have saved time and money by being specific. The order here dismisses the petition for redetermination of deficiencies for lack of prosecution. Petitioner asked for a continuance on the day of trial, and IRS moved to dismiss.

Judge Carluzzo holds off on both, sends the parties off, and asks for a status report. Petitioner gives none, but IRS states “on June 12, 2012, the parties conferred and ‘resolved five out of eleven of the issues asserted in the notice of deficiency.’”

Judge Carluzzo, a patient jurist, goes on to state: “Nevertheless, as of the date of respondent’s status report, certain substantiating documents long promised by petitioner had yet to be provided to respondent. The reductions, if any, in the deficiencies here in dispute as a result of the resolution of the five issues referenced in respondent’s status report are not apparent from anything submitted.”

So we don’t know what the final number is, IRS not having told us exactly to what IRS and petitioner agreed. But Judge Carluzzo has had it with petitioner, and dismisses the petition.

Now Section 7459(d) tells us what the Tax Court has to do when a petition is dismissed in a redetermination: “If a petition for a redetermination of a deficiency has been filed by the taxpayer, a decision of the Tax Court dismissing the proceeding shall be considered as its decision that the deficiency is the amount determined by the Secretary. An order specifying such amount shall be entered in the records of the Tax Court unless the Tax Court cannot determine such amount from the record in the proceeding * * *”

So there’s a judgment for IRS in whatever amounts IRS and petitioner agreed to. Plus Section 6662(a) penalties, of course.

But wouldn’t it have made Judge Carluzzo’s life a lot simpler if IRS had specified in the status report exactly what IRS’ deal was with petitioner? And what was IRS’ bottom line?

Oh, by the way, the Order is Ogungbayi v. Commissioner, Docket No. 17493-11 S, filed 8/10/12.

Yes, you have to be more specific.

Unabated, On an Erroneous Refund

The tale of Luther Herbert Alcorn, III, 139 T. C. 4, filed 8/9/12, is a comedy of errors, ending in unabated interest. Judge Wells traces the errors, from Lute’s misplaced 1040-ES payment through IRS’ ignoring his note and double-crediting his ES payment, to Lute’s not noticing that his refund was $4 grand too much.

Lute filed timely and included his $4 grand 1040-ES payment, but he put it on the wrong line, line 62, “withholding”, lumped in with his other withholding, and not line 63, “previous overpayment applied plus 1040-ES”. I can feel Lute’s pain; I made a similar mistake myself one year, withholding from an IRA distribution didn’t get properly credited, so my refund was too small, and I spent the best part of a year trying to get that omelet unscrambled, fortunately without interest or a subsequent year’s deficiency resulting.

But Lute wasn’t so lucky. Lute attached a note to his 1040, stating his $4G estimated was included in the withholding amount. IRS argued they had no time to read billets doux from taxpayers, but their own Manual says “‘Examine all attachments to the return’ and ‘all taxpayer-initiated correspondence must be responded to within 30 days.’ Internal Revenue Manual pt. 3.11.3.3.7 (Jan. 1, 2008).” 139 T. C. 4, at p. 16. (Footnote omitted.)

Lute’s note wasn’t a model of clarity, but Judge Wells said it could have tipped IRS off that Lute’s 1040-ES payment was already included in the computations in his return.

IRS double-credits the $4K, sends Lute a big refund, but then IRS wakes up, discovers the erroneous refund, asks for and gets its money back. Lute asks for and gets abatement of the late payment penalty IRS imposed, because Lute didn’t file or pay late, but when Lute asks for abatement of interest, IRS says “Since the tax information shown on your original return was incorrect or incomplete, this is considered a contributing factor in the issuance of the refund, and therefore does not qualify for the removal of the interest charge under the Tax Reform Act of 1986.” 139 T. C. 4, at p. 5.

Now for the law; since nobody disputes the facts, this is a pure question of law (summary judgment). Sections 6404(e)(1) and 6404(e)(2) are the basic rules. Section 6404(e)(1) is the famous IRS managerial or ministerial delay; Section 6404(e)(2) is the mandatory interest abatement for erroneous refunds less than $50K unless taxpayer error caused the error. And each abatement period commences to run at different times, although they may overlap.

Naturally, Lute and IRS each claim the other made the mistake and they themselves were blameless, but Judge Wells says no: “Although neither party is willing to admit to making an error, it is clear to us that both parties made errors. Accordingly, we examine the statute to decide whether, on the basis of the facts and the errors committed by both parties, respondent abused his discretion in denying petitioner’s request for abatement of interest.” 139 T. C. 4, at p. 9.

IRS claims this is not an erroneous refund, but overstated withholding. That doesn’t fly, because the plain language of Section 6602 and Section 7405 relegates IRS to a civil action for recoupment of the erroneous refund, and not deficiency, followed by lien and levy, because there was no underpayment of tax.

So the question for Judge Wells is whether IRS abused its discretion by denying Lute the refund under Section 6404(e)(2), where the magic language is “the taxpayer in any way caused the erroneous refund.” Judge Wells notes that Northern District of Ohio once ordered a refund where the taxpayer contributed to the erroneous refund, and later the Court of Federal Claims, relying on the N.D. Ohio case, found IRS had made a serious error in addition to that taxpayer’s erroneous claims; but Tax Court refuses to follow those cases, because both fail to explain how the words “in any way” don’t mean in any way.

Judge Wells finds in Section 6404(e)(1) that IRS has discretion to abate interest, so that Section 6404(e)(2) likewise gives IRS discretion to abate, even though the statute doesn’t say so.

“For instance, some erroneous refunds will also result in deficiencies, and, for those deficiencies, the Commissioner is authorized by section 6404(e)(1) to abate interest on a deficiency caused by an error or delay ‘if no significant aspect of such error or delay can be attributed to the taxpayer’. That limitation authorizes abatement even if the taxpayer is somewhat at fault for the error or delay, as long as the taxpayer’s fault is not a significant aspect of the error or delay. Consequently, the section 6404(e)(1) limitation is not as restrictive as the limitation under section 6404(e)(2), which reserves mandatory abatement for those situations where the taxpayer has not ‘in any way caused’ the error. If a taxpayer committed some minor fault that contributed to the Commissioner’s issuance of an erroneous refund but that was nonetheless overwhelmingly the Commissioner’s error, and, if that refund resulted in a deficiency, the Commissioner clearly would be authorized to abate interest pursuant to section 6404(e)(1) for the period after the Commissioner contacted the taxpayer in writing. However, if section 6404(e)(2) is read to restrict abatements on erroneous refunds to only those situations where the taxpayer did not cause the erroneous refund ‘in any way’, then the taxpayer would be ineligible for abatement pursuant to section 6404(e)(2). Because that result seems incongruous, we conclude that the ‘in any way caused’ limitation under section 6404(e)(2) applies only to the mandatory nature of section 6404(e)(2) and does not restrict the Commissioner’s authority to abate interest with respect to erroneous refunds.” 139 T. C. 4, at pp. 19-20. And IRM pt. 20.2.7.5 (Mar. 9, 2010) states that IRS has discretion to abate interest under Section 6404(e)(2) even for refunds greater than $50K.

So did IRS abuse its discretion? No. Lute did make the mistake that set the train of events in motion, and when he got the refund check he should have noticed something was wrong.

“In respondent’s (IRS’) January 28, 2011, letter denying petitioner’s request to abate the interest on petitioner’s excess refund, respondent explained that, because an error on petitioner’s return contributed to the issuance of the refund, petitioner did not qualify for interest abatement. We cannot conclude that it was an abuse of discretion for respondent to decline to abate interest because of petitioner’s mistake on his Form 1040. That determination is consistent with the limitations regarding taxpayer fault in both section 6404(e)(1) and (2). Additionally, we note that petitioner should have been aware that respondent had issued an erroneous refund when he received a much larger refund than he expected because the May 11, 2009, letter and tax statement explained that respondent had changed the amount of estimated tax reported on petitioner’s return. That explanation should have alerted petitioner to respondent’s error and prompted petitioner to contact respondent to inquire about the refund, as petitioner did when he received respondent’s August 30, 2010, letter telling petitioner that he owed money. On the basis of the foregoing, we conclude that respondent did not abuse his discretion when he denied petitioner’s request for abatement of interest with respect to the erroneous refund.” 139 T. C. 4, at pp. 23-24.

Sorry, Lute, but thanks for the lesson.