Joe Veriha claimed his truck leasing operation was passive, but the IRS said his position was too aggressive, so Joe’s operation gets recharacterized as active, in Joseph Veriha and Christina F. Veriha, 139 T.C. 3, filed 8/8/12, with Judge Wells at the wheel.

Joe ran a trucking business C Corp, but leased his trucks and trailers from a Sub S he owned 99% of, or else from an LLC he owned 100% of. Joe also ran the C Corp, which employed both him and Chris; he materially participated in the C Corp.

Among the other little quips and jingles introduced by the celebrated Internal Revenue Code of 1986, as elaborated by Treasury, is Reg. 1.469-2(f)(6), Income Tax Regs. (sometimes referred to as the “self-rental rule or the recharacterization rule”).

This goodie says that, while all rental activity is generally (don’t you just love the word “generally”?) passive, rental of equipment from an entity controlled by taxpayer, which equipment is used in a trade or business in which taxpayer materially participates, is active, not passive. Thus passive losses cannot be used to offset income generated by such rental activity.

Now Joe’s Sub S rentals made money, but Joe’s LLC rentals lost, so Joe of course wanted to net the two and pay tax only on the overall net. IRS said Joe could net within the Sub S, and net within the LLC, but could not net the LLC’s losses against the Sub S’s gains. See my blogpost “Winning the Paper Chase”, 6/6/12.

Joe had separate leases for each truck and each trailer, either from his Sub S or his LLC.

Judge Wells: “Each tractor was leased (to Joe’s C Corp) as one unit, and each trailer was leased (to Joe’s C Corp) as one unit. The monthly rate for leasing each tractor was determined by the tractor’s age, and the monthly rate for leasing each trailer was determined by the type of trailer. During 2005, the tractors and trailers owned by (Joe’s Sub S) and (Joe’s LLC) were all parked in the same lot and were intermingled. All the tractors were painted the same yellow color, and all received the same scheduled maintenance. (Joe’s C Corp) paid the expenses for all of the tractors and trailers and insured all the tractors and trailers under the same blanket insurance policy. In determining which tractor or trailer to use on a route, (Joe’s C Corp) made no distinction between those (Joe’s Sub S) owned and those (Joe’s LLC) owned. Similarly, when it assigned drivers, (Joe’s C Corp) did not make any distinction on the basis of the ownership of the tractor or trailer.” 139 T. C. 3, at p. 4.

“Section 1.469-2(f)(6), Income Tax Regs., explicitly recharacterizes as nonpassive net rental activity income from an ‘item of property’ rather than net income from the entire rental ‘activity’. Section 469 and the regulations thereunder distinguish between net income from an ‘item of property’ and net income from the entire ‘activity’, which might include rental income from multiple items of property. Even when items of property are grouped together in one activity, section 1.469-2(f)(6), Income Tax Regs., still applies to recharacterize rental income from an item of property as nonpassive income.” 139 T. C. 3, at pp. 7-8 (Citation omitted.)

Now here’s where the trail becomes tangled. “The parties disagree about the definition of the phrase ‘item of property’. In the notice of deficiency, respondent (IRS) determined that the income from (Joe’s Sub S) should be recharacterized as nonpassive income. The notice of deficiency does not explain the rationale for that recharacterization, and petitioners contend that the notice of deficiency determined that each fleet of tractors and trailers (Joe’s Sub S) and (Joe’s LLC) owned was a separate ‘item of property’ and that the income from (Joe’s Sub S) should be recharacterized pursuant to section 1.469-2(f)(6), Income Tax Regs. However, on brief respondent contends that the notice of deficiency determined that each individual tractor or trailer is an ‘item of property’ but that respondent elected not to challenge the offsetting of income and losses with respect to each tractor or trailer within (Joe’s Sub S) or (Joe’s LLC). In contrast, petitioners contend that the entire collection of tractors and trailers, i.e., all the tractors and trailers whether owned by (Joe’s Sub S) or (Joe’s LLC), constitutes a single ‘item of property’.” 139 T.C. 3, at p.8.

Of course, neither the Code nor the Regs define the term “item of property”, so Judge Wells hits the books and finds: “…‘item’ is defined as a separate thing that is part of a larger collection. Those definitions support respondent’s contention that each separate tractor or trailer is an ‘item of property’. Indeed, the articulation of petitioners’ argument requires the use of a term such as ‘collection’, ‘group’, or ‘whole’, all of which serve to distinguish the collection of tractors and trailers from any single tractor or trailer, i.e., any single ‘item of property’. Accordingly, we conclude that each individual tractor or trailer is an ‘item of property’ within the meaning of section 1.469-2(f)(6), Income Tax Regs.” 139 T. C. 3, at pp. 9-10.

Joe argues that IRS did, at least in one reported case, treat bunch of over-the-road trailers as a single item of property, but Judge Wells won’t drive that road. “We are not persuaded by petitioners’ contention. We have repeatedly held that, even with respect to the same taxpayer, the Commissioner is not bound in any given year to allow the same treatment as in prior years.” 139 T. C. 3, at p. 11.

“Accordingly, we conclude that respondent is not bound to treat petitioners’ tractors and trailers as one item of property even though the Commissioner may have treated the over the road trailers … as one item of property. Moreover, it is not even clear that… the  Commissioner actually treated all of the over the road trailers as one item of property. Indeed, the Commissioner’s treatment of the trailers … is consistent with respondent’s position in his brief that, although respondent considers each individual tractor or trailer a separate item of property, respondent is electing not to challenge petitioners’ offset of the income and losses from each item of property within (Joe’s Sub S) and (Joe’s LLC).” 139 T. C. 3, at p. 12. (Citation omitted)

And if Joe claims that the entire fleet of tractors and trailers were all one “item of property”, why did he have two entities to run the rentals? Joe could have put them all under one entity, but under good old Commissioner v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134 (1974), you can pick the business form, but once you do, you’re stuck with it.

So no go, Joe. But your winning Sub S can net its aggregate losses against its aggregate winnings to get the amount of active income on which you must pay tax.

That’s the claim of Gregory Raifman and Susan Raifman in T. C. Memo. 2012-228, filed 8/7/12, and Judge Wells is prepared to listen, even though IRS wants Greg and Sue tossed on summary judgment.

See my blogpost “It Might Be a Rip-Off But It Isn’t a Theft”, 6/16/11. There, Oscar Hawaii couldn’t show that anyone made away with his stock or that his stock was worthless, so no theft loss. But here, it’s a different story.

Greg’s and Sue’s financial whiz Joltin’ Joe Ramos hooked them up with the improbably-named but larcenously-inclined Yuri Debevc Derivium. Derivium, through his eponymous financial corporation, claimed to convert big capital gains on appreciated stock into non-taxable loan proceeds.

In a manner reminiscent of Mid-Coast Financial (see my blogpost “Game Ends In No Score”, 5/30/12), Derivium lends Greg and Sue 90% of millions’ worth of the stock they pledge to Derivium, which gets the stock registered in the name of Derivium; loan terms are  principal to be repaid in three years with interest accruing. Derivium supposedly is going engage in hedging transactions via its overseas siblings and subsidiaries, so they can return the stock untouched by human hands when Greg and Sue repay the loan with interest.

Of course, it’s the classic ring-a-ring-rosie. Derivium hedges nothing, sells the stock, sends the 90% to Greg and Sue, keeps the 10% for itself, using part thereof to play Ponzi with other suckers. Finally, Greg and Sue demand back their stock, which has increased in value, at loan maturity, but by that time Derivium is over the hill and far away.

Greg and Sue sue all and sundry, but get only “a paltry sum” from Joltin’ Joe, and a soldier’s farewell from Wachovia Securities, that cleared the stock sale.

When Greg and Sue get a deficiency from IRS for a year subsequent to the Derivium swindle,  they claim they’d have a loss carryforward to offset the deficiency, if the Derivium deal was in fact theft.

Now we remember from poor ol’ Oscar Hawaii that State law decides whether there’s been a theft loss. Greg and Sue are Californians, and the Bear Republic has a unitary theft statute, combining all the good old law school criminal law 101, everything from classic robbery to embezzlement to larceny by trick or device.

The case comes up on a CDP, and even though IRS concedes that the AO should have considered the carryforward but didn’t, IRS doesn’t want to send the case back to Appeals, and asks for Rule 121 summary judgment.

IRS doesn’t get it.

First, de novo review of liability, as Greg and Sue never got the chance to dispute their tax liability with respect to one of their deals with Derivium.

Second, the question of loan vs. sale. Judge Wells finds a basketful of cases holding that the Derivium deals were sales, not loans. Title to the stock passed to Derivium under the documents; Derivium could do what it wanted with the stock, ostensibly in aid of its hedging operations (nudge-nudge, wink-wink) and it did; it dumped the stock, took its cut, sent the suckers some money, and jumped the hedge, leaving the suckers to whistle for their stock.

Every other Derivium customer who tried to claim “loan” got told that they had sold their shares, with a call option to cause Derivium to sell the shares back to them for the “principal and interest”. If they could find Derivium.

But Greg and Sue take a different tack. “Petitioners contend that the. . . Loan was neither a loan nor a sale but rather a theft. Section 165(a) allows a taxpayer to deduct any loss sustained during the taxable year that is not compensated for by insurance or otherwise. Section 165(c) limits the deduction for individuals to losses incurred in a trade or business, losses incurred in a transaction engaged in for profit, and casualty and theft losses. Under section 165(e), ‘any loss arising from theft shall be treated as sustained during the taxable year in which the taxpayer discovers such loss.’ A taxpayer is not entitled to deduct a loss if he has a claim for reimbursement and there is a reasonable prospect of recovery. Sec. 1.165-1(d)(2)(i), (3), Income Tax Regs. A reasonable prospect of recovery exists when the taxpayer has a bona fide claim for recoupment from third parties or otherwise and there is a substantial possibility that such claims will be decided in the taxpayer’s favor. The amount of a casualty or theft loss is generally limited to the lesser of the property’s reduction in fair market value or the property’s adjusted tax basis. Secs. 1.165-7(b)(1), 1.165-8(c), Income Tax Regs. Taxpayers bear the burden of proving both the occurrence of a theft within the meaning of section 165 and the amount of the loss.” T. C. Memo. 2012-228, at pp. 16-17.

Bringing California law into play, Judge Wells finds that, because Greg and Sue tried to get their stock back at the stated maturity of the “loan”, rather than just walking away, or rolling the “loan” over, or trying to get their stock back before maturity, Greg and Sue have spelled out a case of theft. Now all they have to do is prove it.

“From the beginning, according to Mr. Raifman’s affidavit, Derivium misrepresented the nature of the transaction into which petitioners entered. As far as we can tell, Derivium never engaged in a plausible hedging strategy. Instead, its alleged actions appear to be tantamount to a massive bet that the price of all of its clients’ stocks would fall, ‘hedged’ only by a Ponzi scheme. Mr. Raifman also states in his affidavit that petitioners relied on Derivium’s misrepresentations when they chose to enter into the . . . Loan program and that they were defrauded. Indeed, it appears that the failure of Derivium to honor petitioners’ options to repurchase their ValueClick stock cost petitioners millions of dollars. On the basis of the statements in Mr. Raifman’s affidavit, we conclude that the instant case is distinguishable from . . . the other prior Derivium cases. Accordingly, we conclude that there remains a dispute over genuine issues of material fact concerning the existence of a theft loss under California law.” T.C. Memo. 2012-228, at pp. 22-23. (Footnote and citation omitted.)

Now this case was decided on summary judgment, that is, on the papers and not after a trial with witnesses. A party can only get summary judgment if there are no material questions of fact for a trial; and the party opposing summary judgment gets the benefit of the doubt if they can show a disputed fact other than just a denial.

So Greg and Sue will get a trial, where they can try to prove the exact extent of their loss, and that, when they claimed the loss on their 1040, they had no reasonable prospect of recovery from Derivium, Joltin’ Joe or Wachovia.

And Judge Wells delivers a semi-rebuke to IRS, by way of a farewell footnote: “We are puzzled by respondent’s choice not to seek remand of petitioners’ case to the Appeals Office, despite respondent’s concession that the Appeals Office erred by failing to consider whether petitioners’ carryback with respect to their claimed theft loss during 2006 was within the scope of the Appeals hearing. Accordingly, we will order respondent to wait until he has concluded the examination of petitioners’ amended 2006 return before proceeding with the instant case in this Court. In that regard, we will also order the parties to submit a status report advising the Court when the examination of petitioners’ 2006 return has been concluded.” T. C. Memo. 2012-228, footnote 10, at p.24.

That’s Fortunato Gonzalez and Maria C. Gonzalez, petitioners in T. C. Sum. Op. 2012-78, filed 8/6/12, a “not-for-nuthin’”, with Chief  Special Trial Judge Panuthos rolling the dice.

Fortunato wasn’t, and Maria didn’t do better. They were gamblers; amateurs, not pros, and at the close of play they were down big time, they claimed. IRS didn’t think so, brandishing W-2Gs showing $20K in winnings from a casino, that never made it onto Fortunato’s and Maria’s 1040.

Fortunato and Maria showed on the trial they cashed checks near the weekends, when they played, and didn’t make much money from anything else. They didn’t have losing betting slips or players’ club cards, or anything but their bank statements and the canceled checks they cashed.

CSTJ Panuthos: “Petitioners attempted to substantiate gambling losses, relying on (1) their general testimony that they lost more money than they won, (2) checks that were cashed regularly so that funds would be available at the casino, and (3) the theory that all gamblers lose money.” T.C. Sum. Op. 2012-78, at p. 5.

See my blogpost “I’m a Rambler, I’m a Gambler”, 7/18/11:  “Moore said that he called the IRS in 2004 to ask how to keep track of his gambling losses and that the IRS told him he could use bank statements. Moore claimed to have kept bank statements as records of his gambling transactions, but he did not present any bank statements as evidence.” 2011 T.C. Mem. 173, footnote 3, at pp. 3-4.”

But Faustino and Maria got it right. They had the bank statements and their canceled checks, and played show-and-tell at trial. So CSTJ Panuthos gives them a Cohan approximation, and sends them off for a Rule 155.

Chief STJ Panuthos: “Petitioners wrote checks to cash at least once a month for most of the year in issue, and most of the checks were negotiated near weekends and holidays. We are satisfied that at least some of these funds and some of the winnings were used to engage in gambling activities. Taking into account the credible testimony of petitioners, the fact that gambling winnings were used to engage in additional gambling activity, the cashing of checks on the weekends, and the fact that petitioners’ disposable income from other sources was otherwise limited, and using our best judgment to reasonably estimate the amount of gambling losses, we allow petitioners a gambling loss of $15,000. Accordingly, petitioners may deduct $15,000 of gambling losses against the $20,700 of gambling winnings.” T.C. Sum. Op. 2012-78, at pp. 6-7.

Better than nothing, but keep good records, gamblers. They might help you win even when you don’t win.

Maybe Not, But They’d Better Pay Their Taxes

That’s the lesson for Martin Olive, courtesy of Judge Diane Kroupa, in 139 T. C. 2, filed 8/2/12. And Judge Kroupa does a judicial double reverse backflip worthy of Olympic gold, in the tradition of The Great Dissenter, Judge Mark Holmes, by allowing ol’ Marty more costs of goods sold than IRS allowed him, notwithstanding that he was dealing a Federally-designated controlled substance.

To tie in with the Bob Dylan 1966 hit “Rainy Day Woman #12 and 35”, alluded to in the title of this blogpost, Marty was pushing pot, but it was OK by California law. He was selling pursuant to the California Compassionate Use Act of 1996 (CCUA), codified at Cal. Health & Safety Code sec. 11362.5 (West 2007), 139 T.C. 2, at p. 2. This beneficent statute allows persons certified by licensed health care practitioners, and their caregivers, to obtain cannibis sativa and similar plantlife to alleviate their symptoms.

Marty specialized in vaporware. No, not imaginary software announced by giant outfits to stifle innovation, but which never hit the market. Marty vaporized the boo, so the sick, sore and lame might more easily ingest its analgesic properties. He was one of fifty licensed grass pushers, once he remembered to get his license.

Marty provided atmosphere as well as vapor. “He established the Vapor Room so that its patrons, almost all of whom were recipients (including some with terminal diseases such as cancer or HIV/AIDs) could socialize and purchase and consume medical marijuana there.

“Petitioner designed the Vapor Room with a comfortable lounge-like, community center atmosphere, placing couches, chairs and tables throughout the premises. He placed vaporizers, games, books and art supplies on the premises for patrons to use at their desire. He set up a jewelry-store-like glass counter with a cash register on top and jars of the Vapor Room’s medical marijuana inventory displayed underneath and behind the counter.” 139 T. C. 2, at pp. 5-6.

We should have had Marty around when we were in college, eh? Maybe not; only joking, IRS, OPR and Departmental Disciplinary Committee.

Unfortunately, public benefactor Marty underreported income and claimed deductions for his grassroots operation. But Section 280E prohibits any deductions for expenses paid or incurred in trafficking substances illegal under Federal law, including, but without in any way limiting the generality of the foregoing as the high-priced lawyers say, Mother Mary (in case you wondered who, or rather what, was the star of the Beatles 1970 hit “Let It Be”).

However, in a retail sales operation, which concededly Marty was running, cost of goods sold is not a deduction, but an adjustment to gross receipts necessary to calculate gross income. Notwithstanding the foregoing, Judge Kroupa calls it a deduction, even though it isn’t.

Based on extrapolated evidence of Marty’s witnesses, with all of whose testimony Judge Kroupa had issues, she nevertheless gave Marty a Cohan break and gave him some more costs of goods sold than IRS would allow.

Marty escapes some accuracy penalties because the law was unsettled at the time when he took deductions leading to part of his understatement of tax due, but not thereafter when he took others, so a Rule 155 will sort that out.

Judge Kroupa obviously has Chief Justice of the Supreme Court in her future. It’s not a deduction, but it is.

A former law partner, now deceased, gave me this valuable advice more than 30 years ago. I should follow it, but I can’t in this instance; my frustrations got the better of me, again.

What sparked this blogpost is Robert L. Bernard and Diolinda B. Abilheira, T. C. Memo. 2012-221, filed 8/1/12. On its face, it’s a routine unreported income (IRA distributions) case, not really worth mentioning, except Robert L. is a former Assistant U. S. Attorney, retired on account of disability (and who, by the way, is still listed as actively practicing law by the Texas State Bar on its website).

So Robert L. is automatically eligible for admission to practice before the Tax Court, without taking the gut-busting examination members of other professions, trades, businesses or callings are obliged to take to secure that privilege, notwithstanding the clear Congressional mandate in Section 7452 (see my blogpost “A Book and a Modest Proposal”, 5/22/12).

I will not catalogue Robert L.’s sins, except briefly: treating IRA distributions as sales of property taxable at capital gains rates, underreporting rents, interest, social security receipts and dividends. Then Robert L. engages in a protracted wrangle over whether his case is to be treated as a small claim (Section 7463).

Judge Cohen: “Petitioners continue to argue that this case qualifies for section 7463 status because the deficiency (ignoring the penalty) is less than $50,000 and their computations show that they do not owe taxes on certain of the distributions, thus bringing the total in dispute to less than $50,000. Petitioner, although trained as a lawyer, stated that they would give up their right to appeal in order to avoid having rules of evidence strictly applied. They apparently assume–erroneously–that relaxed rules of procedure and evidence under Rule 174(b) relieve them of the necessity of timely and appropriate evidence and arguments based on applicable law. Rule 174(b), however, refers to consistency with ‘orderly procedure’ and requires evidence that has ‘probative value’. In any event, this case is governed by procedures and rules applicable to cases not eligible for an election under section 7463.” T. C. Memo. 2012-221, at pp. 5-6.

You can read the rest for yourself. It isn’t pretty.

Isn’t it time to revisit Rule 200?

 Or, How He Outsmarted Himself

There’s the old story of the two sailors on a life raft in World War II, after their ship had been torpedoed. One says to the other, “Could have saved ourselves a lot of trouble if we’d jumped overboard the first night out.”

That’s one of two lessons for Michael Craig Worsham, taught by Judge Goeke,  in T. C. Memo. 2012-219, filed 7/31/12.

The second is that if a little learning is a dangerous thing, too much learning is even more dangerous. Mike’s got academic credentials by the bushelbasketful–“ a bachelor of science in chemistry, a master of science in civil engineering and a juris doctor from the University of Baltimore School of Law.” T. C. Memo. 2012-219, at pp. 3.

Before entering law school, “(H)e moved to Maryland in 1993 to work for the U.S. Army Environmental Center at Aberdeen Proving Ground. Over the next several years he attended law school at night, was sworn in as a member of the Maryland bar in 1998, and left the army in 2001 to start a solo law practice from his home. Petitioner’s practice was not in the area of tax, and he did not take any tax courses in law school.” T. C. Memo. 2012-219, at p. 3. Too bad, Mike, you should have done. If you think education is expensive, try ignorance. But you did that.

Mike filed income tax returns and paid tax when due for every tax year from 1989 through and including 2004, but skipped every year thereafter, claiming he found, “without looking for it”, reasons why he didn’t owe tax. Needless to say, his “reasons” were the good old tax-protester jive. Judge Goeke wasn’t buying.

IRS prepared a SFR for Mike for 2006, a year when his law practice brought in $193K gross and paid him $118K net. But the SFR only showed about $6K in tax and about a grand in additions to tax (non-filing and non-paying).

Mike petitions Tax Court. Bad mistake, dude, because IRS subpoenas his bank accounts, find much loot, and amends its answer to Mike’s petition to allege a deficiency ten times greater than earlier deficiency, plus fraud penalties.

Mike moves to dismiss his case, and writes to his bank, stating “(B)ecause I am dismissing this case, the Subpoena issued by the IRS to M&T Bank should no longer be valid, and M&T Bank should not be required to respond by producing copies of my account records.” T. C. Memo. 2012-219, at p. 7.

Judge Goeke finds this maneuver less than funny. “Shortly after he mailed this letter to M&T Bank, we denied petitioner’s motion to dismiss.” T. C. Memo. 2012-219, at p. 7.

I’ll spare you the next eighteen pages of Judge Goeke’s deconstruction of Mike and his unsought brilliant discovery. It’s our old friend Crain revisited for the hundredth time. “Crain v. Commissioner, 737 F.2d 1417, 1417 (5th Cir. 1984), which stated: ‘We perceive no need to refute these arguments with somber reasoning and copious citation of precedent’. T. C. Memo. 2012-219, at p. 11.

And our other old chum, Scott F. Wnuck, in 136 T.C. 24, filed 5/31/11. “Addressing frivolous tax-protester arguments: (1) wastes the limited resources of the Court; (2) delays the assessment of tax; and (3) risks dignifying such arguments or suggesting that they have some colorable merit.” T. C. Memo. 2012-219, at p. 10.  (Citation omitted.) See my blogpost “One’ll Get You Five”, 5/31/11.

So Mike’s intelligence and education, with or without income tax courses, and his prior history of taxpaying, establish he knew he had to file. So now to establish fraud: besides other matters discussed in the opinion, Mike’s attempt at cleverness by seeking to dismiss his petition when he hears that IRS is looking for his bank records backfires big time. Judge Goeke “…we also note that after learning of the subpoenas duces tecum issued to his banks petitioner filed a motion to dismiss, seeking to have his case dismissed without prejudice. After filing the motion to dismiss, petitioner mailed a letter to one bank in which he stated: ‘Because I am dismissing this case, the Subpoena issued by the IRS to M&T Bank should no longer be valid, and M&T Bank should not be required to respond by producing copies of my account records.’ Essentially, once petitioner knew respondent was about to discover the true amount of income he received during 2006 he sought to avoid the consequences by paying only the smaller deficiency and additions to tax originally determined by respondent. We believe these facts are evidence that petitioner was more concerned with trying to conceal the true amount of income he received than with presenting good-faith (but misguided) arguments regarding his Federal tax liability and duty to file a Federal tax return.” T. C. Memo. 2012-219, at p. 20.

Clear and convincing, so Mike gets the fraud penalty.

But Mike gets a first-timer’s bye on the Section 6673 frivolity penalties.

Mike, you should have taken the income tax course. Or better still, just paid the man the seven grand.

No, not another chapter of David Brian Smith and His Electric Back Scrubber from my blogpost of 7/19/12. This time Treasury and IRS are offering to do the washing, as the proposed FATCA reciprocal and non-reciprocal infoshare treaties were rolled out.

School is out at Tax Court today, so just a few words on offshoring money. Nothing wrong with that; Mr Romney and every US taxpayer is at liberty to have accounts in any and every port or haven anywhere in the world or outer space.

All one need do is check the right boxes (7a and 7b) and fill in the blanks on Form 1040 Schedule B , pay your taxes, file your Form 90.22-1 and Form 8938 (in different places with different information required, and different due dates; see my blogposts “Frequently Asked Questions”, 7/22/11, and “Let Us All Have the Same Story”, 10/7/2011), and all’s right with the world (or at least with IRS and DOJ).

And take a peek at my blogpost “What Not To Say”, 11/3/11.

So Treasury has made deals with various countries to swap the skinny on their dodgers, if they’ll do likewise with ours. Holding hands and issuing a joint communiqué yesterday, France, Germany, Italy, Spain, the United Kingdom and the United States solemnly undertook to “work towards common reporting and due diligence standards to support a move to a more global system to most effectively combat tax evasion while minimising compliance burdens.”

“‘Tis a consummation devoutly to be wished”, as a certain figure in the Danish government remarked four hundred or so years ago.

But I saw some missing names from the reciprocators–like the Bahamas, Switzerland, the Cayman Islands, Gibraltar, and the Cook Islands, among others. I wonder when they will join the happy throng and, as the late great Blue Eyes exhorted, start spreadin’ the news.

And “can’t be deduced from first principles.” Some might rephrase the foregoing to read “can’t be deduced from any principles whatever.” This is the lesson for Charles Grant Beech and Elizabeth A. Beech, in an eponymous Summary Op throwaway, T.C. Sum. Op. 2012-74, filed 7/26/12.

Elizabeth A. got money from Momma’s IRA when Momma died. So this is yet another IRA busted play, where the beneficiary, who is not the decedent’s spouse, gets the distribution in hand on decedent’s death, and puts the money into his or her own IRA within 60 days. Of course, that triggers income eo instante. Not spouse, no rollover, says Section 408(d)(3)(C).

One can, of course, do a trustee-to-trustee, a financial forward pass whereby the beneficiary never puts paw to money. Caselaw and a Rev. Rul., cited in the decision, so provide. But Elizabeth A. got the check in hand, so game over.

IRS “professionally and honorably”, in Judge Holmes’ phrase, concedes the accuracy penalty.

Elizabeth A. argues substantial compliance, but that avails her not. STJ Dean: “The Court cannot find that petitioners substantially complied with section 408(d)(3)(A)(i) because section 408(d)(3)(C) expressly denies rollover treatment to an inherited IRA. ’Many parts of the tax code are compromises, and all parts reflect the need for lines that can’t be deduced from first principles. * * * The Code’s lines are arbitrary. * * * Congress has concluded that some lines of this kind are appropriate. The judiciary is not authorized to redraw the boundaries.’ Kim v. Commissioner, 679 F.3d 623, 625-626 (7th Cir. 2012), aff’g T.C. Dkt. No. 11902-10 (May 20, 2011) (bench opinion).”

See my blogposts “Ignorance is Bliss?” 11/10/11, and “A Long Dry Spell”, 11/22/11.

So I’ll repeat what I said last November 22: “(W)hat a monumental trap for the unwary has been created by the rollover and distribution rules in the pension and retirement fruit salad in the 400s of the Code.”

Fans of great opera will remember the confrontation between Tosca and Scarpia, when Tosca asks the price of the life of her lover, Cavaradossi. “How much?” asks Tosca. Scarpia echoes her question, “How much?” “The price,” she replies.

That’s the question for Bernard R. Shepherd and Desiree Shepherd, T. C. Memo. 2012-212, filed 7/24/12. And the answer is that Bernie and Desiree can’t prove the price, so they must include in their income the relief of indebtedness they received from Capital One. So the answer to Capital One’s oft-reiterated question “What’s in your wallet?” is, according to Judge Ruwe, “Less than they thought they had.”

In the year at issue, Cap One scrubbed some credit card debt Bernie and Desiree had racked up with what Cap One had placed in their wallets. Bernie and Desiree failed to include on their joint Form 1040 the amount shown on the Form 1099-C Cap One sent them.

SNOD issues.

Bernie and Desiree claim they were insolvent, and schedule assets and liabilities, with all but three of which IRS agrees. They disagree about the values of Bernie and Desiree’s beach house, their principal residence, and Bernie’s pension with the State of New Jersey.

Burden of proof is on Bernie and Desiree, specifically the excess of liabilities over assets immediately before the cancellation.

Bernie and Desiree introduce real estate tax bills, but those are found wanting, because New Jersey notoriously low-balls the real estate tax assessments on homes, and also because no method of valuation is stated on the bills. Neither is the litigation settlement Bernie wangled with the municipality for the beach house proof of value, because (a) again it states no method of valuation and (b) it’s for a period three years after the cancellation, not immediately before.

Sound familiar? See my blogpost “Method to His Madness?”, posted 6/18/12. Method of valuation is essential.

Bernie claims he prepared comparables, prices of houses similar to his in the same neighborhood sold at around the same time: “At trial Mr. Shepherd testified that in his opinion the value of the beach house immediately before the discharge was approximately $340,000. Mr. Shepherd’s valuation testimony was allegedly based on comparable sales that he assembled for the purpose of a property tax appeal.” T. C. Memo. 2012-212, at p. 7. But Bernie never put the comparables in evidence nor did he describe them; worse, he never stated when he derived them, whether “immediately before” or at some other time.

As for their principal residence, Bernie and Desiree do no better. They have an “exterior broker price opinion/appraisal” from the mortgagee, Chase Bank, but don’t tell Judge Ruwe that an “exterior broker price opinion/appraisal” is a drive-by shooting from the hip of a real estate broker, who never sees the inside of the house, and anyway, that’s from years after the cancellation, and after the judicially-noticed meltdown in the housing market. And the real estate tax bills they proffer for their home are as disregarded as the ones for their beach house.

Judge Ruwe: “The tax bill does not describe the property in detail nor the methodology used in determining the tax value. As we noted earlier, a value placed upon property for local taxation purposes is not determinative of fair market value of the property for Federal income tax purposes in the absence of evidence of the method used in arriving at that valuation.

“Furthermore, in New Jersey the assessed value of property is generally not equivalent to the fair market value of the property.  See City of Passaic v. Passaic Cnty. Bd. Of Taxation, 113 A.2d 753, 756 (1955) (“There has been general agreement for over a century that individual property valuations and assessments have been and are marred by the grossest inequities.”). In fact, the statutory framework for property assessments in New Jersey specifically contemplates that the assessed value of a property for tax purposes will not be equivalent to the fair market value of the property.” T. C. Memo. 2012-212, at pp. 10-11 (Citations omitted.)

So without reliable values for their home and the beach house, Bernie and Desiree are out, but Judge Ruwe goes on to examine Bernie’s pension, as apparently both Bernie and IRS spent a lot of time on that issue. Even though exempt from execution by creditors under State law, pensions are still assets. Bernie took out a loan from the pension fund before the cancellation, that he was paying back currently, and listed the loan as a liability, but didn’t list his credit balance with the pension fund as an asset. That’s a no-no, and beside, Bernie could have withdrawn up to 50% of his credited portion of the pension plan via loans (he could have more than one at a time outstanding). So Bernie’s credit balance with the pension fund must be more than the loan he had outstanding immediately prior to cancellation.

Bernie and Desiree, you’re solvent, so pick up the cancellation.

Not Quite

Here’s a T.C. full-dress treatment leading off 139 T.C., Leah M. Carlebach and Uriel Fried, 139 T.C. 1, filed 7/19/12. See also Daniel Stern and Reizel Stern, T.C. Memo. 2012-204, filed 7/19/12, which follows Carlebach.

Leah was a U. S. citizen, Uriel wasn’t; Dan was a U. S. citizen, Reizel wasn’t. They did, however, obey the Biblical injunction to “be fruitful, and multiply, and fill the earth”. The two couples also had in common that each claimed that their numerous kids were “derivative” U. S. citizens via their respective parent’s citizenship.

That triggers child, additional child, and child care credits, and dependents’ exemptions.

Except it doesn’t, because in the years at issue the said offspring weren’t certified. There are only two ways to be a U.S. citizen: be born here (14th Amendment to Constitution), or be naturalized.

Now a 2000 Federal statute made it possible for children of one U. S. parent to be certified as a U. S. citizen, and that’s a “derivative” citizenship, but to get the brass ring, you have to ride the carousel of 8 USC§1433. And that’s what IRS put into Regulation 1.152-(2)(a)(1).

Leah claims the regulation is invalid, and that as long as the child is at some time a U.S. citizen, she gets the credits and exemptions. But Judge Halpern makes short work of that. Tax years are twelve-month periods. So far as possible one’s tax status must be settled in the particular tax year.

The kids weren’t certified until after the years at issue. So no exemptions or credits.

But Leah does get the penalties. And so does Dan.