Or, If You Choose the Form, You’re Stuck With the Substance

That’s the takeaway from Judge Cohen’s dissection of Jess Miller’s corporate machinations in Jess L. Miller, 2011 T.C. Mem. 189, filed 8/9/11.

Jess had an S corp of which he was sole shareholder. In the year before the year at issue, he entered into a contract of sale with his son, to sell Sonny a majority interest. The contract set no closing date; Jess was supposed to resign as officer and director at closing (which never happened so he never did); and Sonny was supposed to pay Jess $95K, which he didn’t do either. Incidentally, Jess had amended the Certificate of Incorporation of his S corp to create a second class of stock, but although Judge Cohen mentions this, the corp is still treated as an S corp throughout.

Jess later filed a 709 claiming he gifted his son 95% of the S corp in the year before the year at issue.

In the year at issue, Jess got substantial cash distributions from the S corp, disproportionately greater to his now-minority interest, and Sonny got less than he should have gotten, given his majority interest. The S corp apparently had neither current nor accumulated E&P, so the only question was whether the distributions  Jess got exceeded Jess’ basis in his S corp stock, and therefore were taxable as long-term capital gains. Section 1368(b) controls.

Judge Cohen: “For S corporations without accumulated earnings and profits, distributions are not included in a shareholder’s gross income to the extent that they do not exceed the adjusted basis of the shareholder’s stock (but are applied to reduce basis), while any distribution amount in excess of basis is treated as gain from the sale or exchange of property. Sec. 1368(b). For purposes of section 1368(b), a distribution is taken into account on the date the corporation makes the distribution, regardless of when the distribution is treated as received by the shareholder. Sec.1.1368-1(b), Income Tax Regs.

“The parties agree that petitioner’s [Jess’] JAM stock basis was $866,795 before he transferred 95 percent of his shares to his son. On his 2002 Form 709, petitioner reported that his adjusted basis in stock transferred by gift on December 31, 2002, was $823,456. Respondent notes that in the notice of deficiency, petitioner’s adjusted basis in his remaining 5,000 shares after the transfer of JAM shares to his son was improperly calculated as $51,661 (instead of $43,339), but respondent does not argue for application of a figure other than $51,661.” 2011 T.C. Mem 189, at pp. 8-9.

Jess claimed he didn’t give Sonny the stock until the year at issue, not the prior year, but his original 709 and the stock ledger book of the S corp say otherwise. Then Jess argues that the transfer to Sonny was part gift and part sale. No, says Judge Cohen, your contract of sale says what you should have done, and you didn’t do it. And there is no sign of any payment for the stock, so no sale.

Since the distributions were certainly disproportionate, Jess argues they didn’t create a second class of stock but should be recharacterized, citing Regulation Section 1.1361-1(l)(2)(i), which provides, in part:

“Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.”

Jess argues that the facts and circumstances test should not be applied to change the character of the distributions, but rather to change the date of transfer of the shares. Misplaced, says Judge Cohen. The facts and circumstances clearly show when the stock was transferred.

Judge Cohen again: “It is well established that ‘a transaction is to be given its tax effect in accord with what actually occurred and not in accord with what might have occurred’ and that ‘while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not’. Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148-149 (1974).” 2011 T.C. Mem. 189, at p. 10.

In short, choose the form, and you’re stuck with the substance.

Or, You Have to Be Current If You Want An Alternative

 So Judge Halpern reminds us in Simone’s Butterfly, 2011 T.C. Mem. 187, filed 8/8/11. Simone’s Butterfly, a D.C. corporation, ran up $50K in liabilities, interest and penalties for the years at issue, and didn’t make its 2010 estimated tax payments. Butterfly filed its returns showing tax due for those years, but paid nothing. So IRS assessed tax, and sent Butterfly the Notice of Intent to Levy.

Butterfly missed an initial phone appointment with Appeals, but later submitted an incomplete Form 433-B in support of an OIC.

Issue presented: Was Appeals’ denial “arbitrary or capricious, lacks sound basis in law, or is not justifiable in light of the facts and circumstances”? 2011 T.C. Mem. 187, at p. 9, specifically in denying Butterfly an OIC because Butterfly wasn’t current with its 2010 estimated payments?

The statute is Section 6330(c)(3)(c), which propounds this test: is the method of collection chosen by IRS (in this case, lien and levy) “no more intrusive than necessary” to collect the taxes, interest and penalties concededly due?

Yes, says Judge Halpern: “…petitioner [Butterfly] had over $50,000 of unpaid taxes for years beginning in 2003. It appears to have provided her [the Appeals officer] an incomplete Form 433-B, and it did provide her with inconsistent financial information. [Butterfly’s attorney] suggested an installment agreement, but she provided no terms. Moreover, [the Appeals officer’s] decision to preclude petitioner from entering into an installment agreement because of its failure to pay estimated taxes was based on applicable procedures contained in the Commissioner’s Internal Revenue Manual (IRM).[Footnote Omitted.] According to those procedures, in determining whether a taxpayer is eligible for an installment agreement an IRS employee must:

‘Analyze the current year’s anticipated tax liability. If it appears a taxpayer   will have a balance due at the end of the current year, the accrued liability may be included in an agreement. Compliance with filing, paying estimated taxes, and federal tax deposits must be current from the date the installment agreement begins. * * *’

“IRM pt. 5.14.1.4.1(19) (Sept. 26, 2008) (emphasis added). Respondent avers, and petitioner does not deny, that petitioner made no estimated tax payments for 2010.” 2011 T.C. Mem. 187, at p. 13.

It’s not just the Manual, says Judge Halpern. Installment agreements, OIC and other alternatives to levy run the risk of pyramiding delinquencies if the taxpayer can’t come current when the alternative begins. “Estimated tax payments, intended to ensure that current taxes are paid, are a significant component of the Federal tax system, and [the Appeals officer] was entitled to rely on their absence in reaching her conclusions. See Cox v. Commissioner, 126 T.C. 237, 258 (2006), revd. on other grounds 514 F.3d 1119 (10th Cir. 2008); Schwartz v. Commissioner, T.C. Memo. 2007-155. In fact, petitioner’s circumstances illustrate one of the reasons for requiring current compliance before granting collection alternatives such as an offer-in-compromise or an installment agreement; namely, the risk of pyramiding tax liability (i.e., that failure to pay current tax liabilities might result in an increasing total tax liability notwithstanding some payment of past tax liabilities). See Orum v. Commissioner, 412 F.3d 819, 821 (7th Cir. 2005), affg. 123 T.C. 1 (2004).” 2011 T.C. Mem. 187, at p. 14.

So summary judgment for IRS.

Or, Documentation is the Name of the Game

 Once again Tax Court stresses the old rule: Documentation isn’t the most important thing, it’s the only thing. Thus spake Judge Wherry in James and Deborah Ledger, 2011 T.C. Mem. 183, filed 8/2/11.

Jimmy took out an endowment insurance policy in the early Seventies that paid off in the year at issue to the extent of $40K after the investment in the contract was deducted. Jimmy took out more than a dozen loans against the policy over the years, and claimed he paid tax on the proceeds each time, but introduced no evidence to show he’d ever paid any tax.

The insurance company paid off the loans at maturity of the policy via a bookkeeping entry, and sent Jimmy the net proceeds; he got the proceeds, but the 1099-R the insurer mailed him showing the $40K payout, Jimmy claims he never got. No matter, says Judge Wherry, the parties stipulated it was sent and the amount it showed, 2011 T.C. Mem. 183, at p. 3, footnote 2.

Our old friend Section 72(e) makes all insurance payouts other than annuities gross income, to the extent the payout exceeds investment in the contract (as defined in the statute). Judge Wherry lays it all out thus: “The term ‘investment in the contract’ is defined under section 72(e)(6) as ‘(A) the aggregate amount of premiums or other consideration paid for the contract before such date, minus(B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income’.

“For Federal income tax purposes, loans against a life insurance contract’s cash value are treated as true loans from the insurance company to the policyholder with the policy serving as collateral. See Minnis v. Commissioner, 71 T.C. 1049, 1054(1979); Sanders v. Commissioner, T.C. Memo. 2010-279; Atwood v. Commissioner, T.C. Memo. 1999-61. Thus, using the policy’s proceeds to satisfy the loans has the same effect as paying the proceeds directly to the policyholder. See Atwood v. Commissioner, supra.” 2011 T.C. Mem. 183, at pp. 5-6.

See also my blogpost “A Dangerous Thing”, posted 4/13/11, wherein I describe how an attorney with an LL.M. in Taxation came a cropper on this principle.

Jimmy may have conflated taxes he paid on dividends on the policy with taxes he never paid on loans against the policy. “Mr. Ledger testified at trial that he had already ‘paid taxes’ on any money he took out of the policy, specifically any dividends that were issued to him. Mr. Ledger also testified at trial that he does not ‘know the difference between a dividend or calling the insurance company and say [sic], I need another $3,000 for the kids school and they sent it to me.’” 2011 T.C. Mem. 183, at p.6.

Not good enough, Jimmy, says Judge Wherry. You never proved what taxes you paid, if any. And your want of knowledge of the difference between a loan and a dividend will not help you.

Bottom line–As the old advertising slogan for the finance company said, “Never borrow money needlessly, but when you must, borrow confidently…” but keep meticulous records.

Or, Your Wish Is Our Remand

It was John Churchill’s wish that Appeals reconsider his reduced circumstances in fixing his RCP (Reasonable Collection Potential). John’s wife had divorced him between his Collection Due Process hearing and the determination his Rule 122 motion in Tax Court  contested. Judge Holmes grants John’s wish in John L. Churchill, 2011 T.C. Mem. 182, filed 8/1/11.

John was a California real estate agent in the boom-and-bust market of the early years of this millennium. John claimed he married Sharon halfway through the series of years at issue as a marriage of convenience, to gain access to her health insurance. In fact, John had heart attack number three while Appeals was considering his OIC, 2011 T.C. Mem. 182, at p.3.

Judge Holmes tells the story of John’s marital and tax woes: “John Churchill offered to settle thirteen years of tax debts totaling more than $250,000 for only $2,500. The Commissioner rejected this offer because it was based on his income alone, even though his bride had a good and steady income, and it’s IRS policy in community-property states to consider both spouses’ incomes even if only one has a tax debt. This made the bride unhappy, and she told Churchill that if he didn’t solve his tax problems, she would leave. He didn’t, and she did.” 2011 T.C. Memo. 182, at pp. 1-2.

John never contested liability, so no trial de novo and it’s all about abuse of discretion.

Appeals considered the bride’s income because she and John were married at the time of the hearing, and California, that famous community-property state, holds spouses liable for each other’s debts, even those contracted pre-nuptial. John attempted to argue his medical condition and health-insurance costs were not considered by Appeals, but the record shows Appeals considered whatever John brought before them.

John’s argued that the marriage was one of “convenience,” and should have been disregarded; he and bride filed separate tax returns. But Judge Holmes isn’t buying it: “Churchill claims that Schwarz’s [bride’s] assets and income should not be included because their marriage was one of convenience. The Commissioner does not distinguish among motivations for marriage: for income-tax purposes, married is married.” 2011 T.C. Mem. 182, at p. 10, footnote 5.

And an Appeals hearing is a snapshot in time. Appeals cannot abuse its discretion by not considering events that had not yet taken place at the time of the hearing.

But the intervening divorce does give Judge Holmes sufficient rope to rescue hapless John. “At one time, we thought we could consider new information where it became available after the CDP hearing–at least when it wasn’t the taxpayer’s fault that he didn’t raise the issue before. See Magana, 118 T.C. at 494 (“This case does not involve an allegation of recent, unusual illness or hardship * * * that might cause us to make an exception to the general rule set forth herein and to consider petitioner’s new hardship argument”). A few years later, however, we firmly limited our review of section 6330(c)(2) issues to those presented in the CDP hearing. See Giamelli v. Commissioner, 129 T.C. 107, 115 (2007). Accordingly, the Court cannot now update Churchill’s snapshot and make our own determination. But can we remand?” 2011 T.C. Mem. 182, at p. 11.

Yes, says Judge Holmes. First, courts can remand under their general powers to resolve disputes expeditiously. Second, remand is available where the party whose determination is being reviewed has abused its discretion. Finally, “(E)ven more compelling is that the Supreme Court has held that when there is a question of  ‘changed circumstances’ raised on appeal, well-established principles of administrative law will generally require the issue be remanded back to the agency for its consideration. INS v. Ventura, 537 U.S. 12, 14-18 (2002); see also SKF USA, Inc. v. United States, 254 F.3d 1022, 1028 (Fed. Cir. 2001) (remand generally required when subsequent events may affect the validity of the agency action). It is clear that remand doesn’t ‘encroach upon administrative functions.’ Ford Motor Co. v. NLRB, 305 U.S. 364, 374 (1939).

“We therefore hold that we do have authority to remand a CDP case for consideration of changed circumstances when remand would be helpful, necessary, or productive. This standard is satisfied in this case. This means that the answer to the question with which we began–did the Commissioner abuse his discretion in declining Churchill’s offer in compromise–is that we can’t say yet.” (footnotes omitted) 2011 T. C. Mem. 182, at pp. 13-14.

So John goes back to Appeals. His medical insurance and state of health are not for reconsideration, as John introduced no evidence of changed circumstances there.

Although poor Lawrence Wickersham dies between trial and judgment, his faithful wife (and part-time dancehall operator) Mary J. carries on, in Lawrence L. Wickersham, Deceased, and Mary J. Wickersham, 2011 T.C. Mem. 78, filed 7/28/11. All their property was jointly titled and they filed jointly, so no need for administrators or executors, at least for tax purposes.

The Wickersham holdings included mixed-use residential/commercial property in Iowa, a towing business in Iowa, and the dancehall in Nebraska (Utter Place, which doesn’t figure in the computation of tax liability, but matters when deciding whether the residential property in Iowa qualifies for Section 121 treatment).

In the year at issue, the Wickershams sold their home and business (on the same property) and granted a permanent easement to Polk  County to expand the road that ran past the property.

Judge Kroupa parses the transactions. On the business side, the equipment and the wrecker get ordinary income treatment (Sections 1231 and 1245 raise their heads; recapture of depreciation trumps everything else). Judge Kroupa buys the Wickershams’ basis allocation for the land and buildings, not IRS’s, as the geography of the land (which IRS argued), goes for the Wickershams’ analysis. But the basis information the Wickershams had as to the building was inadequate to establish the IRS’s figure was wrong. And of course the commercial building portion of the property gets Section 1250 treatment; more ordinary income. The basis allocation also goes for allocating the gain on the sale of the road-widening easement to Polk County.

Now for the tough question: Does Dancehall Mary get the Section 121 half-million-dollar exclusion for the residential portion?

In the first place, Lawrence and Dancehall Mary fibbed about two tax years during the five years preceding the residential sale. They filed Nebraska income tax returns, claiming residence there. Lawrence and Dancehall Mary’s lawyers, including no less than James Monroe, tried to get Judge Kroupa to disregard the erroneous addresses, but Judge Kroupa didn’t buy it: those returns were signed under penalty of perjury. Dancehall Mary also went to Nebraska monthly to run parties at Utter Place. She even swore she was a Nebraska resident to get and keep the liquor license for Utter Place, without which the dancehall would be utterly worthless (sorry, guys).

On the other hand, poor Lawrence had all his medical treatments for throat cancer, and his hernia operation, in Iowa. He and Dancehall Mary entertained their six children and twenty-two grandchildren in Iowa, the vast majority of whom lived but a few miles from Lawrence and Dancehall Mary. Their professionals were all Iowa-based, their banking and credit card statements were sent to Iowa, all but one of their numerous motor vehicles were Iowa-registered, and they claimed Iowa homestead tax exemptions. Finally, they bought a home a few miles down the road to replace the one they’d sold.

Lawrence and Dancehall Mary were “cavalier”, to use Judge Kroupa’s word, about their primary residence. However, in a “close call”, again to use Judge Kroupa’s phrase, the Iowa residence fit the Section 121 parameters with a wee bit of squeezing. So Dancehall Mary gets the half-million exclusion as to the aliquot portion of the easement sale and the residential property sale.

Finally, Dancehall Mary escapes the negligence penalty. She provided all the information she had to, and relied in good faith upon, a woefully overmatched EA, who prepared the return  for the year at issue.

Said Judge Kroupa:  “Petitioners hired Ms. …, an enrolled agent, at the recommendation of their longtime attorney. Her firm prepares approximately a thousand income tax returns each year. Petitioners’ return was the most complex that she had ever prepared. Despite this fact, she failed to inform petitioners she was unsure. Ms. … further testified that the IRS audited fewer than 25 of the returns she prepared in 22 years, and changes were required on only two returns after audits. Petitioners’ return was one. Ms. … paid a $1,000 return preparer penalty for errors in petitioners’ return …. This was the only time she had ever been assessed such a penalty. We find that Ms. … had sufficient expertise to justify petitioners’ reliance.” 2011 T.C. Mem. 78, at p. 26. [Name omitted to spare embarrassment.]

The $1,000 penalty was probably a lot more than the EA charged for preparing the return. And she probably lost a client, and suffered a lot more grief than the whole thing was worth.

Recovered from the New York State Bar Association Tax Section Summer Meeting, I can say that, while the sessions provided much information, the information provided was hardly the stuff of which this blog is made.

I’ve said before, I’m writing for the practitioner in the trenches, the man or woman who prepares returns, advises clients other than Fortune 500 multinationals and who has to deal with the day-to-day issues, what one might call the ” small change” of Federal income, estate and gift taxation.

If,  per contra (as those who went to expensive law schools might say), one has to advise on the capitalization of a  subsidiary of a US multinational, or deal with seven-tier partnership structures, then clearly this meeting was for you. Some of the simple cases I blogged were examined in exhaustive (and sometimes exhausting) detail by professors and partners in major law firms.

Fascinating, yes. A glimpse from the foothills at the mountaintops; or almost dreamlike,  like Mr Roberts gazing at the mighty task force from the bridge of his rustbucket supply ship, going once more from Tedium to Apathy.

But of no use to the ordinary practitioner, I fear.

There are taxes and then there are taxes.

Their Cause and Cure

Sitting in the lovely Mohonk Mountain House, awaiting the start of the New York State Bar Association Tax Section’s Summer Meeting, I am lamenting the paucity of recent meaty Tax Court decisions. The summer doldrums seem to have overtaken litigants and judges.

So I turn my attention to the recent spate of blogs and chatter about the FAQs issued by IRS anent the latest iteration of OVDI–the Overseas Voluntary Disclosure Initiative, IRS’ latest appeal to the unrepentant to confess their nonreporting and nonpayments of tax in respect of their offshore cookie jars, and come over to the side of the Lord–or at least Doug Shulman and Co.

One LinkedIn discussion, to which I contributed, speaks to the “reasonable cause for delay” discussion in FAQ 25.1. The Executive Committee of the NYSBA Tax Section is to discuss a lengthy request, to be sent in letter form, to IRS, requesting an exegisis of the latest go-round of multiple FAQs, with suggestions for clarification.

All this is laudable, of course, as, while these three abide, faith, hope and clarity, the greatest of these is still clarity. I am entirely in favor of finding out whether the lion will bite, otherwise than by sticking one’s arm in the lion’s mouth.

I was discussing these initiatives with a tax expert at a well-known accounting firm. She remarked that it was all very well that IRS was issuing fresh guidance, but hasn’t the IRS’ offshore treasure hunt been going on since 2007?  And what part of “you must tell IRS about any offshore account you have with more than $10,000 in it, and pay any tax you owe” did anyone not understand? And would not IRS do better to catch some offshore procrastinators and nail them hard, pour encourager les autres, rather than expend energies on yet another round of FAQs that no one but tax lawyers will read?

I really could not answer those questions.

But It Isn’t Where Your Tax Home Is

So learn Captain Jac Baker and Aircrew Cynthia Baker in JAC E. and CYNTHIA L. BAKER, 2011 T.C. Sum. Op. 95, filed 7/19/2011. Although this is another fact-specific “don’t quote me” Section 7463, the decision goes into the general rules for tax home, and is good CPE reading.

Captain Jac was tugmaster of the vessel Malulani and, for the years at issue, “began and ended each voyage in the Honolulu, Hawaii, port. Each tug voyage lasted approximately 3 days. On eight occasions during the years in issue, Mr. Baker either began or ended his voyage in a port other than Honolulu: five of these occasions were in neighboring islands in Hawaii and three were in the continental United States.” 2011 T.C. Sum. Op. 95, at p. 4. Captain Jac recorded his unreimbursed employment expenses in a calendar he kept.

Aircrew Cynthia flew for Delta for the years at issue, as cabin attendant, based out of JFK. She flew one to four times a month during the years in question, mostly to Europe, but kept no records of the destinations. She shared an apartment near JFK with nine other aircrew, but proffered no evidence of what she spent there.

Captain Jac and Aircrew Cynthia were married. They lived in Washington State, apparently because it was the most appealing dry land halfway between JFK and Honolulu. Each deducted their travel expenses from and to their Washington State home, claiming that was their tax home.

No, says Special Trial Judge Dean. Aircrew Cynthia’s tax home is JFK, and Captain Jac’s is Honolulu. Both were permanent employees, whose employment was of indefinite duration. Although each claimed unreimbursed employee expenses, neither filed Form 2106 for the years at issue, although they did reduce the expenses claimed by the 2% AGI “floor”.

Captain Jac and Aircrew Cynthia tried to shift burden of proof via Section 7491, but their recordkeeping doesn’t pass muster.

They based the deductions at issue on Section 162. Special Trial Judge Dean: “Section 162(a)(2) allows a taxpayer to deduct traveling expenses, including amounts expended for meals and lodging, if such expenses are: (1) Ordinary and necessary, (2) incurred while away from home, and (3) incurred in the pursuit of a trade or business. Commissioner v. Flowers, 326 U.S. 465, 470 (1946). ‘The exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors.’ Id. at 477.” 2011 T.C. Sum. Op. 95, at p. 10.

The fact that Captain Jac and Aircrew Cynthia are married doesn’t mean that each can’t have a tax home separate from the other. While they may be together till death do them part,  for tax purposes they can be spread across the world.

Captain Jac’s tugboating endeavors almost always started in Honolulu; only rarely did he ever start anywhere else. He had a permanent place of employment for tax purposes. Aircrew Cynthia likewise was home-ported, out of JFK, and rarely if ever flew from anywhere else.

Temporary employment (what I used to call TDY in an earlier incarnation), of limited duration and a sufficient distance from one’s tax home, might allow the deduction of unreimbursed employee expenses for travel. Not here. They were permanently based elsewhere than Washington State, and their personal preferences decided where they made their permanent residence.

However, Captain Jac and Aircrew Cynthia get a bye. They used the same CPA for all the years at issue, and for years before (I somehow doubt they will use him or her for subsequent years). Special Trial Judge Dean concluded: “…considering the totality of the facts and circumstances, we are satisfied that petitioners, who used the same C.P.A. for the years in issue that they had used for several prior years, acted in good faith and come within the reasonable cause exception of section 6664(c)(1). Accordingly, we hold that petitioners are not liable for the section 6662(a) accuracy-related penalties for the years in issue.” 2011 T.C. Sum Op. 95, at pp. 21-22.

But You’re Not a Pro If Gambling  Isn’t Your Full-Time Job

 So learns Randy L. Moore, in 2011 T.C. Mem. 173, filed 7/18/11. Randy delivered food and worked as a traveling x-ray technician. But he spent his every spare moment at the casino, working the slots. He claimed he was a professional gambler, filed Schedule C so claiming, but his expenses were $40K and his winnings only $25K. He claimed a $15K loss against his x-ray wages.

Everyone agrees that gambling losses can be offset against gambling winnings, but any other gambling expense can only be deducted by professional gamblers. Likewise, non-professionals offset their losses against winnings via the Other Income line on Form 1040 for winnings, and on Schedule A for losses. Schedule C is for pros only.

IRS first raised the issue of Randy’s pro status at the answer stage of the proceedings, so IRS had Rule 142(a)(1) burden of proof. IRS claimed that Randy never replied to the answer, so their allegation of his non-professionalism must be deemed admitted under Rule 37.

No need to go there, says Judge Morrison; the trial record is sufficient to show that Randy is an amateur without any deemed admissions. Even though having the burden of proof, IRS discharges it easily.

Randy kept no records. His winnings were established by W-2Gs from two casinos.  Judge Morrison said: “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.

Judge Morrison went on: “Other documents from the two casinos purportedly have more data on Moore’s gambling activities, but we do not find the documents comprehensible or reliable.” 2011 T.C. Mem. 173, footnote 4, at p. 4.

Randy never studied gambling in a systematic way (he said he “read a couple books” about gambling, but aside from showing ignorance of the partitive genitive, that was insufficient to show professionalism). He never made a profit gambling, and his gambling certainly afforded him personal pleasure. The greatest part of his income came from his work as a rambling x-ray technician. In fact, he adjusted his gambling time around his x-raying gigs.

Randy apparently (because he never cited it by name) relied on “Commissioner v. Groetzinger, 480 U.S. 23 (1987), which he said supported the notion that he was a professional gambler because he gambled ‘full time’. But Moore’s situation differs from that of the taxpayer in Groetzinger…. The taxpayer in Groetzinger gambled 60 to 80 hours a week for 48 weeks during the year at issue and had no other employment.” 2011 T.C. Mem. 173, at p. 12. Randy was rambling around x-raying 40 hours per week during the year at issue.

So Randy falls foul of Regulation Section 1.6662-4(d)(3)(ii), which provides that an authority is not relevant if materially distinguishable on its facts. Randy was negligent, and if the Rule 155 recomputation shows substantial underpayment, Randy gets the 20% penalty. PS- Randy also left out almost $8900 of wages on his return.

So Randy may have been a rambler, but he wasn’t enough of a gambler to qualify as a pro.

Or, Drafting the Credit Shelter Trust

 Hints for drafters of credit shelter trusts (those designed to remove all non-taxable assets from an estate and pass them on to the heirs) are always useful, and some good ones can be found in Estate of Ann R. Chancellor, 2011 T.C. Mem. 172, filed 7/14/11.

Ann’s husband Lester predeceased her, creating through his will a trust wherein he placed all non-taxable assets, to the maximum amount permitted by law (the so-called unified credit). Judge Thornton takes up the story: “Under the terms of the trust as stated in the will, during decedent’s lifetime the cotrustees were authorized to apportion trust income among decedent, Mr. Chancellor’s children, and Mr. Chancellor’s grandchildren (the beneficiaries) ‘in accordance with their respective needs.’ The cotrustees were also given the right and power to invade the corpus of the trust and to use such part thereof and if necessary, all of it, for the necessary maintenance, education, health care, sustenance, welfare or other appropriate expenditures needed by * * * [Mr. Chancellor’s] wife and the other beneficiaries of this trust taking into consideration the standard of living to which they are accustomed and any income available to them from other sources.’” 2011 T.C. Mem. 172, at p. 2.

Ann’s 706 didn’t mention the trust assets. IRS said she had a general power of appointment over the trust corpus, so they should have been included, and assessed a deficiency.

No question that this is a power of appointment, as Ann could have directed the trust corpus to herself or the kids and grandkids. But the Section 2041(b)(1)(A) exception saves a general power if it is “limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent”.

So we have a two-part test:  “ascertainable standard”,  and “relating to health, education, support or maintenance”.

Lester’s estate plan passes both tests. First, IRS concedes that the “taking into consideration the standard of living to which * * * [the will beneficiaries] are accustomed” satisfies the ascertainable standard test. “Accustomed standard of living” has gotten around the Section 2041(b) slalom for years.

Now for the “relating to the health, education, support, or maintenance” test. IRS says the “welfare or other appropriate expenditures” language flunks the test–too broad. Not so, says Judge Thornton: “maintenance and sustenance” are not restricted to the bare necessities of life. And the “welfare or other appropriate expenditures” language is limited by “taking into consideration the standard of living to which they are accustomed”.

So Ann’s estate is off the hook. And drafters of credit shelter trusts have another phrase for their form files.