In deciding whether litigating fiduciaries should be reimbursed legal fees and disbursements from the estate for which they are acting, Judge Goeke reminds us that the key question is, ‘Is the estate a player or a spectator?’ Is the fiduciary fighting for the estate, or is the estate a mere stakeholder while the fiduciaries fight with one another or with someone else? To see an in-depth analysis, look at Estate of Raymond J. Gill, Deceased, Sabal Trust Company, Personal Representative, 2012 T.C. Mem. 7, filed 1/9/12.

Famous Ray was a man of means. He and his wife Joan had an elaborate estate plan, with credit shelter trusts, marital trusts, living trusts, and springing trusts for the children and grandchildren of the said Famous Ray and Joan.

Joan dies first, and that’s the problem, because Famous Ray takes a business trip to Germany, and brings back a souvenir costing ten years of litigation and $830K in legal fees and disbursements, namely, the Beautiful Valerie, who becomes Mrs Famous Ray II (hereinafter “MFR”). MFR causes Famous Ray to restructure the estate plan, oust his children (Mark and Mrs. Alabaster) as fiduciaries, and install MFR and SunTrust in their place and stead, and give MFR all kinds of goodies.

Mrs. Alabaster, on getting the news, gleams, but not, as Katherine Lee Bates suggests in her immortal hymn “America, the Beautiful”, “undimm’d by human tears.” No, Mrs. A springs to the attack as soon as Famous Ray is in the cold, cold ground and she gets wind of MFR’s shenanigans.

Enter the lawyers. Lawsuit follows, then mediation follows, then comes a stipulation that MFR immediately breaches. More lawsuits, more mediation, and a new stipulation. Mrs. A ousts MFR and recoups some cash (which goes to her and Mark). Finally, Sabal Trust Company succeeds SunTrust, who aided and abetted MFR throughout their ten-year odyssey through the Florida courts.

Emerging bloodied but victorious, and installed as fiduciary, Mrs A seeks, inter alia as my high-priced colleagues say, to get paid back for the $830K she and Mark ponied up for the legal talent.

Now Judge Goeke gets down to business. But first, “(W)e have corrected minor mathematical errors made by the parties in their calculations. Those corrections have reduced the total administration expense deductions sought by $6.” 2012 T. C. Mem. 7, at p. 15, footnote 3. Ya gotta love a court that, faced with a claim for $830K, has time to do the arithmetic and find $6, which is less than one minute of a white shoe second-year associate’s billable time.

Next, IRS left off disbursements in reckoning the $2.8 million deficiency slapped on Famous Ray’s estate. Judge Goeke: “In his calculations, respondent [IRS] took only attorney’s fees into account and failed to include related court costs (such as those for transcripts and depositions) incurred by the estate’s lawyers. Such costs are deductible under section 20.2053-3(d), Estate Tax Regs.” 2012 T. C. Mem. 7, at p. 16.

But whether fees or disbursements, these must be chargeable to the estate under local law. Canvassing Florida law, Judge Goeke finds some part of the legal fees claimed to be allowable as charges to the estate.

But are they reasonable? Whether allowable or not by State law, to pass muster for deductibility for Federal estate tax purposes these fees must be reasonable. Judge Geoke finds they are: “Because Fla. Stat. Ann. sec. 733.106(3) allows attorneys to be awarded reasonable attorney’s fees only for services to an estate, and the legal fees comprised mostly attorney’s fees, we find this is strong evidence of the reasonableness of the fees. In addition, the estate introduced into evidence voluminous records of legal fees incurred by the Gill children over the years in which litigation was ongoing. Considering these records as a whole, we see nothing unreasonable about those fees. We also consider the fact that the Gill children were reimbursed less than their actual legal fees. Respondent offered no evidence of his own that the legal fees were unreasonable.” 2012 T.C. Mem. 7, at p. 21. No evidence from IRS? On what then did IRS base its deficiency?

Final fence before the finish line: were the legal fees in question “essential to the proper settlement of the estate”? If not, no deduction. And State law is not dispositive on this point. See Reg. 20.2053-3(c)(3).

Here comes the test: is this a dispute between beneficiaries as to who gets what, with the estate uninvolved as it only has to pay one or the other; or is this a question of who is a fiduciary and are they acting as such? If the former, in the immortal words of Humphrey Bogart in the 1948 classic “Treasure of the Sierra Madre”, “why don’t everybody smoke their own?” But if acting as a fiduciary, even with a personal interest in the outcome, and even if the end result of the legal process puts money in the fiduciary’s own pocket, the legal fees and disbursements are proper deductions. Judge Goeke canvasses the caselaw, and finds that, as to some of the fees, Mrs A was acting as fiduciary, so she gets some of the fees, even though the outcome of the litigation enriched her personally.

Some deductions the estate doesn’t get, largely because of poor recordkeeping.  Each litigation stands on its own, and Judge Goeke goes through the who, what, where and when of each, and if the paperwork isn’t clear, Mrs A loses, as she has the burden of proof. And even MFR’s and SunTrust’s legal fees, for which they were reimbursed by the estate for the time they were fiduciaries, are deductible, to the extent allowable, reasonable and essential.

The accountants’ fees are disallowed, again for poor recordkeeping. Shame on the accountants. But the lawyers weren’t all that much better, either.

Takeaway–Document, document, document. Have the lawyers do their bills to show exactly which clients they represented, in what capacity (individual or fiduciary), and what they did and when they did it. And the accountants likewise.

Or, Less Work for Us Tax Court Bloggers?

Though no new Tax Court cases came down on January 6, IRS kindly filled the gap by issuing IRS Notice 2012-8 on January 5, setting out a proposed replacement to Rev. Proc. 2003-61, 2003-2 C.B. 296, the Section 6015(f) equity relief for the innocent spouse.

Apparently the spate of Tax Court cases over the last few years has caused IRS to re-engineer its approach where the requestor makes out a case for spousal abuse by, or financial control exercised by, the non-requestor. And the proposed Rev. Proc. also cleans up the process generally.

A couple of points follow, but read the whole Notice, there’s a lot more.

IRS will “streamline” its treatment of innocent spousery when: “… the requesting spouse establishes that the requesting spouse:

(1) Is no longer married to the nonrequesting spouse…;

(2) Would suffer economic hardship if relief were not granted…; and

(3) Did not know or have reason to know that there was an understatement or deficiency on the joint return…, or did not know or have reason to know that the nonrequesting spouse would not or could not pay the underpayment of tax reported on the joint income tax return …. If the nonrequesting spouse abused the requesting spouse or maintained control over the household finances by restricting the requesting spouse’s access to financial information, and therefore, because of the abuse or financial control the requesting spouse was not able to challenge the treatment of any items on the joint return, or to question the payment of the taxes reported as due on the joint return or challenge the nonrequesting spouse’s assurance regarding payment of the taxes, for fear of the nonrequesting spouse’s retaliation, then the abuse or financial control will result in this factor being satisfied even if the requesting spouse had knowledge or reason to know of the items giving rise to the understatement or deficiency or had knowledge or reason to know that the nonrequesting spouse would not pay the tax liability.” Notice 2012-8, at pp. 14-15.

The proposed Rev. Proc. also defines “economic hardship”, a useful step when what we usually see is a dissection of a spouse’s income and expenses, a time-wasting exercise that cannot be applied in any case but the one at bar. Here’s IRS’ new answer: “If the requesting spouse’s income is below 250% of the Federal poverty guidelines, or if the requesting spouse’s monthly income exceeds the requesting spouse’s reasonable basic monthly living expenses by $300 or less, then this factor will weigh in favor of relief unless the requesting spouse has assets out of which the requesting spouse can make payments towards the tax liability and still adequately meet the requesting spouse’s reasonable basic living expenses. If the requesting spouse’s income exceeds these standards, the Service will consider all facts and circumstances in determining whether the requesting spouse would suffer economic hardship if relief is not granted.” Notice 2012-8, at pp. 17-18.

Oh yes, IRS will apply all these new procedures at once, without waiting for the Rev. Proc. to issue in final form. “Because the provisions in the proposed revenue procedure expand the equitable relief analysis by providing additional considerations for taxpayers seeking relief, until the revenue procedure is finalized, the Service will apply the provisions in the proposed revenue procedure instead of Rev. Proc. 2003-61 in evaluating claims for equitable relief under section 6015(f). If taxpayers conclude that they would receive more favorable treatment under one or more of the factors provided in Rev. Proc. 2003-61 they should advise the Service in their application for relief or supplement an already existing application. Then the Service will apply those factors from Rev. Proc. 2003-61, until a new revenue procedure is finalized.” Notice 2012-8, at p. 3. So until the new Rev. Proc. is issued, it’s gambler’s choice.

Hopefully, the new procedures will supply speedy relief to the innocent without the need for Tax Court intervention, and discourage the undeserving. Of course, for a $60 petition fee, the undeserving can still waste Tax Court’s time.

Maybe there will be less in the innocent spouse sphere for us bloggers to blog about, as well.

But That Doesn‘t Mean You Get a Deduction

Budding authors, before you sing Richard Rodgers’ and Lorenz Hart’s 1940 classic song from “Pal Joey”, read and heed the lesson Judge Vasquez gives you would-be best-sellers in Michael S. Oros, 2012 T. C. Mem. 4, filed 1/4/12.

Mike worked full-time for Intel (ba-bing, ba-bing), but he hankered for far horizons and, he claimed, for the fame and fortune of professional authordom. So he wrote up a business plan (he had an MBA), and took off on a four-month trip spanning two tax years, during which he visited South America, Australia, Asia and Africa. He collected vacation pay and sabbatical pay from Intel while doing so. He said he was going to write a book, self-publish it and make money therefrom.

Mike took 4542 photographs (though not professionally-trained, he claimed he was an accomplished amateur photog), kept a detailed diary of his travels, and arranged his travels around events he wanted to see and photograph. He produced credit card receipts and statements from his trip at trial, but didn’t itemize what was business and what wasn’t.

But four years after his trip, all Mike had was a 100 to 150 page first draft of his book, which didn’t make it into the record at trial. And Mike had never written anything before.

Mike seeks about $19K in Schedule C deductions, against no income. Mike didn’t give up the day job at Intel.

Now Judge Vasquez agrees that just because someone hasn’t published before, that doesn’t mean they’re not in the trade or business of writing for profit. Every for-profit author had a first story that didn’t make money, or where the author lost money. And just because they have a day job doesn’t mean they’re not a for-profit author, either. Moreover, IRS never claimed Mike wasn’t in it for profit.

But the newbie Shakespeare has to show continuous effort, or, as Judge Vasquez puts it, “(P)etitioner failed to produce evidence to show some intent or effect on his part to engage in and continue in the writing field with substantial regularity and with the purpose of producing income and a livelihood. In Hawkins v. Commissioner, supra, we noted that the taxpayer’s published book of poetry “could just as easily be an isolated venture for the personal satisfaction of * * * [the taxpayer] seeing * * * [her] poetry in print as it could be a product of trade or business.” Id. The same could be said of petitioner; his planned travel book could just as easily be an isolated venture for the personal satisfaction of taking a worldwide trip and seeing his travel adventures in print as it could be a product of a trade or business.” 2012 T. C. Mem. 4, at p. 7.

And you can satisfy your intellectual curiosity about the Hawkins case at Hawkins v. Commissioner, T.C. Memo. 1979-101, affd. without published opinion 652 F.2d 62 (9th Cir. 1981).

Anyway, even if Mike was in it for the money, he falls foul of the strict substantiation of Section 274(d), IRS’ big torpedo for eager taxpayers. To deduct travel and meals, you have to show who, what, when, where, how and why for each and every expense as you make the payment, and tie it in to the business.

So Mike’s literary venture, while personally rewarding and possibly artistically meritorious, fails of taxpayer subsidy.

IRS says “Time for the five-and-ten, the Section 6662(a) negligence with substantial understatement (the greater of $5000 or ten percent of tax properly due) penalty on top”. But Mike says he went to his friendly neighborhood tax preparer, who had more than 36 years of experience, and told the preparer the whole story. And said preparer told Mike to go for it.

So Mike acted in good faith and with reasonable cause, and, as Judge Vasquez puts it, “(B)ecause the reasonable cause and good faith exception is a defense to both negligence and a substantial understatement of income tax, the section 6662 penalty does not apply.” 2012 T. C. Mem. 4, at p. 11.

Takeaway–Just because you could write a book doesn’t mean you’re in it for the gold. Write and keep writing, substantiate and keep substantiating, even if you don’t give up the day job.

OR, Employer’s Evasion Is No Defense to Employee

This is the lesson Judge Cohen teaches Tom Henk (not to be confused with Tom Hanks, co-star of the captioned 2002 movie), who is caught, and hit for self-employment tax, in Thomas G. Henk, Jr., a Section 7463 “Just Sayin’”, 2012 T. C. Sum. Op. 2, filed 1/4/12.

Tom worked for an outfit called Dealer Financial Services, who sacked him on June 13 of the year at issue. Tom got a $10K check from Franklin Financial Corp., a “sister” of Dealer, although Tom never worked, or did anything else, for Franklin. The $10K was supposedly severance pay Dealer owed Tom.

Franklin filed a Form 1099-MISC on Tom, but Tom never reported the $10K and claimed he never got the money, although as trial approached he conceded receipt. As Doctor Johnson famously remarked, “Depend upon it, Sir, when a man is to be hanged in the morning, it concentrates his mind wonderfully.”

Dealer, of course, never paid FICA, FUTA or Medicare/Medicaid taxes on anything but the wage money Tom earned up to the date they canned him. And Franklin never paid such taxes on the post-canning $10K.

Tom claimed at trial that the $10K was wages, upon which Dealer should have paid FICA, FUTA, and all that jazz, and that Franklin was a conduit that Dealer was using to escape its tax liability. But Tom couldn’t prove that on the record, although it does look mighty suspicious. Judge Cohen points out that the issue of whether Dealer or Franklin has to pay any part of the FICA, FUTA, etc., that’s owed on the $10K is not before the Court.

But Tom is before the Court; IRS says the $10K is nonemployee compensation upon which SE tax is due, and Judge Cohen opines simply:  “Petitioner’s suspicions concerning the motivation of his former employer are irrelevant to the taxability of the amount that he received.” 2012 T. C. Sum. Op. 2, at p. 3.

IRS concedes the 92.35% SE computation and 50% AGI deduction (the year at issue was before the self-employed give-up in the current, 2011, law, so the AGI break is 50%, not 57.51%, on the $10K), and Tom gets stuck for the rest.

Takeaway– If the check is suspicious, protest it then, not after IRS nails you. Or maybe drop  a Form SS-8 ,“Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding”, on Federal or whoever is the gamester.

It’s been quite a year; 125 posts and still enthusiastic. Best wishes to all.

Oliver Wendell Holmes, Jr., was known as “The Great Dissenter” on the US Supreme Court a hundred years ago. His intellectual descendant, Mark V. Holmes, the judge who writes like a person, has written a fine dissent in Randall J. and Karen G. Thompson, 137 T. C. 17, filed 12/27/11.

This is a son-of-BOSS phony partnership that was blown up six years ago, with decided cases sinking Randy. So Randy is precluded from fighting over business purpose, economic substance, or whether he owes IRS telephone numbers in tax, interest, and penalties. Even though Tax Court may have gotten its subject matter jurisdiction wrong back then, Randy never appealed, so he’s stuck with Tax Court’s determinations, even though there are later cases that went his way.

For a quick refresher on issue preclusion and claim preclusion, a/k/a collateral estoppel, see Judge Wherry’s lengthy footnotes numbers 22 and 23, at 137 T.C. 17, pp. 32-33.

The question here is Tax Court’s jurisdiction over affected items, that is individual partners’ tax items that follow from partnership items, but aren’t themselves partnership items. Once the partnership-level adjustment becomes final, TEFRA gives IRS the power to assess these directly to the partner without the need for a SNOD, if they are merely computational, so as not to waste time sending out SNODs for simple arithmetic problems.

IRS issued Randy a SNOD anyway as well as an assessment, since IRS Chief Counsel wanted belt-suspenders-and-crazy-glue, because no one could tell what was or was not a merely computational affected item.

IRS got the numbers wrong in Randy’s SNOD but corrected them. Anyway, says IRS, Randy’s items are merely computational, no partner-level fiddling is needed, so Tax Court has no subject matter jurisdiction. And IRS’ math errors are not “determinations”, so they don’t trigger Tax Court jurisdiction.

The majority, per Judge Wherry, holds that way, and throws out Randy’s petition.  Judge Wherry writes the brief that IRS should have written but didn’t, in 36 pages, and Judges Colvin, Halpern, Vasquez, Thornton, and Paris agree.

Judges Morrison and Gustafson wisely sat this dance out.

Judge Cohen concurs in result only without separate opinion, but Judge Goeke dissents, and Judge Kroupa agrees. The fact that the majority took 36 pages to decide they had no jurisdiction means that each case has to be weighed, says Judge Kroupa. The fact that the SNOD numbers were wrong doesn’t, as the majority claim, invalidate the SNOD. IRS did decide something, there was a determination, so Randy can go to Tax Court, even though he will be thrown out based on his prior unappealed Tax Court losses.

Now for Judge Holmes. He agrees that Randy can’t argue that he had outside basis or that he doesn’t owe the 40% substantial understatement penalty, because he lost on those and never appealed. But Judge Holmes challenges the majority’s analysis of whether an affected item requires partner level determinations. It’s the analysis that troubles Judge Holmes.

A computational adjustment is just the bottom-line change on the partner’s return caused by the change at partnership level. But there are two baskets into which these adjustments can fall. Judge Holmes: “Sometimes the IRS has to send each partner a notice of deficiency, sometimes the IRS can just directly assess each partner and send him a notice of computational adjustment, and sometimes the IRS has to do some combination of both. See sec. 6230(a); sec. 301.6231(a)(6)-1(a), Proced. & Admin. Regs.; see also Napoliello v. Commissioner, 655 F.3d 1060, 1063-1064 (9th Cir. 2011) (citing Olson v. United States, 172 F.3d 1311, 1317 (Fed. Cir. 1999)), affg. T.C. Memo. 2009-104.” 137 T.C. 17, at p. 43.

If the change at partner level arising from the affected item requires a determination at partner level, then the deficiency procedure must be followed. If the only change at partner level is a math item coming from the change at partnership level, then straight to assessment, no SNOD. Incidentally, partner gets no ticket to Tax Court with the concomitant stay of collection.

Once again, Judge Holmes says it in a footnote: IRS could clear this up in the abusive shelter area by creating a single-track deficiency procedure, where both partnership and partners are in it together. 137, T.C. 17, at p. 44, footnote 3. Cf. poor old Beverly Bernice Bang, 2011 T.C. Sum Op. 1, filed 1/4/11, and my blogpost “Bang-A Warning to Tax Matters Partners (and their advisors)”, 1/5/11. If Bev could have bailed on the jojoba deal for $2700 and avoided the $32,000 assessed against her twenty-two years later, I can’t think why she wouldn’t have done so. But back to Randy.

The majority says, it’s all math, so straight to assessment. Judge Holmes says, I’ll concede three of the four items IRS changed on Randy’s return are math, but number four, knocking out his loss on liquidation of the partnership, doesn’t even appear on the 1065.

That’s a paraphrase; now in his own words: “The majority says that we can go ahead and eliminate it anyway because we decided… that the partnership was a sham, and no one can take a loss in disposing of an interest in a sham partnership. I don’t disagree. But it doesn’t quite answer the jurisdictional question that we have– does a taxpayer get to come to our Court to learn this lesson, or does he have to go to a refund court to hear the same bad news?” 137 T.C. 17, at p. 46 (footnote omitted).

More to the point, can Randy use Tax Court’s stay of collection to try to stash his cash before the IRS descends upon him and his?

Judge Holmes goes on. Eliminating Randy’s outside basis doesn’t get the right tax, because the loss Randy claimed took into account the cash he got for supposedly selling his partnership interest on liquidation. IRS disallowed a loss greater than what Randy claimed, because IRS skipped a step; IRS didn’t merely get the math wrong, they got the formula wrong. So it’s not just a math error, or a pure math computation.

The issue, briefly, is whether the partner adjustment is a “work it out with a calculator” adjustment flowing from the partnership adjustment, or whether there’s a legal question involved. Reg. Section 301.6231(a)(6)-1(a)(2) gives examples of mere math adjustments, like changes in threshold for medical deductions based upon AGI where the partnership adjustment gives the partner more gross income, and thus a higher AGI, which involves nothing more than simple arithmetic.

But Judge Holmes finds there’s a legal question here: outside basis, that forms no part of a partnership return. And there was a determination– collateral estoppel operates to keep Randy from fighting the issue again.

Another point. “I also think that it’s important to consider, when thinking about whether a computational adjustment requires partner-level determinations, whether a partner had the opportunity at the partnership level to dispute all issues of law and fact that will affect the computational adjustment. Otherwise we may see cases like the Thompsons’ again in a collection due process proceeding.” 137 T.C. 17, at pp. 56-57. (citations and footnotes omitted).

Again, for Randy it doesn’t matter; he had his chance, and he blew it. But the “thick line” Congress drew between partnership adjustments and partner adjustments not involving partnership matters is blurred here by the majority, says Judge Holmes, and “(T)he silt we stir today will cloud the cases we plunge into tomorrow.” 137 T. C. 17, at p. 61.

Can’t say it better than that.

Or, The Limits of Game-playing

A certain Director at a major accounting firm directed my attention to the new Treasury Regulations concerning Cost Sharing Arrangements and Platform Contribution Transfers among controlled entities.

She suggested that small businesses, for whose tax advisers I am writing, might encounter such dealings, principally in-bound US corporations and LLCs controlled by foreign entities. Quoting from the introduction to these regulations, “(A) unifying underpinning of the section 482 regulations is that controlled transactions reflecting similar economics, regardless of the type of transaction (such as transfer of intangibles or provision of services), should be valued in accordance with similar principles and methods.” Simple enough.

And as today is a Federal holiday, wherefore  school is out at Tax Court, I thought I’d fish for interesting morsels in TD 9568, a/k/a 80082 Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations, wherein the new Regulations appear.

But as I read the first fifty or so of the 202 pages of TD 9568, it became clear that it would be a rare small US firm that encountered the deals to which the Regulations were directed.

Again quoting TD 9568, “(I)t has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collections of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that this rule applies to U.S. businesses and foreign affiliates that enter into cost sharing arrangements.

“Few small entities are expected to enter into cost sharing agreements, as defined by these regulations. Accordingly, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration (CCASBA) for comment on their impact on small businesses. CCASBA did not have any comments.”

Quite possibly the CCASBA’s eyes glazed over at the same point as mine did.

So I’ll take Treasury at its word, and presume my readers will rest content with my abstract of the Regulations, as follows. The calculations of cost and profit must be reasonable, and must be based upon arms’-length or equivalent transactions. You can’t have the right to reject future contingent payments. You can’t mix-and-match discount rates to get the results you want. Play nice, kids.

Takeaway–In the immortal words of the old cartoon about the schoolgirl’s book report, “This book told me more about penguins than I wanted to know.”

 Santa Claus May or May Not Be Coming, But Tax Court Has Something

With apologies to John Frederick Coots and Haven Gillespie, the authors of the 1934 classic “Santa Claus is Coming to Town”, I note that, before going off to celebrate, Tax Court plays surrogate Santa Claus, handing out coal to bad boys and girls. On Thursday last, Tax Court gave out five lumps. I’ll summarize them quickly, as (a) they have little instructional or entertainment value, and (b) I am instructed by a certain Director at a major accounting firm to discuss the IRS’ new Cost Sharing Agreement regs. The latter will get separate treatment.

First, Syed A. and Rafiunnisa R. Ahmed, 2011 T.C. Mem. 295, filed 12/22/11. Sy wins religious discrimination suit, footnotes the recovery on his return (because he got a 1099-MISC), but doesn’t pay tax. Although the general release he signs says he is surrendering any claims for “personal injuries”, Judge Wells says personal injuries are greater than physical injuries (my emphasis), and that’s what Section 104(a)(2) requires. Sy had a heart attack, he claims, and was made to work where he got nauseated from malodorous chemicals, but neither the complaint nor the settlement agreement itemized physical illness or injury, and the general release was the usual boilerplate. IRS wins.

Second, Illya Bell, 2011 T.C. Mem. 296, filed 12/22/11. Illya claims he was unemployed for ten years, but before that (the year at issue) he ran a landscaping business; he couldn’t get the records to show income and expense because of the order of protection his ex-wife got against him, and a criminal case he was dealing with. He went to an individual (qualifications unspecified) to have his taxes done. He claims she made up numbers, especially his income, although some (his deductions) were accurate. He claims he sent in the return without reading it, although he signed it under penalty of perjury. Judge Wherry says he must have had some of the expenses his return showed and that he testified to, so giving Illya a 75% Cohan haircut (proved allowable expense but not amount), he nevertheless refuses to abate one penny of Illya’s income as stated, and sticks him with nonpayment and accuracy penalties as well.

Third, John C. Hughes, 2011 T. C. Mem. 294, filed 12/22/11. John protests a notice of lien. He claims he had no equity in his house and moved out anyway. He also claims he has only Social Security to live on, the lien hurts his credit, he sometimes can’t pay his bills and his income is below the median income for his home state of Georgia. Judge Wells gets this prize package, and unwraps it thus. The lien covers all property, real and personal, now owned or hereafter acquired, until tax paid or lien expires as provided by law. If Johnny is broke now, tomorrow is another day, as they say in Georgia. Every tax lien hurts the taxpayer’s credit, but John never claimed he could pay what he owed if the lien were lifted, and even if he could pay if it were lifted, IRS has discretion. And half the population of Georgia has income below the median, cause that’s what the median is, Johnny, half above, half below. Oh yeah, and John hadn’t paid taxes for at least eight years. IRS wins.

Fourth, Wayne Lasier Wilmot, 2011 T. C. Mem. 293, filed 12/22/11. I wanted to give this more space, but on reflection it doesn’t deserve it. Lasier was an oceanographer-turned-photographer, but he still worked for NOAA and taught at Johns Hopkins. He claimed his $50K-plus annual losses from what he called his photography business. But he put no photographs into evidence, he had no business plan or separate business bank account, he turned down work because he didn’t like it, he lost money every year for six years; and even if IRS conceded in one subsequent year he was engaged in business, that doesn’t bind IRS for any other year, especially not the year at issue. Judge Morrison goes through the for-profit laundry list, and washes Lasier out.

Finally, Terry L. and Cheryl A. Wright, 2011 T.C. Mem. 292, filed 12/22/11. We’ve heard this same old song before, the foreign currency Section 1256 shuffle. Ter and Cher need to bury a big gain, so they buy offsetting euro options, like our old pals Ricky and Tari Garcia, 2011 T.C. Mem. 85, filed 4/13/11; see my blogpost “An Option Isn’t a Contract”, 4/14/11. As with Ricky and Tari, Ter and Cher could walk away if the price of the euro didn’t hit the sweet spot, they didn’t have to deliver the currency on the magic date if they didn’t want to, and the options weren’t traded on any exchange. Ter and Cher’s argument when confronted with Garcia? Tax Court was wrong about Garcia. Judge Wells’ reply: No we weren’t wrong, you’re wrong, you flunk the Section 1256(g)(2) tests, and you’re out.

Best wishes to all for a Merry and a Happy. And good health and prosperity.

 Or, Tax Court Litigation Can Be Hazardous to Your Health (Financial, if Nothing Else)

This is the lesson Judge Holmes, a judge who writes like a person and not like a lawyer, is trying to teach Erik McBride Thompson, in 2011 T.C. Mem. 291, filed 12/19/2011.

Erik started by trying to do good, and ended up by doing well. Erik, a son of the pioneers in tiny Milan, Minnesota (population 300), went to Stanford University. There, he earned three degrees. From there, he went to Truk, once Japan’s Gibraltar of the Pacific and now a proud member of the Federated States of Micronesia, with the Peace Corps. Leaving the South Pacific, he returned to Milan, where he ran the Prairie Sun Bank and the Prairie Land & Lumber Company. In short, Erik was a very big bullfrog in the Milan pond.

But the call of the islands was irresistible, so Erik imported 100 Trukians to work in the local meatpacking plant. This move prospered Milan so well that Erik got considerable green fallout therefrom. But domestic tranquility wasn’t enough; Erik decided the wars in Iraq and Afghanistan were immoral and illegal, so he had to do something.

Or rather, not do something: he didn’t file proper returns or pay his income taxes.

With the usual result. IRS descended upon the banker-lumberjack with Substitutes for Returns, SNODs and breathings of fire and slaughter. After Erik spent a year fiddling around in Appeals to no visible purpose, and filed his petition with Tax Court,  IRS sent Erik a Branerton letter (see Branerton Corp. v. Commissioner, 61 T.C.691, 692 (1974)) which is a way to commence informal discovery without resort to formal demands; to try to agree on exhibits and facts before hitting the real matters in dispute.

Erik’s reply was not quite in line. Judge Holmes: “‘You may be curious about my decision not to file * * * my actions are designed to call us back to the rule of law and stop the slaughter of innocents.’ The letter goes on at some length but leaves no doubt that Thompson intended to resist paying taxes because he disapproved of the wars in Iraq and Afghanistan.” 2011 T.C. Mem. 291, at pp. 4-5.

Erik waxed eloquent about the Nuremberg Principles. The Nuremberg Principles provided that compliance with the law would be no excuse for those tried if the conduct would be complicit in, for example, a crime against humanity. United States v. Malinowski, 472 F.2d 850, 856 n.7 (3d Cir. 1973). 2011 T.C. Mem. 291, at p. 5, footnote 5.

However, Judge Holmes was less concerned with Erik’s hypothetical trial before an international war crimes court than about his approaching trial in United States Tax Court, and told Erik that if he didn’t provide some evidence 14 days before trial, he would be precluded from producing any at trial.

So Erik coughed up some paper. Judge Holmes, however, moved things right along. “But when we called the case for trial, Thompson still banked on a continuance. As the Commissioner reminded us, however, Thompson had spent almost a year with the Appeals officer doing nothing. We therefore denied his request.

“This finally jolted Thompson into action.” 2011 T.C. Mem. 291, at pp. 5-6.

Erik claimed investment interest carryforwards that would wipe out his past due taxes. Judge Holmes explains in “people talk” what investment interest is, in footnote 7 at page 6 of his decision, to which I refer everyone. As I said, here is a Judge who uses “people talk”. And the best part of his decisions is in the footnotes, where he explains things.

Of course, Erik plays around with handing over documents, and IRS wants everything precluded, claiming that to let them in would reward Erik’s dilatory tactics. Judge Holmes says he’ll let the documents into evidence. “We take into account that the documents’ purpose was to substantiate the disputed expenses, which we find does not prejudice the Commissioner. Cf. Cagle v. Commissioner, T.C. Memo. 1993-217. We also recognize that Thompson is going at this pro se and for the first time. He would be unlikely to get such indulgence in the future, and we have other ways of discouraging delay. See sec. 6673.” 2011 T.C. Mem. 291, at p. 8, footnote. In the immortal words of the late great Conrad Veidt, “Ve haff our vays of making you talk.”

Erik has a problem with his investment interest claim. He can prove some payments of interest, but not that the loan  was intended, and the loan proceeds were used, to purchase investment property. “The purpose is crucial because it determines whether the interest paid is deductible. When we know a taxpayer paid a deductible expense, we sometimes can estimate the amount. See Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930). The converse does not hold true–knowing the amount (without more) does not let us estimate that an item is deductible.” 2011 T.C. Mem. 291, at p. 11, footnote 12.

Erik also claimed losses from a residential real estate rental operation. Judge Holmes unpacks this one: “The Commissioner argues that ‘petitioner was not able to establish that the rental activity was non-passive or that the activity was engaged in for a profit.’ Showing unusual chutzpah, Thompson blames the Commissioner for waiting too long to raise the issue of character of the losses. (At trial Thompson focused on the amount of the loss.)

“It’s true that if an issue is untimely raised–unfairly surprising the opposing party by not giving him a chance to adequately address it at trial–-we’ll refuse to consider it.

“But we disagree with Thompson’s premise. The Commissioner didn’t raise this issue for the first time on brief; he raised it at trial. (And considering Thompson hadn’t bothered giving the Commissioner anything relating to his deductions and losses until one week before trial, this was no small feat.)” 2011 T.C. Mem 291, at pp. 13-14 (Citations and footnotes omitted–but go back and read them).

Erik’s disputed deductions are disallowed for failure to sustain his burden of proof, and since no exception to penalties applies to him, Erik gets the full carload.

Not one whit deterred, Erik apparently girds his loins for future voyages of discovery before the panel of the USTC. “Petitioner is on a fact-finding journey through the Tax Court and any encouragement of delay, hindrance, or cost increasing would be directed at future proceedings. Petitioner does not ‘disregard * * * the rules of this court,’ but rather hopes to learn them and possibly use them in the future.” Answering Brief for Petitioner at 9-10.” 2011 T.C. Mem. 291, at p. 16, footnote 15.

To cool Erik’s ardor, Judge Holmes fires a parting shot: “A final word of caution. Thompson seems to welcome future opportunities to come to the Tax Court. We can help pro se litigants with legitimate claims, but not those who make frivolous arguments. Perhaps Thompson believes conflating the two is worth the risk; he is now cautioned that section 6673 allows the Court to impose sanctions of up to $25,000 on taxpayers making frivolous arguments.” 2011 T.C. Mem. 291, at p. 16 (footnote omitted).

Erik, you did good, you did well, now leave well enough alone.

Levy First, Notice Afterwards vs. Lien First, Notice Afterwards

Levy is OK even if Form 3552 notice comes after notice of levy, but not if notice of lien comes first, and Form 3552 comes after. Thus spake Judge Paris, in Michael J. Conway and Raymond T. Nakano, 137 T.C. 16, filed 12/19/11. Case will probably be cited as Michael J. Conway tout court, although both go  up together under Rule 122(a), fully stipulated.

Mike and Ray were officers of the ill-fated National Airlines, founded 1999, cratered 2000. They were responsible parties for filing returns and paying Section 9502(a) Airport and Airways Trust Fund taxes, which I never heard of either, but anyway the trust funds weren’t turned over, and IRS is looking for trust fund recovery penalties (TFRP). Mike and Ray had sued in Federal District Court for refunds after IRS denied their claims (and IRS only took three years to do so), but these taxes are Subtitle Ds, not Subtitle Cs, and so are not divisible and Section 6331(i) does not bar collection. Clear? Thought not.

Anyway, Mike and Ray lost all their District Court cases and Circuit Court appeals.

Ray is first one on the Tax Court chopping block. He claims he got Form 1058 Notice of Levy first, and then two weeks later he got Form 3552 Notice of Tax Due.

Mike is next. He got letter 3164B “we are attempting to collect”, two weeks later gets Letter 3172, Notice of Lien and Right to Hearing, and a week later gets his Form 3552.

Both guys get a CDP. They claim they didn’t get 60-day demand notices and therefore the lien and levy were invalid.

Originally Appeals were going to withdraw the notices and re-serve in both cases, but SO Villaverde, who made that determination, got promoted to Team Manager. His successor, SO Hernandez, agreed with him, but then the Manager overruled her, and decided IRS could proceed to lien and levy. Judge Paris furnishes a bemused footnote: “The record does not reflect whether the Appeals team manager who overruled SO Hernandez was former SO Villaverde or another person.” 137 T. C. 16, at p. 9 (footnote 7).

As to Ray and the Notice of Levy, Judge Paris: “Respondent [IRS] contends that he gave Nakano valid notice and demand when he issued Nakano the levy notice on May 22, 2006. The levy notice went beyond the typical notice of intent to levy by including a demand for immediate payment of the specific amounts of TFRP owed, listed by period at issue, within 60 days of the assessments. In this limited circumstance, the Court agrees that this levy notice constitutes notice and demand.

“‘The form on which a notice of assessment and demand for payment is made is irrelevant as long as it provides the taxpayer with all of the information required under * * * [section 6303].’ Hughes v. United States, 953 F.2d 531, 536 (9th Cir. 1992) (quoting Elias v. Connett, 908 F.2d 521, 525 (9th Cir. 1990)); see also Deputy v. Commissioner, T.C. Memo. 2003-210. Section 6303 requires only that the notice (1) state the amount of unpaid tax, (2) demand payment, and (3) be issued within 60 days of assessment. The levy notice here did provide Nakano with all of the information required under the statute because it listed the type and amount of unpaid tax for each tax period, explicitly demanded payment, and was sent within 60 days of the assessments. The Court therefore holds that respondent gave Nakano the notice and demand required by section 6303.” 137 T. C. 16, at p. 13.

Ray challenges the assessments, but gets no joy from Judge Paris, who finds no prejudice in the mischaracterization of the quick assessments here as “jeopardy” assessments, or IRS’ misstatement that the assessments were untimely.

So Ray goes down in flames.

Now for Mike. Mike says the Letter 3164B was inadequate notice. IRS says “yes it was, and anyway, we don’t need no stinkin’ letter, Mike was boss of National and knew he owed tax, he’d been litigating with us for years and lost every time.” No good, says Judge Paris. IRS did not follow the law, therefore abuse of discretion and Mike wins.

First, “(T)he Letter 3164B merely reflected that unpaid taxes were owed but did not state the amounts, types, or periods of the unpaid taxes. Respondent [IRS] contends that the Letter 3164B did not have to state the amounts owed because, by the time respondent issued the Letter 3164B, Conway’s multiple communications with IRS Appeals (before the assessments) regarding the amounts of the unpaid TFRPs had provided him with constructive notice. Even if Conway had previously seen the proposed assessments, section 6303(a) required respondent, after making an assessment of tax, to either leave notice and demand of payment at Conway’s “dwelling or usual place of business” or mail it to his last known address. Cf. Resyn Corp. v. United States (In re Resyn Corp.), 945 F.2d 1279 (3d Cir. 1991) (IRS’ filing of a proof of claim in bankruptcy did not satisfy section 6303(a) because it did not employ either of these notification methods). Therefore, since the Letter 3164B gave notice of nothing other than that unpaid taxes were owed, it did not constitute a valid postassessment notice and demand.” 137 T.C. 16, at pp. 15-16.

Judge Paris goes on: “Next, the lien notice did not constitute valid notice and demand under section 6303 and section 6321. Respondent’s argument assumes that the lien notice issued to Conway on June 1, 2006, can serve as both notice and demand under 6303 and notice under section 6320. This assumption is flawed. A tax lien imposed under section 6321 arises at the time of assessment, see sec. 6322, and is enforceable when a ‘person liable to pay any tax neglects or refuses to pay the same after demand’, sec. 6321 (emphasis added). Moreover, section 6320(a)(1) requires the Commissioner to notify ‘the person described in section 6321’ of the NFTL filing. (Emphasis added.) This person is the person liable to pay who has refused to pay after demand (emphasis by the Court). Thus, the Commissioner must issue notice under section 6320(a)(1) only after demand has been made and the person neglects or refuses to pay. Therefore, no notice can serve as both assessment notice and demand under section 6303 and also postlien notice under section 6320(a)(1).” 137 T.C. 16, at pp.16-17. One size does not fit all.

IRS went backwards. Lien first, notice afterwards. No can do.

IRS’ argument that Mike, as CEO of the downed airline, knew right well that he had to pay the trust fund tax, fares no better. Judge Paris shoots IRS down: “Respondent relies on Jersey Shore State Bank v. United States, 479 U.S. 442 (1987), to support his argument. Respondent’s reliance on Jersey Shore is misplaced. The penalty imposed on the bank in Jersey Shore was nonassessable and not subject to administrative collection procedures. Id. at 447. Thus, the Supreme Court’s reasoning in Jersey Shore does not support the proposition that any notice Conway may have had eliminated the need for respondent to issue notice and demand before the lien on Conway’s property arose.” 137 T.C. 16, at pp. 17-18. Mike’s notice of lien bites the dust.

So Mike wins, Ray loses. And although IRS’ administrative procedures here were far from admirable, they do get Ray’s property.