In 27 Pages or Less

 IRS has come up with fresh regulations on the due-diligence requirements for preparers of EITC returns. See my blogpost “The $500 Misunderstanding”, 10/25/11.

In 27 pages, IRS says that (a) providers of generic information about EITC to walk-ins at a tax preparer’s office are not non-signing preparers and don’t have to worry about the $500 penalty; (b) a firm cannot be subject to the $500 penalty unless one of the following three conditions is satisfied: (1) a member of the principal management of the firm knew of the failure to comply with the due diligence requirements; (2) the firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements; or (3) the firm failed to comply with its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference; and (c) retention of EITC records no longer runs three years  from filing of the return (because the taxpayer may take the return from the preparer and file it themselves, and preparer cannot know when, or whether, taxpayer filed), but for the period ending three years after the later of the date the tax return or claim for refund was due or the date it was transferred in final form by the tax return preparer to the next person in the course of the filing process.

Simple, huh?

Oh yes, and the economic impact on preparers will be “minimal.”

Nit-pickers, obsessive-compulsives and terminal insomniacs may find the complete text at FR Doc. 2011-32487 Filed 12/19/2011 at 8:45 am; Publication Date: 12/20/2011.

The old saying “the lawyer who represents himself has a fool for a client” is proven once more in Peter A. McLauchlan, 2011 T.C. Mem. 289, filed 12/19/11. Pete was a partner in a Texas law firm during the years at issue (identity of law firm sealed by Court at Pete’s request; pseudonymously AR), but tax wasn’t his area of expertise.

Of course, he prepared his own returns. And of course his firm affiliation can be found by doing a simple Google search. Sealing a person’s professional affiliation in the Internet Age is like trying to hide a Great White Shark in your bathtub, but we’ll keep it anonymous here.

At least he didn’t represent himself before Tax Court.

Pete claimed some Schedule C expenses that were reimbursable by his firm’s policy, with no countervailing custom or practice, and for some of which he was reimbursed. He had some pass-through charitables and depreciation, and those gimmes Judge Kroupa let him have.

As for the reimbursables, AR had a policy: “AR had a written reimbursement policy that specifically provided for reimbursement of certain indirect AR expenses. Reasonable travel expenses were reimbursable, including expenses related to client maintenance and development. Interoffice travel expenses involving an automobile were reimbursable. Lease and rental automobile expenses incurred for client travel were reimbursable. Business meals and entertainment were reimbursable if authorized and approved. Continuing legal education expenses were reimbursable if approved.

“The written reimbursement policy, however, also provided that in-town transportation (i.e., transportation within a 20- mile radius of an attorney’s home office) expenses and spousal travel expenses were not reimbursable.

“As a matter of routine practice, AR would reimburse other indirect AR expenses that were not provided for in the written reimbursement policy, including State bar membership expenses and professional organization expenses. AR did not have a limit on the amount for which a partner could be reimbursed. Reasonableness, rather, was the overarching standard for approving reimbursement of indirect AR expenses. AR would deem an expense unreasonable if it was personal, excessive or not in AR’s best interests.” 2011 T.C. Mem. 289, at p. 4.

Pete’s Schedule C expenses were, he claimed, unreimbursed expenses. IRS said if they were proper expenses properly paid (which they didn’t concede), they were partnership expenses paid by a partner, and therefore not deductible by the partner. Judge Kroupa: “Generally, a partner may not directly deduct the expenses of the partnership on his or her individual returns, even if the expenses were incurred by the partner in furtherance of partnership business. Cropland Chem. Corp. v. Commissioner, 75 T.C. 288, 295 (1980), affd. without published opinion 665 F.2d 1050 (7th Cir. 1981). An exception applies, however, when there is an agreement among partners, or a routine practice equal to an agreement, that requires a partner to use his or her own funds to pay a partnership expense. Id.; Klein v. Commissioner, 25 T.C. 1045, 1052 (1956).

“The AR partnership agreement required petitioner to pay indirect AR expenses that were unreimbursable. There was no routine practice at AR that required petitioner to pay any other AR expenses. Accordingly, the expenses at issue are deductible if they were (1) indirect AR expenses, (2) unreimbursable and (3) actually incurred.” 2011 T. C. Mem. 289, at pp. 6-7.

Examining the expenses, the AR partnership agreement, and Pete’s own “general and vague” and “self-serving, unverified and undocumented” testimony (2011 T.C. Mem. 289, at p. 9), Judge Kroupa finds Pete never was denied reimbursement for anything he claimed, and his in-town, nonreimbursable automobile deductions hit the Section 274(d) roadblock. Strict substantiation: nothing else will serve, but again Pete offers only “general, vague, self-serving and uncorroborated testimony”, 2011 T. C. Mem. 289, at p. 11.

Game over for Pete’s Schedule C.

Now for the Section 6662(a) accuracy penalty. After the ritual incantation, Judge Kroupa nails Pete: “A taxpayer is not liable for an accuracy-related penalty, however, if the taxpayer acted with reasonable cause and in good faith with respect to any portion of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including the taxpayer’s efforts to assess his or her proper tax liability, the knowledge, experience and education of the taxpayer, and the reliance on the advice of a professional. Sec. 1.6664-4(b)(1), Income Tax Regs.

“Petitioner is well educated and has been an attorney for over 20 years. He prepared his own Federal income tax returns for the years at issue. Petitioner admitted that he had difficulty preparing his tax returns, yet he failed to seek the assistance of a tax professional.

“Moreover, the full amount of each underpayment resulted from petitioner repeatedly disregarding the rules and regulations on reporting income and claiming deductions against income. Petitioner failed to offer any persuasive evidence that he acted with reasonable cause and in good faith in disregarding the relevant rules and regulations.” 2011 T. C. Mem. 289, at pp. 12-13.

So Pete loses–all the way.

Takeaway–Hire your tax professional before you get to trial. Hire them even before you do your own return.

Or, The Big Payday

 Papa Allen and his sons are fighting over the boodle, when the kids bought out Papa via a cashless stock option in Allen L. Davis, et al., 2011 T.C. Mem. 286, filed 12/12/11. Judge Kroupa faces an all-star cast of lawyers in this consolidated proceeding (fourteen for the battling Famous Famiglia Davis, and four for IRS). This is a “whipsaw”–someone owes big-time tax, and IRS doesn’t care who.

Briefly, Papa Allen fronted the kids $100K to open a business called Check-N-Go, a payday lender. In the old days, it was six for five in seven days, or three broken fingers in eight; the sharks would lend a worker five dollars and get back six dollars in seven days. Should the worker not pay, the appropriate digits would. Now, in these enlightened days with direct wage deposit, the shark just gets a check in advance for the amount lent, and cashes it electronically on the magic day–perfectly legal–and nobody gets hurt.

Now the business took off. Papa Allen just happened to have been a banker, and he had to stay in the business so the kids could get bank loans and expand the business. Did they ever; the business grew at a 37% annual rate. Now the business was a Sub S, with the kids, and some of their cronies who also bankrolled them in the earlies, as shareholders, along with Papa Allen.

There were various buyout and rights of first refusal, so when Mama Allen tried to dump Papa Allen and grab half his stock, the kids threatened to use the buy-sell to pick Mama Allen’s pocket on the way to the courthouse.

Finally, Papa Allen wants to take the money and run, he and the kids having taken turns kicking one another off the Board of Directors and out of management. The kids were now making it on their own (we don’t need no stinkin’ gratitude). So Papa Allen cashes out for $36 million, according to IRS, and $25,31,378.30, (so in original, at p. 14) according to Papa Allen’s pet appraiser, via a redemption of his stock, called the cashless option, by the corporation per an amended buy-sell. Judge Kroupa dumps the appraisal, stating that the stock could not be readily valued, the strike price for the redemption was negotiated after the kids had fought with Papa Allen, and so the price was freely negotiated. And to use Papa Allen’s appraiser’s valuation means the corporation would be taking a big loss on the redemption.

Now Papa Allen claims he had no income from the redemption. And, he claims, the corporation, which treated the payout to Papa Allen as compensation, has no deduction. The corporation (the kids and cronies) claim yes, it was compensation and we have the deduction. IRS says “we don’t care, talk among yourselves, but someone is paying tax.”

Judge Kroupa says the kids credibly testified that Papa Allen got the redemption deal because they needed to keep him in management to secure bank financing, and needed his banking creds to keep their lenders happy. Besides, the redemption agreement required Papa Allen to notify the corporation if he was electing Section 83(b) treatment and recognizing gain in the year he got the redemption option. If it isn’t compensation, Section 83 doesn’t apply, so why mention it?

Now that it’s compensation, is it reasonable? Section 162 doesn’t help. But Judge Kroupa takes a practical approach. “At the time the agreement was entered into, it was fair to CNG [the corporation]. Allen threatened to leave CNG unless he was given the opportunity to maintain his ownership interest in CNG. CNG, however, needed Allen to secure financing. The bank group extended CNG credit only because of Allen’s experience at Provident, and the covenant in the credit agreement required Allen’s participation in the day-to-day management of CNG. CNG needed that financing to fuel its exponential expansion.

“CNG was exceptionally successful from the time the Allen Option was granted to the time it was exercised. During that period, CNG opened 272 new stores. CNG’s revenues increased approximately 37 percent from $199.3 million to $272.7 million, and its EBITDA increased approximately 40 percent from $44.6 to $62.3 million.

“This success was mostly attributable to Allen. CNG could not have expanded as quickly as it did without Allen because the covenant requiring Allen’s participation in CNG’s management was not removed until the credit agreement was renegotiated in September 2004. ‘An employee responsible for the financial success and growth of a large and complex enterprise is entitled to substantial compensation.’ Lundy Packing Co. v. Commissioner, T.C. Memo. 1979-472; see also Albert Van Luit Co. v. Commissioner, T.C. Memo. 1975-56.” 2011 T. C. Mem. 258, at pp. 19-20.

So with this tribute to his business acumen and managerial skill, Judge Kroupa sticks Papa Allen with $36 million in income, and a Rule 155 bean-count to enjoy. Meantime the kids and cronies split a $36 million flow-through deduction against ordinary income.

Takeaway–Nothing like building a successful business to get you slammed by your family and the IRS.

Or,  If You Want a Refund, Ask For It

Taking his cue from John Osborne’s 1956 London hit, thus instructs STJ Dean, in Abdelrahman Rabie, 2011 T.C. Sum. Op. 137, filed 12/12/11. AbRab overpaid his taxes in the year at issue, but IRS issued a SNOD claiming he underpaid. After concessions, everyone agrees AbRab overpaid. But the lookback in Section 6512(b)(3)(b) bars his refund.

AbRab never filed his return for that year until three and a half years later. He did timely file an undated 4868 auto-extension, but that showed a balance due. Then,  two years after his return was due (as extended), he sent IRS a letter apologizing for not filing but claiming he always got a refund in the past. He  sent in a return, and what he styled a “corrected return”, a year after that, which “corrected return” everyone agrees finally got AbRab’s numbers right.

Now, does AbRab get a refund? STJ Dean says no.

“A taxpayer seeking a refund of overpaid taxes ordinarily must file a timely claim for a refund with the IRS that meets the requirements of section 6511. That section contains two separate provisions for determining the timeliness of a refund claim: The taxpayer must file a claim for a refund ‘within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid.’ Sec. 6511(a)(1).

“Section 6511 also defines two ‘lookback’ periods: if the claim is filed ‘within 3 years from the time the return was filed’, then the taxpayer is entitled to a refund of the portion of the tax paid within the 3 years immediately preceding the filing of the claim plus the period of any extension of time for filing the return. Sec. 6511(b)(2)(A). If the claim is not filed within that 3-year period, then the taxpayer is entitled to a refund of only that ‘portion of the tax paid during the 2 years immediately preceding the filing of the claim.’ Sec. 6511(b)(2)(B). If no claim has been filed the refund cannot exceed the amount that would be allowable under section 6511(b)(2)(A) or (B) if a claim was filed on the date the refund is allowed. Sec. 6511(b)(2)(C).” 2011 T. C. Sum. Op. 137, at pp. 4-5.

Clear, right?

AbRab says he did make a claim, albeit informally, in his 4868 or in his “so sorry but I always get refunds” letter. And those, he says, were timely.

No, says STJ Dean. Even though the courts have accepted claims even so vague that IRS rejected them out of hand (provided they were timely amended to demystify), “(I)t is not enough, however, that the facts supporting the claim reach the IRS in some ‘roundabout’ fashion. ‘The evidence should be clear that the Commissioner understood the specific claim that was made even though there was a departure from form in its submission.’” 2011 T. C. Sum. Op. 137, at pp. 5-6 [Citations omitted.]

In fact, even a 37-page letter was found insufficient in Martin v. United States, 833 F.2d 655 (7th Cir. 1987), because “…to be considered an adequate informal claim, the writing must be ‘sufficient to apprise the IRS that a refund is sought and to focus attention on the merits of the dispute so that an examination of the claim may be commenced if the IRS wishes.’” 2011 T.C. Sum. Op. 137, at p. 7. The taxpayer in Martin never said a refund was wanted, or demanded an IRS administrative review of the return.

IRS need not launch an independent investigation into every piece of paper or e-correspondence it receives. IRS need not, like Peer Gynt in Ibsen’s play, “go round about”. AbRab never said “I want a refund.” He only said he always got one before, and took three and a half years to get the numbers right. His 4868 was insufficient, because it showed a balance due. Even so, in the past a 4868 was held to be sufficient notice when taken together with other documents submitted by the taxpayer (Kaffenberger v.United States, 314 F.3d 944, at pp. 955-956 (8th Cir. 2003). But AbRab’s letter wasn’t specific enough.

Nevertheless, AbRab might be OK in Tax Court, even if not with IRS.

“A taxpayer seeking a refund in this Court, however, does not need to actually file a claim for refund with the IRS. He need only show that the tax to be refunded was paid during the applicable lookback period. Sec. 6512(b). In this case, the applicable lookback period is set forth in section 6512(b)(3)(B), which provides that this Court cannot award a refund of any overpaid taxes unless it first determines that the taxes were paid ‘within the period which would be applicable under section 6511(b)(2) * * * if on the date of the mailing of the notice of deficiency a claim had been filed (whether or not filed) stating the grounds upon which the Tax Court finds that there is an overpayment’.

“Section 6512(b)(3)(B) treats delinquent filers of income tax returns less favorably than those who have filed timely. Whereas timely filers are most likely to have the opportunity to seek a refund in the event they are drawn into Tax Court litigation, a delinquent filer’s entitlement to a refund in Tax Court depends on the date of the mailing of the notice of deficiency. Section 6512(b)(3)(B) directs the Tax Court to measure the lookback period from the date on which the notice of deficiency is mailed and not the date on which the taxpayer actually files a claim for refund. In the case of delinquent filers, section 6512(b)(3)(B) establishes only a 2-year lookback period, so the delinquent filer is not assured the opportunity to seek a refund in this Court. If the notice of deficiency is mailed more than 2 years after the taxes were paid, the Court lacks jurisdiction to award the taxpayer a refund.” 2011 T. C. Sum. Op 137, at pp. 9-10. {Citations omitted.]

Unhappily for poor ol’ AbRab, the SNOD got mailed to him after the three-year window had closed, so he was out of luck even if the three-year lookback applied.

Takeaway–Every letter to IRS should say “I want a refund”. If you file a 4868 and can state in good faith that you overpaid, write on the front in big letters “I want a refund”. And tell ‘em AbRab sent you.

Or, A Little Learning Is a Dangerous Thing

Once again I quote Alexander Pope, as I did in my blogpost “A Dangerous Thing”, 4/13/11:

A little learning is a dangerous thing;
Drink deep, or taste not the Pierian spring:
There shallow draughts intoxicate the brain,
And drinking largely sobers us again.

This was advice an unnamed Missouri law firm should have heeded, but their failure to read and heed bails out DeeDee Dennis, in Denise Diana Dennis, 2011 T. C. Sum. Op. 134, filed 12/5/11.

Echoes of poor ol’ Debbie Crane (see my blogpost “No Hurt, No Foul?”, 11/1/11). DeeDee wins a discrimination suit (race this time, not sex), claiming damages for “loss of self-esteem, humiliation, emotional distress and mental anguish and pain, and related compensatory damages.” 2011 T.C. Sum. Op. 134, at pp. 2-3.

What’s wrong with this picture? No physical injury or illness.

Now for the kicker. Judge Wells takes up the story:  “…petitioner signed a document from her attorneys titled ‘Settlement Distribution – Tax Consequences’, which stated, among other things:

“‘Counsel has informed client that there are complicated issues surrounding the taxability of employment discrimination awards and/or settlements. Counsel has further informed Client [sic] that payment for non-physical injuries are generally taxable * * *.

*******

“‘Counsel informed Client [sic] that the law is unsettled as to whether emotional damages in non-physical injury cases are taxable. Counsel informed client about the decision in Murphy v. Internal Revenue Service 460 F.3d 79 (2006) holding that such damages are not always taxable. Counsel has urged client to obtain professional tax advice and provide a copy of the attached case to the tax professional to determine what, if any, impact it has on the resolution of the issue of the tax consequences associated with this settlement. Counsel has informed Client [sic] that there has been an appeal of that case and the case may be overturned and/or may not be followed by the Courts in Missouri * * *’.

“The case mentioned in that document, Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), was later vacated by the Court of Appeals for the District of Columbia Circuit on December 22, 2006, Murphy v. IRS, 99 AFTR 2d 2007-396, 2007-1 USTC par. 50,228 (D.C. Cir. 2006). The Court of Appeals subsequently heard additional arguments before issuing another decision on July 3, 2007, in which it held that the taxpayer’s compensatory award for emotional distress was taxable. Murphy v. IRS, 493 F.3d 170 (D.C. Cir. 2007). However, petitioner was not aware of those developments.” 2011 T.C. Sum. Op. 134, at pp. 3-4.

DeeDee and her lawyers were both unaware that Murphy’s Law had trumped the Murphy case. If anything could go wrong, it did.

DeeDee went to a franchise tax preparer when she got the 1099-MISC showing her recovery in the lawsuit. The franchisee didn’t have a clue whether the award was or was not taxable, although Section 104(a)(2) had not changed. DeeDee, disappointed at the clueless franchisee, went to another preparer, whose address she did recall but whose name she did not, obtained that preparer’s oral opinion that the award was not taxable, and rewarded that preparer by taking her business to still another preparer. She never showed that preparer the 1099-MISC (DeeDee said she had lost it), said the settlement was confidential, and the preparer, taking her at her word (serious mistake), never put the settlement income on DeeDee’s return.

IRS wants the Section 6662(a) accuracy penalty.

Judge Wells again: “Petitioner is obviously unfamiliar with tax law. She was advised by the attorneys who handled her lawsuit that she should seek professional advice regarding the tax treatment of her income from the settlement. By advising her of the Court of Appeals’ holding in Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), those attorneys also provided her with a reason to believe that the income from the settlement might not be taxable. Petitioner consulted three different tax preparation services, and none of them advised her that the income from the settlement was taxable. On the basis of petitioner’s background, education, and actions seeking advice on a complex tax issue, we conclude that petitioner had reasonable cause for her position and acted in good faith on her belief, although mistaken, when she failed to report her income from the settlement.” 2011 T.C. Sum. Op. 134, at pp 9-10.

Judge Wells finds that the tax advice her attorneys gave was erroneous when given, as Murphy I had already been overturned by the time they wrote their disclaimer.

As with Debbie Crane, litigators–don’t give tax advice unless you know what you’re talking about. Drink deep, guys and gals. Or leave the stuff alone.

Or, A Sentence or Two

Somebody reads my blog. I got an e-mail on Friday, 12/2/11, from J. P. Finet, Legal Editor with the BNA Daily Tax Report, asking me to comment on Coffey v. Com’r, No. 11-1362, decided 12/2/11 by the Eighth Circuit. I’ll quote the relevant portion of the e-mail: ”That decision appears to be at odds with the Third Circuit’s ruling in Appleton v. Commissioner, which allowed the U.S.V.I. to intervene. What I am looking for is just a sentence or two from Mr. Taishoff about why practitioners should care about the ruling.”

I was out getting a drink when Mr. Finet’s e-mail arrived, so I didn’t respond at once. My apologies, sir.

However, anyone who has ever read this blog, much less ever encountered me in any other context, knows that I never limit myself to “a sentence or two.” Wind me up, and I’ll give the Energizer Bunny a decent run for his/her loose change.

Coffey is not “at odds” with Appleton, except for a hyper-technical parsing of FRCP 24, which I leave to the law review editors. See my blogpost “Missed It, But Better Late Than Never,” 8/24/11, wherein I summarized the Third Circuit’s decision, reversing Tax Court. Third Circuit remanded the case, stating that Tax Court (Judge Jacobs) got intervention under FRCP 24 wrong.

Appleton talks about as-of-right intervention. Coffey talks about either as-of-right or permissive intervention. But Third Circuit and Eighth Circuit agree. Holding in both cases: USVI should be allowed in at the trial stage. Appleton involves an argument about effective and orderly tax administration. Coffey goes off on the administration of USVI’s “unique” economic development program, but that’s embodied in Section 934.

Effective tax administration or economic development program, call it what you will, is, and of right ought to be, an essential governmental interest, beyond economics. And in Appleton and Coffey the issue is statute of limitations. In both cases, returns were filed per Code; three-year period ran; and no IRS  claim of tax-protester phony returns or fraudulent returns. IRS says, “You filed with BIR (United States Virgin Islands Bureau of Internal Revenue), per Section 932(c)(4). But the statute of limitations is open because you never filed with IRS.” Eighth Circuit noted that Section 932(c)(4) says filing with BIR satisfies filing requirement.

If IRS is right, no VI taxpayer who filed properly per Section 932(c)(4) has ever filed a return. And even if they were audited by BIR, paid up, and case closed–they are still subject to IRS audit.

So USVI has a very real interest. If BIR says it’s over, is it over?

Why should practitioners care? Other than VI practitioners, of course. Because it matters when it’s over. For everybody. We all know that the economic development program for our beautiful but insolvent Islands in the Sun, like all unguided Congressional largesse, led to game-playing. Were the taxpayers in Appleton and Coffey pure of heart and clean of hand? I don’t know. But good or bad, if the law, as embodied in the Acts of Congress, says it’s over, it’s over.

So my reply to Mr. Finet’s request for “a sentence or two why practitioners should care” is “All practitioners should care because it matters that taxpayers, and people, should know that when it’s over according to law, it’s over.”

In-the-trenches tax preparers should welcome IRS’ December 8 town meeting concerning real-time matching of 1099s and W-2 to e-filed returns. The idea is that, if IRS detects a non-reporting, the preparer and taxpayer get immediate notice and a chance to amend. As matters stand, it may be a year or eighteen months before the error is found, triggering interest and penalties.

I know some preparers have objected that this system will allow IRS to match W-2 and 1099s, prepare an individual’s return and mail it to him/her/them for signature, thus cutting out the preparers, paid and unpaid. Is this the thin end of the wedge? I can’t tell. Just sayin’, this year the decree went out from Douglas Augustus that all preparers must be registered; this is the first registration, when Douglas was Commissioner of Internal Revenue and Timothy was Secretary of the Treasury.  Of  course, all the world was to be taxed long before this.

But I just blogged Kurt C. Olsen, 2011 T.C. Sum. Op. 131, filed 11/23/11. Briefly, Olsen updated his tax software in order to report income from a K-1 his wife got, neither his wife nor he ever having seen a K-1 before. He hit the wrong key and, though he accurately reported the payor, didn’t report the income on their Schedule E or transfer that income to their joint 1040. When IRS asserted substantial underreporting long afterwards, Special Trial Judge Armen let Kurt off the hook for the five-and-ten penalty because he clearly acted in good faith. Of course, Kurt still owes tax and interest.

How much time, effort, energy and agita could have been avoided, had Kurt got a next-day e-mail that read something like this: “Hey, dude, where’s the $X your wife got from Y? You got a 1099 but didn’t show it on your 1040”. Time to correct (and presumably avoid penalty), minimal interest, no need to waste scarce Tax Court resources–the benefits could be substantial.

What do you guys think?

Now You See Her, Now You Don’t

The late Jane H. Gudie wanted to avoid probate. She played the living trust gambit, and that worked as far as her native California went. She also wanted to avoid estate tax, but that isn’t going to go so well.  Her trustee/beneficiary Mary Helen Norberg filed a 706 and listed herself as executor, even though she never qualified and never planned to qualify in California or anywhere else. Judge Wherry tells the story, finding that Tax Court has jurisdiction, in Estate of Jane H. Gudie, Deceased, Mary Helen Norberg, Executor, 137 T.C. 13, filed 11/30/11.

As it’s a motion to dismiss, Judge Wherry stresses he isn’t finding facts, just backstopping Tax Court subject matter jurisdiction.

Mary Helen and her sister Ms. Lane were the nieces and sole beneficiaries of the late Jane H.’s largesse–and it was large, about $5 million. Mary Helen and Ms. Lane went through a purported deal whereby the nieces agreed to make annuity payments to the late Jane H. in exchange for Jane H.’s promissory note, secured by the trust assets. If the note was bona fide, the claim against the estate would wipe out those assets. Of course, the nieces never made Payment One to the late Jane H. This carefully-crafted piece of estate tax planning was the work of Robert P. Hess, qualifications unstated.

Jane H. shuffles off this mortal coil. Mary Helen files a 706, signing as executor, although she never was and claims she never will be. IRS, not impressed either with the annuity-note gambit nor Mary Helen’s now-you-see-me, now-you-don’t routine, hits the estate with a great deficiency, claiming GST, gifts within the 3 years before death, and sundry other delictions.

Mary Helen moves to dismiss her own petition for want of subject matter jurisdiction, claiming IRS’ SNOD was sent to her as executor, which she isn’t and never was, and not to the trustees.

Judge Wherry finds Mary Helen was in possession, whether actual or constructive is not stated and it doesn’t matter, of the property of the late Jane H., at least enough to trigger Section 2203 and make her a statutory executor. “…Ms. Norberg, because she was in actual or constructive possession of property of decedent, was a statutory executor. As such, she had the responsibility and authority to file the estate tax return. By filing the estate tax return, she notified respondent of a fiduciary relationship and was the proper person to receive the notice of deficiency.

“Section 2203 defines ‘executor’ for purposes of the Federal estate tax as ‘the executor or administrator of the decedent, or, if there is no executor or administrator appointed, qualified, and acting within the United States, then any person in actual or constructive possession of any property of the decedent.’ In her objection, Ms. Norberg states she ‘was never in possession of any assets of the probate estate of Jane H. Gudie, or of other estates, with respect to any and all times relevant to our motion to dismiss.’ Ms. Norberg attached to her objection the signed declaration of Mr. Hess, who also states that ‘Norberg was not ever in possession of any assets of the probate estate of Jane H. Gudie’. Ms. Norberg and Mr. Hess carefully confine their statements to the ‘probate estate’. The fact that the property Ms. Norberg received did not pass through probate is immaterial to this discussion. This Court has previously held in situations like this that ‘the fact that * * * property interests passed * * * directly rather than as part of decedent’s probate estate is immaterial.’ Estate of Guida v. Commissioner, 69 T.C. 811, 813 (1978); see also Estate of Wilson v. Commissioner, 2 T.C. 1059, 1083-1084 (1943) (stating that if taxpayers could distinguish between probate and nonprobate property to defeat the estate tax, ‘the law would soon be a nullity’).” 137 T. C. 13, at pp. 10-11.

Mary Helen argues that IRS’ affidavits and exhibits are insufficient evidence to defeat her motion, but Judge Wherry steers a course between the motion for summary judgment and the motion to dismiss. In the latter case, the Court is free to look at what it likes. In the former, FRCP 56(e) rules the roost, and there must be admissible evidence. So IRS’ papers stay in, and so does Mary Helen.

Mary Helen claims she never filed Form 56, notifying IRS of her executorship, and therefore she wasn’t. Judge Wherry notes that the Form 56 instructions say a fiduciary may (my emphasis) so notify IRS, but there are other ways–like filing a 706 and signing it as executor. And since Mary Helen never gave notice that she wasn’t a fiduciary until after the SNOD, Mary Helen is definitely in.

Finally, Mary Helen, in her usual style, both raises and doesn’t raise the statute of limitations, but Judge Wherry steers that aside. “Although the argument is unclear, in her motion to dismiss Ms. Norberg appears to argue that the period of limitations on assessment has expired. In her objection to respondent’s (IRS’) objection, Ms. Norberg states she ‘did not and is not asserting in this motion any issue regarding statute of limitations’ and asks us not to rule on this issue. We need not analyze this issue here but do note two things. First, pursuant to sections 6503(a)(1) and 6213(a), the period of limitations on assessment, if open when a notice of deficiency was sent, would generally be suspended if a timely petition was filed until such time as the Secretary is no longer prohibited from assessing the tax. Second, the statute of limitations is an affirmative defense, not a jurisdictional matter. See Rule 39; Freytag v. Commissioner, 110 T.C. 35, 41 (1998).” 137 T. C. 13, at p. 15.

Don’t expect surprises at trial or in the decision.

 And Hope for the Computer Semi-Literate

Two useful “Just Sayin’” 7463s from the flood of good Tax Court cases filed 11/23/11.

First, continuing the popular “For Dummies” series, Judge Holmes writes a useful and practical guide to basis, which the in-the-trenches practitioner can use to explain this essential concept to clients in more-or-less English, free of what Judge Holmes calls “taxspeak”. This can be found in Robert L. Willson, Sr., 2011 T.C. Sum. Op. 132, filed 11/23/11.

I can’t set the scene better than Judge Holmes: “Robert Willson opened a bar in 1986, and it gave him nothing but trouble. He’s seen lawsuits, endless repairs, and even a catastrophic fire. One might say the City of Des Moines did him a favor when it finally condemned the land in 2000 to expand its airport–right around the time Willson began serving a federal prison term. But the Commissioner wouldn’t let things be and says that the condemnation triggered a large capital gain that Willson didn’t correctly report. This meant the bar would give him one more headache–because, though Willson represented himself at trial, the facts as he described them would be worthy of an advanced exam problem in tax accounting.” 2011 T.C. Sum. Op. 132, at pp. 1-2 [footnote omitted].

Willie was an auto mechanic who opened a rock bar after burglar shot him in the arm. He had to rebuild the place, repair, refurbish and remodel it extensively, contend with the change from hair bands to grunge rock, but in Des Moines, Iowa, hair bands were still big until one of his artists-in-residence set off a smoke machine and burned the whole place down. Then the City of Des Moines condemned the whole shebang for an extension to the striving, thriving Des Moines International Airport, triggering a big award.

Willie’s lawyer took custody of the award, because the U.S. of A. took custody of Willie, over something to do with drugs, guns and money–Judge Holmes isn’t quite clear about that, and apparently Willie glossed over that at trial.

Notwithstanding the foregoing, as my high-priced colleagues say, Willie had managed, from Uncle Sam’s Stony Lonesome, to file his tax return timely for the year of the condemnation.

Although they claimed Willie underreported the gain on the condemnation, IRS, gracious as always, waited until Willie was restored to society before trying the case.

Willie chose S case treatment, with its looser evidentiary rules. Willie conducted the trial his own self, as they say in the Des Moines rock bars, and he and his barfly friends made out a reasonable case. But the numbers were flying in all directions, and Judge Holmes had to sift through them.

Again, Judge Holmes does such a good job that I’m not going to excerpt or paraphrase his decision. Just read it, and even copy it for your clients. Willie’s story is the stuff reality shows wish they were made of, so your clients might actually read something you give them (for once), and even more astonishingly remember some of it (maybe).  Judge Holmes’ prose is crystal clear.

Second, Kurt Olsen may have misled the shrink-wrapped guru, but it was an accident, so Special Trial Judge Armen, a judge with a heart (cf. Timothy John Karlen and Jennifer Karlen, 2011 T.C. Sum. Op. 129, filed 11/10/11, and my blogpost “Ignorance Is Bliss? And ‘gude faith, he maunna’ fa’ that’”, 11/10/11), lets Kurt off the penalty hook in Kurt C. Olsen, 2011 T.C. Sum. Op. 131, filed 11/23/11.

Mrs. Kurt got a distribution of interest from Mrs. Momma’s trust fund after a lawsuit, with a K-1 to match. Neither Mrs. Kurt nor Kurt had ever gotten a K-1 from anybody before that.

Now Kurt is an attorney, so that is strike one; except STJ Armen is at pains to point out that Kurt is a patent attorney with the US Energy Administration, with all kinds of security clearances and good conduct badges, so tax evasion where less than ten grand of tax is involved doesn’t really fit Kurt’s lifestyle.

Kurt was a roll-your-own taxpayer, so he rolled up his sleeves and trundled out the software.

STJ Armen tells the tale: “Because he had never dealt with a Schedule K-1 in the past, petitioner upgraded his tax preparation software to a more sophisticated version as a precaution to ensure proper treatment of the unfamiliar form.

“Using the upgraded software’s interview process, petitioner correctly entered the name and tax identification number of the trust, properly reporting the source of income. While transcribing the remaining information, however, he made a data entry error that prevented the amount of interest income from being correctly displayed on Schedule E, Supplemental Income and Loss, of his Federal tax return. Petitioner reviewed the Federal tax return before filing, including using the verification features in his tax preparation software, but did not discover the error.” 2011 T.C. Sum. Op. 131, at p. 3.

The result was the substantial underreporting penalty. Clearly Kurt blew the five-and-ten ($5 K or 10% of tax due) test, but Kurt acted in good faith. He upgraded his software, and put in all the correct info, barring only the single transcription error. “He did not bury his head in the sand and ignore his obligation to check the accuracy of his tax return. Instead, petitioner reviewed the information he entered using his tax preparation software upon completion of the software’s interview process. Despite his best efforts, however, petitioner failed to discover that the amount of the interest income did not appear on the final version of his tax return that was filed.” 2011 T.C. Sum. Op. 131, at p. 7.

So STJ Armen lets Kurt off the substantial underreporting hook. He tried, he really did–energetically.

Or, Why He Stole May Save the Victim

Such is the lesson of City-Wide Transit, Inc., 2011 T.C. Mem. 279, filed 11/23/11, the drought-breaker of a long line of arid, uninteresting cases.

Ray Fouche ran a bus company transporting disabled children to school under contract to the New York City school system. She had a payroll company do the payroll and prepare the 941s, and no one finds any fault with any of that.

But Ray needed to sort out a reduction in certain employment tax liabilities unrelated to the years at issue. So she hires one Manzoor Beg, who claims to be an accomplished CPA. He isn’t an accomplished CPA, but he is an accomplished thief.

He gets official bank checks from Ray to pay the supposed taxes, gets her to sign a blank Form 2848 power of attorney, and has her hand over the returns prepared by the payroll company. He deep-sixes the real returns, and makes up phony returns, claiming false EICs. He then fraudulently alters the bank checks and deposits them in his Himalayan Hanoi account, whence the proceeds go to Hanoi or the Himalayas, but not to IRS. Instead, Manzoor gives the IRS his own Hanoi checks in an amount sufficient to pay the phony taxes, which is of course much less than Ray really owes.

Ultimately, Manzoor makes off with almost $350K, some of it being the money Ray properly owes IRS, plus some other monies he stole from other bus companies. Before he can skip to the fastnesses of Shangri-La or the Hanoi Hilton, the long arm of the law catches Manzoor, and he pleads guilty to money laundering, signing false returns and filing false returns. Before he can be sent to jail, Manzoor dies.

IRS comes after Ray for the back taxes. Ray says she did nothing wrong, her payroll company did nothing wrong, and IRS agrees, but says “too bad, so sad, but you owe the money and you trusted Manzoor.” Ray says “but those are all closed years.” IRS says, “not if there was fraud. Frauds, like diamonds, are forever.”

Ray’s attorneys, Herbert Kantor and Gary Hoppe (and I name them here because they did a real fine job), argue that Manzoor didn’t file false returns to evade the payment of tax, as Section 6501 proscribes, but rather to cover up his theft of Ray’s monies. In other words, Manzoor was trying to steal from Ray, not the IRS.

Now the general rule is that whether the taxpayer or the taxpayer’s preparer was filing the fraudulent return doesn’t matter. The taxpayer and the preparer are in the same boat. But that’s Section 6501(c)(1) learning, from Allen v. Commissioner, 2007 T.C. 37. And that involved filing a fraudulent return to evade or defeat payment of tax. That isn’t the issue here; the issue here is an attempt by any means to evade or defeat tax, per Section 6501(c)(2).

IRS claims that if anyone attempts by any means to evade payment of tax, even if the taxpayer is completely innocent and got no benefit from the skullduggery in question, it’s a fraud and IRS can assess tax at any time.

No, says Judge Vasquez. IRS failed to show by clear and convincing evidence (the standard of proof for fraud) that Manzoor intended to evade payment of tax. “Respondent [IRS] argues that the record clearly and convincingly shows that Mr. Beg intended to evade tax and/or willfully attempted to defeat or evade employment taxes for all of the periods at issue. Specifically, respondent points out that Mr. Beg filed fraudulent Forms 941 and amended Forms 941, pleaded guilty to violating section 7206(1), and had the knowledge and experience to know that his actions would result in the evasion of petitioner’s employment taxes.

“Petitioner counters that the stipulated facts and incorporated exhibits show that Mr. Beg intended to embezzle from petitioner and that he filed the Forms 941 and amended Forms 941 solely to cover up his embezzlement, not to defeat or evade petitioner’s employment taxes. Therefore, according to petitioner, the record does not show by clear and convincing evidence that Mr. Beg had the specific intent to evade tax or willfully attempted to defeat or evade tax, and respondent has failed to carry his burden of proof.” 2011 T.C. Mem. 277, at pp. 16-17.

IRS claims that Manzoor’s acts speak for themselves, and his guilty plea speaks even louder. No, says Judge Vasquez, the guilty plea is a factor but not conclusive. And specific intent to evade or defeat is not a factor in a Section 7206(1) violation, to which Manzoor pleaded guilty.

So the years are closed, and Ray drives off into the sunset. Good job by the defense.