Lesson From The Tax Court: Taxpayers Behaving Badly (2020)

This will be my last post until January.  I will be spending my days (except for Christmas Day) grading exams.  Grades are due Monday, January 4th so you will likely see my next Lesson From The Tax Court on January 11th.

My last blog of the year is a list of some of the cases I read during the year where something in the facts made me just shake my head (SMH in texting parlance).  You can find the previous lists here (for 2018) and here (for 2019).  This year I have five to share with you.  I present them in chronological order.  I invite you to consider which of them may be examples of just an empty head and which are examples of something worse.

New this year is a feature I am calling the Norm Peterson Award.  You will find more explanation below the fold.

1. Even Greed Has Its Limits
Lon B. Isaacson v. Commissioner, T.C. Memo 2020-17 (January 23, 2020)(Judge Marvel).

The taxpayer was a former litigator based in California, disbarred for various financial shenanigans in 2014.  In Tax Court he was disputing a proposed deficiency of about $2.6 million and a proposed civil fraud penalty of just under $2 million.  Ironically enough, one of his litigation specialties had been representing taxpayers accused of tax fraud.  His case involved his failure to report as income his share of a $12.5 million settlement he obtained from the Catholic Church in an abuse case.   His clients in that case were “four individuals whom he knew personally and who considered him to be both their attorney and a trusted friend.”  Op. at 4.

Un-uh.  You know where this is going.

When Mr. Isaacson received the settlement payment, he immediately put the entire amount---both the amount representing his fee and the amounts due to his clients---it into an investment account he had set up with the Swiss bank UBS.  Yes, that UBS.  He instructed the bank to invest the funds aggressively and he repeatedly used both the funds and their earnings for personal consumption.  He did not account for these funds in his business record books and so it is not surprising that he did not report his 60% fee as income for 2007.

Here is how Judge Marvel framed the issue:

“This case turns on whether petitioner earned a 60% contingency fee for his services in 2007. Several other tribunals have dealt with controversies involving these funds over the years. In those prior proceedings petitioner consistently maintained, produced evidence in support of, and convinced other tribunals to accept as true that his former clients were satisfied with his services as an attorney when he secured this settlement in 2007 and that those clients never disputed his right to his asserted fee. Now, however, he asserts that his fee was always in dispute.”

For a variety of well-explained reasons, Judge Marvel applied the doctrine of equitable estoppel, holding that because of Mr. Isaacson’s long-standing and consistent arguments to other courts that there was no fee dispute, he was estopped from arguing in Tax Court that his fees were so much in dispute in 2007 that he did not need to report them as income in that year.

SMH Moment: I am not a litigator but a 60% fee for settling a matter seems pretty greedy.  But the kicker for me is that Mr. Isaacson's representation agreement entitled him not only to a 60% of gross fee award, but it also made his friends pay 110% of his litigation costs.  Really?  A markup on costs?  Heck, why not make it 130%?  I suppose even greed has its boundaries.

2. A Bagful of Documents Makes the Deduction Go Down
Hakeem Abubakr and Sharmila Kassim, v. Commissioner, T.C. Sum. Op. 2020-8 (January 30, 2020) (Judge Gerber).

In some ways this is a typical over-enthusiastic deduction case.  It makes the list because of the taxpayer’s degree of enthusiasm.

Mr. Abubakr was a travel agent.  Ms. Kassim was a software engineer.  They reported his business activity on Schedule C, reporting only some $18,000 in gross receipts and claiming over $94,000 of deductions.  They used the resulting $76,000 loss to reduce and their other income of almost $14,000 in Social Security payments and Ms. Kassim’s $150,000 wage income.

Of the claimed expenses, the IRS actually allowed over $47,000.  To prove up his entitlement to more, Mr. Abubakr dumped over 226 documents on the Court, including spreadsheets, bank records, receipts, and more.  Altogether they showed just over $66,000 of expenses.  But the documents were a confusing mess, containing multiple duplications of amounts, put into different forms.  After sorting through all of it, Judge Gerber held “the documentation he presented accounted for slightly more than $37,000.”  That was considerably less than the $47,000 allowed by the IRS.

SMH moment:  One of the categories of expenses the IRS totally disallowed was a category that Mr. Abubakr titled “other expenses.”  It totaled over $35,000.  He testified that these were amounts that he paid upfront on behalf of his clients for their travel. “He also testified that the clients paid him back for those expenditures. This explanation logically fits with the pattern of a for-profit travel business. What seems lacking in substance are alleged expenditures made on behalf of clients which were not paid back.”  Op. at 6.   Boy, that is sure an understatement!  Mr. Abubakr reported only $18,000 in gross receipts.  How can you say you paid out over $35,000 on behalf of clients that were never, ever, reimbursed!  Either (1) he was an exceptionally poor businessman---although he had been a travel agent since 1980, or (2) he was reporting expenses but not reporting the reimbursements, or (3) he was simply duplicating expenses.  Any of those possibilities makes me SMH.

3. Shifty Used Car Salesman Crosses The Line
Enrique Aguilar v. Commissioner, T.C. Sum. Op. 2020-16 (May 26, 2020) (Judge Gerber)

This is not going to be what you think from the headline.

Mr. Aguilar was a used car sales manager and buyer.  In 2015 he earned a salary of over $140,000.  During the year he had significant legitimate travel expenses, amounting to some $40,000.  His employer reimbursed him for those expenses.

Reimbursed employee expenses can be deducted above the line.  §62(a)(2)(A).  That is, basically, because employees must report the reimbursement as income.  But the reimbursement is not, really, income, and so Congress allows them to offset the reimbursement with a deduction above the line so they can properly reflect income.  Treas. Reg. 1.162-17(b) even says that if reimbursements for employee travel match the expenses, taxpayers do not have to report either.

Unreimbursed employee expenses, in contrast, must be deducted below the line and are subject to an overall 2% floor.  §67(a).  That’s a bummer because those deductions fight against the standard deduction.  ....not to mention that in the dark years of 2018 through 2025, §67(g) sucks those deductions into a black hole of nothingness.

Mr. Aguilar and his return preparer thought they found a way to shift his unreimbursed employee expenses above the line.  They created a fake Schedule C!!  On that Schedule C they reported his $40k of reimbursements as income, and against that they deducted the $40k of reimbursed expenses, plus another $22k of various other expenses.  To be on the safe side they apparently duplicated about $11k of the Schedule C deductions as itemized deductions on Schedule A!  Turns out that was a good move.

SMH Moment.  The crazy scheme almost worked because the IRS screwed-up in Exam.  Exam treated the Schedule C as legit.  SMH.  While it disallowed all of the $40k reimbursed expenses and all of the $11k itemized deductions over on Schedule A, it allowed $12k of the various other expenses claimed on Schedule C!

The Exam screw-up meant that when IRS Chief Counsel attempted to argue that the entire Schedule C was a sham, Judge Gerber said “The Court...cannot agree that petitioner is not entitled to deduct the $12,060 of expenses respondent, pursuant to an examination, allowed in the notice of deficiency.”  Then Judge Gerber held that since the IRS had allowed the $12k and since $12k was very close to the disallowed $11k Schedule A expenses, he would allow Mr. Aguliar a below-the-line deduction for the $12k.

Decision under Rule 155, doncha know.

4. Jesus Was Just Kidding When He Said Render Unto Caesar
James A. Lloyd v. Commissioner, T.C. Memo 2020-92 (June 22, 2020) (Judge Halpern).
Mr. Lloyd runs an organization called the Christian Media Network.  He failed to file returns for 6 years.  Each year he earned between $260k and $400k in gross receipts.  In the NODs, the IRS dinged him for total liability of $515k consisting of $400k of unpaid taxes, a §6651(a)(1) penalty of $90k, a §6651(a)(2) penalty of $10k, and a §6654 (failure to pay estimated tax) of $14k.  And that is not including accrued interest.

Many religious traditions also support progressive taxation. See Adam Chodorow, Biblical Tax Systems and the Case for Progressive Taxation, 23 J. of Law and Religion 51 (2007).  Here our taxpayer is a professed Christian, so it makes sense to look at that tradition.

Sure enough, since the early days of the income tax, various Christian theologians have supported the progressive structure of taxation.  For a short blog post giving that history, see Diana Butler Bass, A Christian Argument for Progressive Taxation, Sojourners, April 19, 2009.  For a well written longer treatment of the history, see Joshua Cutler, The Religious Roots of the Progressive Income Tax in America, 68 Cath. U. L. Rev. 473 (2019).  And for an intriguing article making the actual theological argument, complete with biblical analysis, see Susan Pace Hamill, An Evaluation Of Federal Tax Policy Based On Judeo-Christian Ethics, 26 Va. Tax Rev. 671 (2007).

But even if your theology does not run in that direction, it’s really hard to get around the very straightforward advice Jesus gives in Matthew 22:15-22, the famous quote where he says you need to pay your taxes.  Here’s a nice Baptist sermon explaining just that point.

Mr. Lloyd did not seem to get the message.

Mr. Lloyd petitioned the Tax Court, claiming he owed zero tax on his six-figure yearly income.  His main argument was tax protestor nonsense that (1) Congress could tax only something called income but (2) Neither Congress nor the Courts could define the term because that would be illegally amending the Constitution since the word "income" is used in the Constitution, and therefore (3), in his own words, “lacking a definition of ‘income’ leaves 26 USC/IRC, by itself, as a vague, ambiguous, arbitrary and capricious law that is therefore a nullity and void from its inception.”  Op. at 9.

Boy, talk about text without context becoming a pretext for the urtext!

But that’s not the worst of it.

SMH Moment:  In addition to the bizarre reasoning above, Mr. Lloyd proclaimed that he, individually, was “functioning as a church” therefore owed no taxes.  If Mr. Lloyd were French, he might have said: L'église c'est moi.  Here are his actual words: “In publicly functioning as a church, James Lloyd and the Christian Media ministry which he directs, are immune from Income Tax liability by the First Amendment of the United States Constitution."  Op. at 10.

It will not surprise you that Judge Halpern imposed a §6673 penalty of $2,500.  Sua sponte, even.

5. Putting the “Delay” in CDP
Francis I. Spagnoletti v. Commissioner, T.C. Memo. 2020-140 (October 8, 2020)(Judge Lauber)

Mr. Spagnoletti is a lawyer, a litigator whose license is currently suspended because of misconduct by an employee of his law firm in a tort matter.  He still is associated, however, with the law firm that bears his name and his suspension ends in 2023, barring further professional problems.

Mr. Spagnoletti reported tax liabilities on his 2015 and 2016 late-filed tax returns but did not pay them.

The creaky collection machinery of the IRS eventually sent Mr. Spagnoletti a we-want-to-levy CDP notice in May 2018.  By that time his total liabilities exceeded $1.2 million.  Ever the litigator, Mr. S. timely invoked his CDP rights and asked Appeals for an Installment Agreement.  He offered to pay off the 2015 and 2016 liabilities in four installments over a four month period.  But he gave no financial information, and the Settlement Officer noted that he had made no estimated tax payments for 2017 or 2018.  By late November 2018 Mr. S. had filed his 2017 return and had not paid the taxes due on it.  That liability raised his total liabilities to over $1.9 million.  Nor had Mr. Spagnoletti yet paid any estimated taxes for 2018.  Nor had he yet submitted any financial information.  Nor had he yet made any payments towards the outstanding liabilities.  He just repeatedly called Appeals and said, in effect, “I promise I can pay this off in four installments.”

I often call CDP “Collection Delay Process” and Mr. Spagnoletti really milked that cow.  It was not until May 2019 that Appeals issued it Notice of Determination.  By invoking his CDP rights he bought a year and never had to give the IRS any collection information or deal with any collection action.

Mr. Spangoletti timely petitioned the Tax Court for review, which means he filed his petition by June 2019.  The IRS moved for Summary Judgment in February 2020.  Judge Lauber, a  reliably efficient Tax Court judge, issued the opinion on October 8, 2020.

SMH Moment:  Mr. Spangoletti argued that the Settlement Officer had abused her discretion by not accepting his offer to pay his 2015 and 2016 liabilities in full in four monthly installments.  A bemused Judge Lauber pointed out that “it is not an abuse of discretion for an SO to reject collection alternatives where the taxpayer has declined, as petitioner did, to supply the requisite financial information. In any event the SO effectively did allow petitioner 120 days to make full payment by waiting almost six months before closing the case and issuing the notice of determination.”

The 2020 Norm Peterson Award
Some folks may remember the character Norm Peterson from Cheers.  Others, like me, may only recently have been introduced to him when binge-watching the entire 11 seasons (back when a “season” was a hefty 25 or so shows) on Netflix.  Norm was, the early years, a sleazy tax accountant who regularly gave really bad tax advice.  Then he became a really good housepainter.

In honor of Norm, this award goes to whatever tax position I see reported in any court case (not just Tax Court) or news item that appears to me to be so crazy that it could only have come from Norm.

This year, the Norm Peterson Award goes to whoever told Donald Trump he could deduct $70,000 for haircuts under §162.  Not to split hairs, but there are two reasons why that advice wigged me out.

First, it is well settled that grooming expenses are inherently personal expenses, disallowed under §262.  In Hynes v. Commissioner, 74 T.C. 1266, 1291-1292 (1980), the taxpayer was a news anchor who attempted to deduct his hairstyling expenses, claiming that they were necessary for him to carry out his business.  The Tax Court clipped that deduction right off, writing “The fact that the petitioner's employment contract with the station required him to maintain a neat appearance does not...elevate his expenses for personal grooming to a business expense.”  Id. at 1292.  Heck, even if your employer is the Army, its notorious grooming requirements don’t let you shave down your gross income.  Drake v. Commissioner, 52 T.C. 842 (1969).  As my colleague Eric Chiappinelli put it: “In short, a haircut can't give your gross income a haircut (even if you're A GI).”

Second, the amount is over-the-top.  You can comb through the industry and not find support for that kind of moola.  A New York stylist explains in this Town and Country article: 

“Even at top salons here in Manhattan, a men's haircut is going to be about $150. It would be more for a home visit, which I'm sure is what he gets, but not that much more. Unless he has a stylist who is charging him an insane amount and then laughing all the way to the bank. Trump is the sort of client, too, who probably thinks just because he's spending a lot of money for something that means it's good. But you can't buy taste.”

To be sure, there are actual Norm Petersons out there, particularly in Los Angeles, as you can see in this article in GQ magazine where the author found a tax advisor who would have no problem putting the deduction on a return.  Now that’s a tax advisor who badly needs some continuing professional education.  SMH.

Bryan Camp is the well-coiffed George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to look for a new Lesson From The Tax Court on January 11, 2021 and wishes everyone a Merry, Happy, Peaceful, Productive and/or Fulfilling Holiday Season, however observed or ignored.