Lesson From The Tax Court: Taxpayers Behaving Badly (2021)

This will be my last new post until January.  I will be spending my days (except for Christmas Day) grading exams.  Grades are due Monday, January 3th and then I resume teaching on January 11th, so you will likely see my next Lesson From The Tax Court on January 18th (the day after MLK holiday).

For the fourth year, my last new blog of the year presents cases where something in the facts made me just shake my head (SMH in texting parlance).  You can find the previous lists here (for 2018), here (for 2019) and here (for 2020).  This year I have six to share with you.  I present them in chronological order.  I invite you to consider which of theme may be examples of just an empty head and which are examples of something worse.

This year I also continue giving the Norm Peterson Award.  You will find more explanation below the fold.

(1) One Person’s Work Is Another Person’s Hobby.  Stephen Whatley and Lucile M. Whatley v. Commissioner, T.C. Memo. 2021-11 (Jan. 28, 2021) (Judge Holmes)

This is a classic hobby farm case.  Taxpayer was a hard-working banker, earning substantial income. During the tax years at issue (2004-2008) he spent 70 hours per week in his banking business.  But he had grown up on the farm and, as Judge Holmes writes, he “wanted to find an oasis from banking where he could get back to his roots and work the land.”

So Old Man Whatley bought a farm.  It had over 180 acres of land that included a “nicely done” 3BR, 2BA 2,600 sq. ft. home.  While still putting in the weekly hours at the bank, Mr. Whatley was now able to escape to his farm on weekends.  Writes Judge Holmes, “When he was at the farm....[he] usually began in the morning with a ride through the woods with a hot cup of coffee.  He’d make mental notes of any work that was needed and then tend to those chores.”  Mr. Whatley reported spending 14 hours per week attending to his farm.

Sure sounds like Green Acres, except for one minor detail: during all these years Mr. Whatley kept earning substantial income from banking and kept reporting substantial losses from his “farming.”  His reported yearly losses ranged from $77,000 to $142,000.  By the time of trial he had accumulated six more years of substantial losses, up to $248,000 in 2014.  These losses sheltered anywhere from 30% to 50% of his yearly income from banking.

Yes, this is a classic hobby farm case indeed.  Clearing brush and mending fences is not my idea of a good time but, as Judge Holmes writes, “Whatley...enjoyed going there as a retreat from his grueling and time-consuming banking business.  Though many people do not find farming enjoyable, Whatley did.”

SMH Moment.  At trial Mr. Whatley tried to argue his cattle farm was really a tree farm, ‘cause it had trees on it, dontcha know!  One problem with that argument was that the land was subject to a federal government Conservation Reserve Program, under which Mr. Whatley received almost $3,000 from the federal government per year to not harvest trees. Judge Holmes is careful to note that the reported losses just for the years at issue far exceeded (by multiples) even the most generous estimate of what future income the timber might eventually generate when the federal restrictions expire.

(2) The Lady Doth Protest Too Much.  Sheila Ann Smith v. Commissioner, T.C. Memo. 2021-29 (Mar. 10, 2021) (Judge Halpern)

Ms. Smith and her husband did not just drink the tax protestor kool-aid, they bathed in it.  In 2012, the IRS noticed they had not filed returns for 2008 because the IRS had received various W-2’s and 1099’s reporting payments to them.  In response the Smiths sent in patently frivolous returns for four years: 2008, 2009, 2010, and 2011.  They also submitted “corrected” W-2’s and 1099’s with tax protestor nonsense neatly typed up.  Stuff such as claiming they were "private-sector citizen (non-federal employee_employed by a private-sector company (non-federal entity)". Op. at 30.

Section 6702 permits the IRS to assess a $5,000 penalty for each frivolous return, without the need to follow the deficiency procedure.  The statute does not require the IRS to let taxpayers correct a frivolous return, but as a matter of administrative policy the IRS will send a “second chance” letter (Ltr 3176C) to the taxpayer.  IRM 5.20.10.4.3 (10-05-2018).

Here, for each year the IRS sent the Smiths a second-chance letter.  In response, the Smiths kept up their protest.  In fact, for two of the years (2008 and 2010) they re-submitted exact copies of the same patently frivolous returns, as if that would change anything.  Well, it did, actually.  Instead of hitting them with four $5,000 penalties, one for each year, the IRS hit them with two additional penalties for submitting the copies.

The Smiths---or at least Ms. Smith---ever vigilant for opportunities to ride the hobby horse, found another opportunity to protest by invoking CDP.  The Settlement Officer was not amused, sustaining collection of the penalties.

Thus it was that Ms. Smith found her way into Tax Court, petitioning for review of the CDP hearing result.  By that time, however, the Tax Court had changed its interpretation of the section 6751(b) supervisory approval requirement for penalties.  The Tax Court remanded to Appeals so the Settlement Officer could see whether the IRS had complied.  The SO crossed out one penalty for non-compliance but sustained the other five.

On return to the Tax Court the Court disallowed two of the remaining five penalties, one because it was imposed on a copy rather than on a return, and the other for failure to comply with the supervisory approval requirement.

SMH Moment.  Not content with cutting her liability in half on procedural luck, Ms. Smith continued to protest the remaining three penalties.  She submitted a 46-page brief filled with garbage to waste the Court’s time.  Judge Lauber imposed the §6673 hazardous waste penalty, albeit only $2,500.

(3) Hiding The Hobby In The Business.  Andrew Mitchell Berry and Sara Alexine Berry v. Commissioner, T.C. Memo. 2021-52 (May 5, 2021) (Judge Kerrigan).

Mr. Berry raced cars as a hobby, winning some prizes in 2014 and 2015.  His income, however, came from being a realtor and owning a construction and remodeling company jointly with Ms. Berry.  They operated through an LLC.  On their tax returns, the Berrys pretended that Mr. Berry’s racing winnings were construction income and his racing costs were construction costs.

SMH moment.  TPs bought a utility trailer in 2014 and attempted to expense it under 179.  TP tried to convince Judge Kerrigan that the trailer was used in his construction business to store materials a remote job sites.  But the IRS produced evidence that in 2018 the TP had listed the trailer for sale and described it as a trailer that had been used to transport race cars.  So Judge Kerrigan did not find Mr. Berry’s testimony credible.  To say the least.... 

(4) The Mellifluous Tax Protestor. Jamillah Kamillah Muhammad v. Commissioner, T.C. Memo. 2021-77 (June 29, 2021) (Judge Lauber).

In 2016 Ms. Muhammad was convinced that the $48,500 she received from her employer, Samuel Merritt University, were not “wages” despite having received a W-2.  It was not that she disputed the receipt of the money or that she disputed her employment relationship with the University.  Oh no.  She disputed that the payments she received were subject to income tax at all because she was not “exercising a Federal privilege” when providing the unnamed services to the University.  Sounds like she was duped by Peter Hendrickson and his crackpot Cracking The Code - The Fascinating Truth About Taxation In America.

SMH Moment:  Despite her lofty rhetoric, the mellifluously named Ms. Muhammad carefully followed the instructions for filling out Form 4852, the form one fills out to correct an erroneous W-2.  The juxtaposition between her following the rules for reporting and her bizarre tax protestor stance that “wages” are not income made me shake my head.

(5) The Wayward IRS Revenue Agent.  Paul Warque & Marie Warque v. Commissioner, T.C. Summ. Op. 2021-18 (July 8, 2021) (Judge Copeland)

Starting in 2009, and during the years at issue, Mr. Warque worked as a revenue agent for the IRS in Laguna Niguel, California.  But he and his wife lived in Las Vegas, Nevada, some 280 miles away.  Not an easy commute.  He would travel there during the week and stay, returning on weekends.

In 2014 and 2015 Mr. Warque asked for a hardship transfer to Las Vegas.  Each year his application was approved, which only meant that he was now eligible for priority consideration if any jobs opened up in Las Vegas.  No jobs opened up.

On their returns the Warques claimed substantial deductions for Mr. Warque’s travel and lodging in Laguna Niguel as “travel away from home.”  The IRS disallowed the deductions and the Tax Court agreed.

SMH Moment.  The Warques claimed that each time Mr. Warque’s hardship applications were approved that somehow made his employment in Laguna Niguel “temporary.”  Wrote Judge Copeland:

“The hardship relocation approval letter clearly stated that there was no certainty that his duty station would be changed to Las Vegas.  The approval was one of eligibility.  The letter clearly stated that there was no guaranty he would be transferred.  In fact he was not transferred.  There could be no reasonable belief that the Laguna Niguel duty station changed to a temporary one in 2015 or earlier.” 

(6) The ACA Is Unconstitutional But I Still Get The Premium Tax Credit.  Karla Amburgey and Mary Amburgey v. Commissioner, T.C. Memo. 2021-124 (Nov. 1, 2021) (Judge Kerrigan)

The year at issue was 2017.  The year taxpayers had used the Florida Health Insurance Marketplace to obtain a policy which charged monthly premiums of $1,779.  They asked for and received $1,279 as an advance Premium Tax Credit (APTC), receiving a benefit exceeding $15,000 for 2017.

But the taxpayers had a modified AGI of $181,183 in 2017, for purposes of calculating eligibility for the Premium Tax Credit.  That is more than 1,100% above the federal poverty line for a 2-person household where they lived.  Remember, the credit is not available for taxpayers whose household income is more than 400% above the federal poverty line.  They were way over the line. Yet they make no attempt to pay back the APTC when they filed their 2017 returns.  More amazing (or discouraging), they actually found a lawyer---one C. Page Hamrick III---to argue the case to the Tax Court.  If that is this C. Page Hamrick III, then it was probably not a great choice of lawyers.

SMH Moment.  Mr. Hamrick attempted to justify his client’s refusal to repay the APTC by arguing that the ACA had become unconstitutional once Congress effectively repealed the Individual Mandate in 2017 by reducing the amount of the shared responsibility payment to zero.  That repeal was effective January 1, 2018.  But the taxpayers were not being assessed a tax liability because of the Individual Mandate.  They were being assessed money they had received in error and needed to return.  So if the ACA were, actually, unconstitutional, that would simply make the APTC payments to them illegal instead of merely excessive!  It would be, actually, and additional reason they would have to return the money.  SMH.  And then, the kicker here is that the year at issue was the year before Congress effectively repealed the Individual Mandate.

And Now...

The Norm Peterson Award for 2021

Norm Peterson was a character on the sitcom Cheers.  In the early years of the show, Norm was a sleazy tax accountant who regularly gave really bad tax advice.  In honor of Norm, I give this award 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 winner is Mr. Preston Olsen.  Preston Olsen and Elizabeth Olsen v. Commissioner, T.C. Memo. 2021-41 (Apr. 5, 2021) (Judge Lauber).

Mr. Olsen is a really smart person.  He graduated from U. Chicago law school.  And he has been a partner in several large law firms, practicing municipal bond law.  You can look him up on LinkedIn.

But Mr. Olsen listened to his inner Norm Peterson.  He invested in a really stupid scheme just to get a tax benefit.  That is also one way to describe a tax shelter: a really stupid deal done by very smart people.

Here, starting in 2009 and continuing through 2014, Mr. Olsen invested in a Rube Goldberg solar power tax shelter scheme solely to claim energy tax credits.  As a result he filed multiple years of tax returns showing $150,000 + of wage income but zero tax liability.  Why he thought that would escape attention is beyond me.  But that's not the SMH moment.

Judge Lauber gives a complete and total takedown of all of Mr. Olsen’s tissue-paper arguments on why this scheme was a legit trade or business or investment activity.

SMH Moment 1.  Here’s how crazy the scheme was: the “investor” would buy plastic fresnel lenses, and the promoters promised to then attach them to poles or towers, track the Sun, concentrate the Sun's rays to warm a “heat transfer fluid,” pump the fluid to a “heat exchanger” that would boil water to create steam to spin a turbine to generate electricity.  Neither of the scheme’s main promoters, a Mr. Johnson and a Mr. Shephard, had the slightest engineering credentials nor did they ever employ anyone who did.  Eventually, they were slammed by the Department of Justice for fraud.  See United States v. RAPower-3, LLC, 325 F. Supp. 3d 1237 (D. Utah 2018), aff’d 960 F.3d 1240 (10th Cir. 2020).

SMH Moment 2.  The selling point of the scheme was not its ability to generate power, but its ability to generate tax credits.  Read the opinions for details.  For a taste, however, here’s how the promoters sold the deal, as described in the opinion:

“The...program is set up so that prospective new members calculate the taxes they expect to pay in the current year.... Once this [is] known, the correct number of lenses to maximize the tax benefits can be purchased. Then when the refund comes, you have enough to pay off your lenses and plus put money in your pocket. Simple.”

SMH Moment 3.  At trial, Mr. Olsen—this very smart tax attorney, remember—managed to give testimony from which Judge Lauber concluded that yes, yes indeed, he figured out how many lenses to buy each year depending on how much income he wanted to shelter!  Writes Judge Lauber:

“We find that Mr. Olsen purchased the lenses primarily to secure tax benefits, not to earn a profit. The promoters induced him to purchase lenses by touting their ability to generate tax savings. They urged him to “[b]uy our solar units with your tax money instead of giving it away to the IRS.” Buying lenses, they said, would enable him to “double * * * [his] investment from the IRS in tax benefits.” They explained that “[y]our objective in purchasing your systems is to zero out your taxes.” And indeed, despite a slight miscalculation in 2014, Mr. Olsen purchased just enough lenses to “zero out” his tax liability for every year at issue. This is strong evidence that he was seeking to maximize tax savings, not to generate economic profit.”

Bottom Line Lesson: Don’t listen to Norm!

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He will resume his weekly Lessons From The Tax Court after Martin Luther King Day in January.