TaxProf Blog

Lesson From The Tax Court: The Hotel California Rule

I love classic rock from the 70’s. Not just for all the great music, but for the way that the bands help me teach tax. For example, Fleetwood Mac teaches a lesson about §162 deductions for uniforms. I know, I know, you would think that lesson would come from the Village People, but it was Stevie Nicks who filed a petition in Tax Court after the IRS disallowed her deduction for stage clothing.

The Eagles’ classic “Hotel California” provides an excellent way to think about Tax Court procedure, as we can learn from the recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018).  In that case, the Tax Court dismissed as untimely Mr. Sadek’s 2017 petition contesting a 2011 NOD that the IRS had sent Mr. Sadek. The NOD was for $25 million and Mr. Sadek has not yet had a day in court to contest that amount. Oh, sure, he can sue for a refund but only if he fully pays the deficiency.  Flora v. United States, 362 U.S. 145 (1960). He could also file bankruptcy and ask the bankruptcy court to determine his tax liability under its powers in 11 U.S.C. §505. But Mr. Sadek’s best hope might come in a CDP hearing. That is what I want to explore in this post.

I think this case teaches a lesson about the relationship between the Tax Court’s deficiency jurisdiction and its CDP jurisdiction. The question is whether Mr. Sadek, who has now lost in Tax Court, will be able to contest the merits of the $25 million in a CDP hearing.  To answer that question, we need to understand the Hotel California rule and how it affects a taxpayer’s ability to turn what is ostensibly a hearing about collection into a hearing about tax liability.

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Lesson From The Tax Court: Last Known Address Rules Apply To The Rich And Famous Too

The rich really are different, and not just because they don't cut coupons.  It often seems that they escape the rules that apply to the rest of us.  Thus, there is understandable fascination when rich bad actors get a comeuppance.  That is probably why so many folks blogged last week's decision about Wesley Snipes, where the Tax Court found that the Office of Appeals did not abuse its discretion in rejecting Snipes' OIC that would pay less than 4% of his $23.5 million tax liability.  "Tax Girl" Kelly Erb put up this terrific post if you want the salacious details.

Today I want to look at a different bad actor, one just as rich as Snipes, albeit a bit less famous.  The recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018), raises the question of whether the IRS is entitled to rely upon its records when sending an NOD to a rich and famous taxpayer who “everyone knew” had fled to Lebanon to ride out an FBI investigation.

In 2011 the IRS sent Mr. Sadek an NOD for over $25 million in tax deficiencies for the year 2005 and 2006.  Mr. Sadek did not file his Tax Court petition until 2017.  The IRS moved to dismiss because, it said, the petition was filed way after the expiration of the §6212 period to petition the Tax Court.  Mr. Sadek also moved to dismiss because, he said, the NOD was not sent to his last known address.  The IRS had sent the NOD to an address Mr. Sadek had left long before 2011.

The Tax Court indeed dismissed the case for lack of jurisdiction.  But since the Tax Court might lack jurisdiction either because of an IRS screw-up (not properly sending the NOD) or because of a taxpayer screw-up (not timely filing a petition) it is important to understand which party messed up and why.

The case teaches a useful lesson about when and how the IRS can rely on its own records in order to meet the last known address requirement.  I think Judge Goeke here got the right result, but I do question how he got there and so I offer what I (oh so modestly) believe is a better path.

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Lesson From The Tax Court: When Payments To A Pastor Are Not Gifts

I don’t think Jesus ever charged for his services.  Jesus instead lived off of gifts.  Sure, some gifts got him in trouble, such as when Mary gave him expensive perfume and his followers complained he should have sold it to raise money for the poor. See John 12:1-8 (dramatized in this clip from Jesus Christ, Superstar).  But mostly Jesus worked off a sandal-strap budget.  He trusted in the generosity of those he encountered on the way. 

Modern preachers usually take a salary for their services.  Churches systematically solicit money from their congregation, both during each worship service and by encouraging yearly pledges.  And the main component of at least most Protestant church budgets (at least based on my experience) is personnel costs, the largest one being compensation for the pastor or minister. 

But modern preachers can receive gifts as well.  And while salary is taxable, gifts are not, thanks to §102.  The question becomes when are payments salary and when are they gifts?  In the recent case of Wayne R. Felton and Deondra J. Felton v. Commissioner, T.C. Memo. 2018-168 (Oct. 10, 2018), Judge Holmes teaches a great lesson how to answer that question. 

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Preacher Taxed On Gifts From Congregation

Forbes: Preacher Taxed On Regular Gifts From Congregation Members, by Peter J. Reilly:

Archbishop Wayne Felton and Deondra Felton are the Senior Pastor and Overseer of Women Affairs, respectively, of The Holy Christian Church of St. Paul Minnesota (HCC). As a bishop, Felton serves as Apostolic Overseer of the Communion of Holy Christian Churches which consists of over 150 churches and ministries in the United States, Riwanda, Kenya and Liberia.The couple got behind in their income tax filing and caught up with joint returns for 2008 and 2009.

They were able to work out most of the issues on the returns with IRS, but there was one issue left for the Tax Court.  Was the cash and checks that congregants put in blue envelopes on Sundays taxable income or could it be excluded as gifts? Judge Mark Holmes, who is noted for his distinctive writing style,  concluded that the blue envelope money is taxable income in his opinion last week. It amounted to $258,001 in 2008 and $234,826 and 2009. ...

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Lesson From The Tax Court: The TFRP Trap For Accommodating Payroll Service Providers

In last week's blog post about Loveland v. Commissioner, we learned that declining the opportunity to go to Appeals for a post-assessment hearing did not bar the taxpayer from raising the non-appealed issue in a later CDP hearing.  This was good for the taxpayer because the declined hearing was non-reviewable whereas the CDP hearing was reviewable (albeit lightly) by the Tax Court.  And we all clapped when the Tax Court remanded the case to Appeals to properly consider the OIC issue and gave Appeals some guidance on how to do that. The Tax Court thought that lesson so important that it made Loveland a reviewed opinion.

This week gives a contrasting lesson.  The contrast will not have you clapping.  This week's case involves the more common lesson that that a pre-assessment opportunity for a hearing with Appeals does indeed preclude the taxpayer from raising the issue in a later CDP hearing.  So it is not a reviewed opinion.  But I also see a second lesson here, about exposure to the Trust Fund Recovery Penalty (TFRP).  I see this case as one about a Payroll Service Provider who went too far in accommodating her client's needs and thereby exposed herself to the TFRP, perhaps needlessly.   This lesson may make you put you hands together, but more likely in prayer for your clients who are in the business of providing payroll services. 

The case is Joanna Kane v. Commissioner, T.C. Memo. 2018-122 (Aug. 6, 2018), and the details, as usual, lie below the fold.  

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Lesson From The Tax Court: Using CDP To Stop The Collection Train

I am not a fan of the Collection Due Process (CDP) provisions Congress stuffed into the Code in 1998.  I call them “Collection Delay Process.”  It’s not that I favor taxpayer abuse!  But I think the source of abuse is rarely bad-acting IRS employees.  Bulk processing is generally the culprit.  The combination of computer-processing and over-whelmed employees creates an assessment process that runs over taxpayers who do not understand how to stop it or slow it down and who cannot afford to hire lawyers to do that for them.  And then, the end of that assessment process starts the engine of the collection train.  CDP is designed to keep the train from going down the wrong collection track before it leaves the station.  But CDP is a badly designed mechanism.  That was my conclusion in 2009, after I studied almost 1,000 CDP cases.  I have seen nothing in the past 10 years to change my mind.  

Those who disagree with me point to cases like the one I’m blogging about today: James Loveland Jr., and Tina C. Loveland v. Commissioner, 151 T.C. No. 7 (Sept. 25, 2018), a reviewed decision written by Judge Buch.  This is one of the rare cases where the Tax Court found that the IRS had abused its discretion in deciding to proceed with collection.  Here it looks like CDP prevented the collection train from running over the Lovelands.  The case provides a good lesson for what works, and what does not work, about CDP.  Keith Fogg also has a good post on this case over at Procedurally Taxing, explaining why it is a reviewed opinion.

The case is also an interesting lesson about Tax Court Procedure.  While the case is ostensibly a ruling on an IRS motion for Summary Judgment, Judge Buch effectively grants Summary Judgment to the taxpayers...who never asked for it.  This disposition—while sensible enough---is apparently an unwritten rule of Tax Court procedure.  At least I did not see a rule.  Nothing in 121.  Maybe I missed it.  But I think the Court is silently borrowing from Federal Rules of Civil Procedure 56.

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Lesson From The Tax Court: What Is A 'Liability' For §108 Purposes?

To qualify for the insolvency exclusion in §108(a) one has to be insolvent.  Section 108(d)(3) defines insolvency as "the excess of liabilities over the fair market value of assets."  But nothing in the Code or Regulations defines the term "liabilities."  The recent case of Richard Bryan Jackson and Nora Irene Jackson v. Commissioner, T.C. Summ. Op. 2018-43 (Sept. 17, 2018), teaches a lesson about the meaning of that word. 

In February, I wrote about Discharge of Indebtedness (DOI) Income.  I called it “The Phantom of The Tax Code.”  Readers will recall that when a taxpayer obtains a loan, the loan proceeds are not reportable as gross income, but it is not entirely clear why.  The most common reason given is that the borrowed funds do not represent a increase in wealth because they are offset by the obligation to repay.  I call this the balance sheet theory.  The logic of this theory means that when the obligation to repay is discharged or relieved by the creditor, that discharge increases the taxpayer’s wealth to the extent that it frees the taxpayer from the obligation.  I go into more detail in my February post.

Section 108(a) reflects this balance sheet theory by allowing taxpayers to exclude DOI from gross income when they are insolvent but limiting the exclusion to the amount of the insolvency at the time of the discharge. For example, if a taxpayer is discharged from $10,000 of debt at a time when the taxpayer is insolvent by $6,000, then the taxpayer can exclude $6,000 of the DOI from income but must report the remaining $4,000 as gross income. 

Today’s lesson is about what types of obligations count as liabilities for purposes of determining insolvency. It turns out that not every obligation to pay someone is a liability.  To see why, read on!

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Tax Prof Amicus Brief In State Corporate Income Tax Case

Hayes Holderness (Richmond), Darien Shanske (UC-Davis) & David Gamage (Indiana), Brief of Tax Law Professors as Amici Curiae in Support of the Department of Revenue of the State of Colorado in Department of Revenue of the State of Colorado v. Agilent Technologies, Inc.:

Amici write to address specific matters of tax policy and history raised by this case. In particular, amici address 1) the history and justification for water’s edge combined reporting (the “water’s edge method”) and 2) the history and justification for the remedial provisions that are uniformly part of state corporate income taxes.

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Lesson From The Tax Court: When Non-Receipt Of An IRS Notice Matters

In 2015, Congress added what is commonly called the “Taxpayer Bill of Rights” to the Tax Code.  Currently codified in §7803(a)(3), it lays upon the IRS Commissioner the duty to ensure that IRS employees “are familiar with and act in accord with taxpayer rights as afforded by other provisions of this title.”  Section 7803(a)(3) then lists 10 (natch!) rights including “the right to be informed” and “the right to appeal a decision of the Internal Revenue Service in an independent forum.”  I wonder whether the person who drafted that last quoted language, or any of the folks who reviewed it, discussed whether it makes any grammatical sense for one to “appeal...in” a forum?  

Putting aside the grammatical question, readers might well question the impact of these rights on IRS operations.  The recent case of Paul T. Venable, II v. Commissioner, T. C. Memo. 2018-144 (Sept. 10, 2018), suggests an answer for the two rights I quoted above: the right to be informed and the right to appeal an IRS decision to an independent forum.  It teaches a lesson about the rare situation where the lack of actual receipt of an IRS notice can be important to a taxpayer’s ability to get judicial review of an IRS decision.  But the lesson does not come from the language in §7803(a)(3).  Nope, the lesson comes from language in “other provisions” in the Code, notably the CDP provisions in §6330(c).

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Lesson From The Tax Court: The Substantial Substantiation Rules In §170

The great philosopher George Carlin understands the problem of stuff.  My wife and I have too much stuff.  My wife, however, hates yard sales.  And we cannot afford a bigger house.  So we give a lot of stuff away. 

When Congress ratcheted up the substantiation requirements for deducting non-cash charitable contributions in 1993, we stopped giving to Goodwill.  That is because Goodwill did not change their pre-printed receipt form to say the now-required magic language “no goods or services were given in exchange for this donation.”  While some of our donations were below the $250 threshold, the aggregate value of our donations of similar items regularly exceeded that amount.  I remember one year I had to go up several layers of management to even get a letter with that language sent to me before I could file my taxes.  So we now favor other charities.

I was not just being picky in wanting a proper contemporaneous receipt, as the recent case of Estelle C. Grainger v. Commissioner, T.C. Memo. 2018-117 (July 30, 2018) demonstrates.  The taxpayer there was massively confused about the basic valuation rules for donations of property.  That’s one lesson here.  But I think another important lesson in this case is just how difficult the substantiation rules in §170 can be for substantial amounts of non-cash charitable contributions.  It was certainly an eye-opener for me, particularly the lesson about Form 8283.

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Lesson From The Tax Court: Distinguishing Property Settlement From (Indirect) Alimony

Congress eliminated the deduction for alimony in the December 2017 Reconciliation Act (informally called the Tax Cuts and Jobs Act).  But the legislation grandfathered in alimony payments made pursuant to divorce or separation instruments executed on or before December 31, 2018. The question of whether a payment qualifies as alimony will thus still be important for many taxpayers for years to come.  The short lesson from the recent decision in Jeremy Adam Vanderhal v. Commissioner, T.C. Sum. Op. 2018-41 (Sept. 5, 2018) is thus worth blogging about.  Plus, it's nice to blog about one of those very rare wins for a pro se taxpayer.

This is mainly a drafting lesson: the tax effect of language in a divorce or separation instrument turns on what the language does more than what the language says it does. Here, Judge Carluzzo gives a very nice lesson on how not to be distracted by what the language says it is doing.

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Lesson From The Tax Court: No Stopping The Perpetual Debate About Conservation Easements

The recent case of Harbor Lofts Associates, Crowninshield Corporation, Tax Matters Partner v. Commissioner, 151 T.C. No. 3 (Aug. 27, 2018) teaches yet another lesson on the importance of the perpetuity requirements when claiming a charitable deduction for the donation of a conservation easement. Last October I blogged about another conservation easement case, Palmolive Building Investors v. Commissioner, 149 T.C. No. 18 (Oct. 10, 2017). I did not get into the substance of the law in that blog, but instead focused on the Golsen rule and why the Tax Court needed to put its best analytical foot forward. I referred readers to Peter Reilly’s great blog post on Palmolive for the substance.

I encourage readers who don't know the Golsen rule to review the Golsen post, because Harbor Lofts is a case that the taxpayers may appeal to the First Circuit Court of Appeals. That is important because it’s the First Circuit who disagreed with the Tax Court’s position regarding the subordination requirement at issue in Palmolive. While today’s case involves a different part of the perpetuity requirement (and so there is no First Circuit precedent to bind the Tax Court), the Tax Court is again agreeing with the IRS in reading the perpetuity requirement strictly, this time finding that a long-term lease is not sufficient to meet the perpetuity requirements. If the Tax Court’s opinion is appealed to the First Circuit, the First Circuit may decide to take the same liberal interpretation of the perpetuity requirement as it did in Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), the case that was like Palmolive.

Today’s post will therefore comment on the Tax Court’s approach to interpreting the perpetuity requirements for conservation easements.  Long story short, I agree with it.  The First Circuit’s liberal approach, while understandable, is wrong.  This post will explain why. To do so, I will have to dip into the substantive law with the caveat, as always, that what I say is subject to correction from alert readers who know this area better than I do.  In particular, I will doubtless expose my ignorance by asking why the taxpayers did not structure the donation differently.  It was likely for a reason that I just cannot see.  The fun starts below the fold. 

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U.S. Appeals Court Urged to Curb IRS Sway Over Cannabis Industry

National Law Journal, US Appeals Court Urged to Curb IRS Sway Over Cannabis Industry:

A Colorado law firm is pressing claims that the Internal Revenue Service wields too much power over the cannabis industry, urging a federal appeals court to curb the agency’s authority to unilaterally determine that state-legal businesses are breaking federal law.

Thorburn Walker, a firm that has become go-to tax counsel for many Colorado dispensaries, has asked the U.S. Court of Appeals for the Tenth Circuit to reconsider a panel decision in Alpenglow Botanicals v. United States of America. The three-judge panel on July 3 said a taxpayer does not have to be convicted of a drug crime for the IRS to revoke its ability to deduct marijuana business expenses.

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Lesson From The Tax Court: The Misunderstood Trust Fund Recovery Penalty

A recent Tax Court case teaches a lesson about the §6672 Trust Fund Recovery Penalty (TFRP), and about the proper scope of a Collection Due Process hearing.  In Kathy Bletsas v. Commissioner, T.C. Memo. 2018-128 (Aug. 14, 2018), the IRS found Ms. Bletsas to be a responsible person who willfully failed to turn over trust fund taxes.  So the IRS assessed a §6672 penalty against her and filed a Notice of Federal Tax Lien (NFTL) to encumber all her property and rights to property.  Ms. Bletsas asked for and received a Collection Due Process (CDP) hearing about the NFTL. 

Represented by the indefatigable Frank Agostino (and by Malinda Sederquist), she argued that the collection decision to file an NFTL was an abuse of discretion because the IRS was getting steadily paid through an Installment Agreement (IA) with the employer and so did not need to file the NFTL against the Ms. Bletsas.  And, hey, she wasn’t really a responsible person anyway!

Trust fund taxes?  Responsible person?  TFRP?  To learn what that’s all about and what lesson Judge Lauber teaches, read on.  No one would blame you, however, if you instead clicked over to YouTube to watch this old Johnny Carson clip with Robin Williams and Jonathan Winters...

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Facebook, Coke Could Face Tax Hit After 8th Circuit's Transfer Pricing Ruling in $1.4 Billion Case Is 'Unmitigated Disaster' For Medtronic

Bloomberg, Facebook, Coke Could Face Tax Hit After Ruling Against Medtronic:

Last week, Medtronic suffered a legal setback in its bid to avoid a $1.4 billion U.S. tax bill — a ruling that may have costly implications for other multinationals battling the Internal Revenue Service over the use of overseas payments to lower their taxes.

Companies including Facebook and Coca-Cola have been fighting the IRS for years over strategies related to so-called transfer pricing — a way that some companies cut their tax liabilities by assigning lower prices for things like intellectual property that they shift to subsidiaries in low-tax jurisdictions such as Ireland or the Cayman Islands.

A federal appeals court on Aug. 16 sent the Medtronic case back to the U.S. Tax Court, saying the judge in a 2016 decision against the world’s biggest medical device maker hadn’t adequately explained how she’d reached her conclusion [Medtronic v. United States, No. 17-1866 (8th Cir. Aug. 16, 2018)]. No dates have been set yet for when the case will return to Tax Court.

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Lesson From The Tax Court: No Relief For Miscalculating ACA Premiums

A pair of cases over the past few weeks teach a lesson about the Affordable Care Act (ACA) premium assistance tax credit calculations.  The cases are Terry Jay Grant and Twila Rose Grant v. Commissioner, T.C. Memo. 2018-119 (Aug.1, 2018) and Luis Palafox and Hilda Arellano v. Commissioner, T.C. Memo. 2018-124 (Aug. 7, 2018).

Readers are no doubt aware that the ACA (a/k/a Obamacare) requires all individuals to purchase health insurance, requires all health insurance plans to contain certain provisions, and subsidizes the purchase of health insurance via a tax credit mechanism.  At the federal government level, the ACA splits up regulatory duties between HHS and the IRS.  HHS regulates stuff like the content of health plans, the establishment of the health exchanges and eligibility requirements, reimbursement policies, and procedures.  The IRS regulates the collection of taxes Congress enacted to fund the law, including the “shared responsibility payment” owed by taxpayers who fail to purchase health insurance (which, as Justice Roberts explained to a surprised readership, is a “tax” for constitutional purposes but not a “tax” for statutory purposes).  But there are several provisions that require significant coordination between the two agencies.

The health care premium subsidies Congress put in the Tax Code are one such provision.  To help certain individuals afford the mandatory health insurance coverage, Congress chose to subsidize the cost of insurance with federal funds.  Congress chose a tax credit as the mechanism to implement the subsidy.  Located in §36B it is there called the Premium Assistance Credit, but is commonly called the Premium Tax Credit (abbreviated PTC).  Certain taxpayers can choose to take the credit as an advance, commonly called the Advance Premium Tax Credit (APTC).   The APTC is paid directly to the insurance provider and not to the individual taxpayers.  

This subsidy structure creates two problems.  First is an awkward timing problem because taxpayers must guesstimate their eligibility for the subsidy and then true-up over a year later when they file their tax returns.  Second is a communication problem because the federal monies are paid directly to the insurance provider who must then properly communicate the amounts to the taxpayers so the taxpayers can do the true-up.

The two cases teach a lesson about the timing problem and the harsh consequences for messing up the guesstimate.

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9th Circuit Withdraws IRS's Victory In Altera 2-1 Decision Issued After Judge's Death

Following up on my previous post, 9th Circuit Reverses Tax Court In Altera, Revives Cost-Sharing Regs In Major Loss For Intel, Other Tech Companies:  in a surpising sequence of moves, the Ninth Circuit has  named Judge Susan Graber as a replacement judge for the late Judge Stephen Reinhard, who cast the deciding vote in the 2-1 case before his death, and has withdrawn its opinion in Altera “to allow time for the reconstituted panel to confer on this appeal,” even though no petition for rehearing has been filed.

• Forbes, Ninth Circuit Pulls Back Big IRS Victory Issued After Judge's Death
• Law360, 9th Cir. Withdraws IRS Win In Altera Cost-Sharing Row
• Leandra Lederman (Indiana), Update on Altera

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Partnering With Business: State & Local Tax Opportunities In Digital Sales

Peter Manda (Chicago), Partnering with Business: SALT Opportunities in Digital Sales, 88 State Tax Notes 425 (Apr. 30, 2018):

In this viewpoint, I evaluate the potential for state and local governments to raise revenue in a post-Quill world. I then examine dynamic sales and how they work, assess the state of current technology affecting online sales, and propose dynamically taxing electronic transactions (including retail sales) as the economy shifts toward a cashless society.

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Classic Lesson From The Tax Court: The Ole December 31st Check Problem

'm on vacation this week but I wrote up this Classic Lesson before I left so you could have something to chew on as you drink your morning beverage of choice.

Timing is at least as important in tax as it is in comedy. Although less common than it used to be before the age of direct deposit and mobile banking apps, the question sometimes arises about when must a taxpayer report as gross income a check received on December 31st but not cashed until January. The flip side is when may a taxpayer take a deduction for a check sent out on December 31st but not cashed until January.

Taxpayers tend to want to push off reporting income into a later year and tend to want to pull back deductions into the current year. Specifically taxpayers who receive a check on the last day of the year would like to say they don’t have income until they cash the check in January. But at the same time, taxpayers who write a check for a deductible expense on the last day of the year want to deduct that expense in that year and not the next.

Taxpayers cannot have it both ways. The good news is that the IRS has long allowed checks mailed on December 31st to be deductible in the year mailed, even when not cashed until January, so long as the taxpayer has truly parted control over the delivery of the check. See Treas.Reg. 1.170A-1(b).

The bad news is that taxpayers are also generally required to report checks received on December 31st as income. The rationale for that, however, is not entirely clear, as one sees in the classic case of Kahler v. Commissioner, 18 T.C. 31 (1952).

 

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WSJ: How One Man Used The ‘Innocent Spouse’ Rule To Win Some Relief In Tax Court

Wall Street Journal Tax Report, So Your Wife Embezzled $500,000 and the IRS Wants to Tax You: How One Man Used the ‘Innocent Spouse’ Rule to Win Some Relief in Tax Court:

Rick Jacobsen’s wife embezzled nearly $500,000.

After her conviction, the Internal Revenue Service asked him to pay more than $100,000 of taxes due on her theft. Yes, embezzled funds are taxable, and Mr. Jacobsen and his wife had filed joint tax returns.

But Mr. Jacobsen fought back, arguing his own case before a Tax Court judge. He said he didn’t know about the embezzlement and shouldn’t be forced to pay because he was an “innocent spouse.” In an opinion released last month, he won relief from about $150,000 of tax, interest and penalties [Jacobsen v. Commissioner, T.C. Memo. 2018-115 (July 25, 2018)]. ...

Mr. Jacobsen’s odyssey through the tax system shows the perils of signing a joint return with a tax cheat. It also shows that innocent spouses can sometimes escape dire tax consequences with a lot of time and effort, even if they can’t afford a lawyer. ... 

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Lesson From The Tax Court: The Power Of The Form 872 Waiver

This past week I learned a lesson about partnership tax returns from the case of Inman Partners, RCB Investments, LLC, Tax Matters Partner, v. Commissioner, T.C. Memo. 2018-114 (July 23, 2018).  Partnership taxation is definitely out of my comfort zone, so I am quite grateful for the help of my colleagues on the double-super-secret-tax-profs-rule-the-world listserv that Paul Caron started back in 1995, shortly after the internet got its graphical interface.  They got me straight on some terminology and sent me off reading some cool stuff.  Still, readers may well spot error, and if you do, please give a correction in the comments.  I am especially hesitant when I think I spot an error in a Tax Court opinion as I did here.  I know full well the error could be mine.

Inman is a case where the partners, but not the partnership, had signed a Form 872 waiver for their 2000 tax year.  The IRS issued a FPAA to Inman Partners.  Inman petitioned the Tax Court and it’s argument was a procedural one: the FPAA was too late because it was issued more than three years after the due date of the Partnership Return.  In response the IRS said “Hey, we got these here waivers!”  Inman said: “those were just signed by the individual partners and were not signed by the partnership and so they cannot waive the limitation period for the FPAA against the Partnership.”   

Judge Holmes held that the language in the Form 872 was strong enough to also waive the limitation on assessment for the related partnership for an earlier tax period.  It might be, however, that the language worked only because of the statutory scheme then in place for partnership audits.  Congress nuked that scheme in the December 2017 tax reform legislation.  Does Inman give us any insights on whether the Form 872 language still works?  For a quick swim through the murky waters of partnership procedure, I invite you to dive below the fold. 

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9th Circuit Reverses Tax Court In Altera, Revives Cost-Sharing Regs In Major Loss For Intel, Other Tech Companies

Wall Street Journal, IRS Wins Court Case Over Intel Corp.:

The Internal Revenue Service won a court case closely watched by technology companies, as an appeals court upheld a regulation governing how corporations divide expenses between their domestic and foreign operations.

Tuesday’s ruling by a panel of the Ninth Circuit Court of Appeals in San Francisco represents a loss for Intel, whose Altera subsidiary challenged the regulation when it was a separate company [Altera Corp. v. Commissioner, Nos. 16-70496, 16-70497 (9th Cir. July 24, 2018)]. Tech companies had billions of dollars at stake in the case because the rules at issue determine where they report some deductions.

The U.S. Tax Court, which handles disputes between taxpayers and the IRS, ruled in favor of Intel [Altera Corp. v. Commissioner, 145 T.C. No. 3 (2015)]. The IRS appealed the decision.

“We conclude that the regulations withstand scrutiny under general administrative law principles, and we therefore reverse the decision of the Tax Court,” wrote Chief Judge Sidney Thomas.

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NY Times: Montana Governor Sues IRS, Warning Of ‘Foreign Money’ In Elections:

New York Times, Montana Governor Sues I.R.S., Warning of ‘Foreign Money’ in Elections:

Gov. Steve Bullock of Montana, a Democrat who has crusaded against the loosening of campaign finance rules, is suing the Trump administration to block it from eliminating a mandate that politically active nonprofit groups disclose the identities of their major donors to the government.

The Treasury Department announced last week that the Internal Revenue Service would no longer require a range of nonprofit organizations to identify any contributors giving more than $5,000, in a move it described as bolstering privacy and easing administrative burdens for those groups. Previously, certain nonprofits had to name their large donors to the government even though they were not supposed to be disclosed to the public.

The change in rules stirred immediate political controversy because of its effect on so-called “dark money” groups, which spend money in elections but are not required to reveal the sources of their funding except to the I.R.S. Under the new reporting regime, groups associated with organizations like the National Rifle Association, Planned Parenthood and Americans for Prosperity, the conservative advocacy network backed by the billionaire Koch brothers, would no longer have to list their donors, even to the government.

But in a lawsuit filed on Tuesday in Federal District Court in Montana, Mr. Bullock and his administration alleged that the Trump administration had flouted proper government process in eliminating the disclosure requirements. The suit asked the court to issue a judgment voiding the new I.R.S. policy. ...

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Lesson From The Tax Court: Origin Of The Claim Test For §162

Last week’s post involved taxpayers whose tax troubles arose from events related to the Great Recession. Those troubles resulted in litigation and a lesson about how the Tax Court applies an “origin of the claim” test in evaluating claimed §104(a)(2) exclusions.

This week’s post also involves a taxpayer whose life took a downturn during the Great Recession. Only this week we look at the more traditional application of the “origin of the claim” test when taxpayers seek to deduct litigation expenses. In Sky M. Lucas v. Commissioner, T.C. Mem.o 2018-80 (June 11, 2018) the IRS sent Mr. Lucas an NOD asserting a tax deficiency of $1.7 million for 2010. Part of that deficiency was due to the disallowance of about $3 million in legal and professional fees related to Mr. Lucas’ divorce litigation.  The multi-year litigation was a fight over some $47 million.  No wonder it was expensive. In the end, Mr. Lucas got to keep most of that.  Mr. Lucas thought he could deduct his litigation costs.  For a great lesson in how the Tax Court applied the origin of the claim test to deny him the deduction, see below the fold.

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22 Tax Profs File Amicus Brief: The Section 107 Housing Allowance For 'Ministers Of The Gospel' Violates The First Amendment's Establishment Clause

Ellen Aprill (Loyola-L.A.), Reuven Avi-Yonnah (Michigan), Linda Beale (Wayne State), Samuel Brunson (Loyola-Chicago), Neil Buchanan (George Washington), Patricia Cain (Santa Clara), Adam Chodorow (Arizona State), Mark Cochran (St. Mary's), Bridget Crawford (Pace), Jonathan Forman (Oregon), Gregory Germaine (Syracuse), David Herzig (Valparaiso), Benjamin Leff (American), William Lyons (Nebraska), Roberta Mann (Oregon), Lori McMillan (Washburn), Joel Newman (Wake Forest), Henry Ordower (St. Louis), Katherine Pratt (Loyola-L.A.), Daniel Schaffa (Richmond), Erin Scharff (Arizona State) & Theodore Seto (Loyola-L.A.), Amicus Curiae Brief of Tax Law Professors in Support of Appellees (Gaylor v. Mnuchin, Nos. 18-1277 & 18-1280, 7th Cir. :

Section 107 allows “ministers of the gospel” to exclude the value of housing benefits from income, whether provided in-kind or as a cash allowance, at a cost of approximately $9.3 billion in forgone taxes over a ten-year window. The trial court dismissed the challenge to Section 107(1), which excludes in-kind housing, on standing grounds, but that section remains relevant to the analysis of Section 107(2). Supporters argue that Section 107(2), which excludes cash allowances, comports with the First Amendment’s Establishment Clause because (1) it is part of a broad policy expressed in a number of provisions that exempts housing provided for the convenience of the employer and (2) tax exemptions do not subsidize religious actors. Alternately, they argue that Section 107(2) is permitted as an accommodation for religion because it equalizes treatment of different religious groups and avoids church/state entanglement. Finally, they claim that eliminating Section 107(2) would imperil other exemptions.

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Lesson From The Tax Court: An 'Origin of the Claim' Test For §104(a)(2) Exclusions

Here at Texas Tech we require all law students to take the basic course in federal income tax. That is not because we are especially cruel, but rather because tax law touches so many other areas of practice that the faculty believes every student should have an introduction to tax. I must shape my course knowing that at least two thirds of the students do not want to become tax lawyers. One tack I take is to highlight tax issues that regularly come up in other practice areas such as family law and litigation.

A case from the Tax Court last week teaches a useful lesson about the intersection of tax with litigation practice.  Jacques L. French and Sherry L. French v. Commissioner, T.C. Summary Op. 2018-36 (July 12, 2018) involves taxpayers seeking to exclude a settlement payment under §104(a)(2), the section that allows taxpayers to exclude from gross income the amount of damages received because of personal physical injury or physical illness.

We usually think about the “origin of the claim” test in the §162 context, where courts use it to decide when taxpayers may deduct expenses associated with litigation. In fact, just this last week I saw another Tax Court opinion that involves this application of the origin of the claim test. I may blog that next week, unless something else catches my eye.

This week, however, I think it is useful to see how the Tax Court takes a very similar approach to deciding when a taxpayer can exclude a damage award under §104(a)(2). In both situations, it is the nature of the claim asserted in litigation that governs the potential exclusion or the potential deduction.  Looking at §104(a)(2) also allows me to give a shout out to the Tax Court's newest Special Trial Judge, Diana L. Leyden.  Her carefully constructed opinion shows us exactly how the Tax Court applies this “origin of the claim test” in the §104(a)(2) context. It makes for a nice lesson from the Tax Court.

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More Commentary On The Supreme Court's Wayfair Online Sales Tax Decision

• Accounting Web, Deconstructing the SCOTUS Sales Tax Ruling
• Reuven Avi-Yonah (Michigan), Designing a 21st Century Taxing Threshold: Some International Implications of South Dakota vs. Wayfair
• Bloomberg Tax, How Will Wayfair Impact Corporate Income Tax Nexus?
• Law 360, 4 Constitutional Questions To Ponder In A Post-Quill World
• Medium, The Attorney Who Convinced The Supreme Court To Allow Internet Sales Taxes Just Admitted That He’s Been Breaking The Law
• Edward Zelinsky (Cardozo), How Wayfair Opens the Door to Taxing Internet Sales

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Lesson From The Tax Court: Naked Assessments!

The Notice of Deficiency (NOD) is almost always clothed with a presumption of correctness. Some might say “cloaked” or “shrouded” are a better terms because what the presumption does is shield all that happened prior to the NOD from judicial scrutiny. Courts will generally not go behind the NOD to examine how the IRS came up with its numbers unless and until the taxpayer gives the court a good reason to disbelieve the NOD (or successfully invokes §7491(a), the provision that shifts the burden of production from the taxpayer to the IRS).

It is easy to apply the presumption of correctness in situations where the NOD is simply denying deductions or exclusions. That is because the taxpayer already bears the burden of proving an entitlement to deductions and exclusions. So if the taxpayer cannot come up with the proof, then too bad, so sad.

It is more difficult to apply the presumption in situations where the NOD asserts that the taxpayer failed to report gross income. In that situation, the IRS must have some basis for the assertion of omitted income. That is, the presumption of correctness does not allow the IRS to just make up numbers. In the seminal case of United States v. Janis, 428 U.S. 433 (1976), the Supreme Court said that “where the assessment is shown to be naked and without any foundation” then the burden shifts to the IRS to show facts that link the taxpayer to the alleged omitted income. I really love the delightfully mixed metaphor the Fifth Circuit used in Carson v. Commissioner, 560 F.2d 693, 696 (5th Cir. 1977): "The tax collector's presumption of correctness has a herculean muscularity of Goliath-like reach, but we strike an Achilles' heel when we find no muscles, no tendons, no ligaments of fact."

Two recent Tax Court cases teach a lesson on what “ligaments of fact” suffice to prevent an NOD from being “naked and without any foundation.” In both of these omitted income cases, the IRS was able to produce enough facts to get back the presumption, but in very different ways. The cases are: Gerald Nelson v. Commissioner, T.C. Memo. 2018-95 (June 28, 2018); and Mohammad Najafpir v. Commissioner, T.C. Memo. 2018-103 (July 3, 2018).

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Lesson From The Tax Court: The One Return Rule

Sometimes I get irritated. When I do I speak in short sentences. Really short. So when I read Judge Buch’s opinion in the recent case of Gary Gaskin and Jessie Gaskin v. Commissioner, T.C. Memo. 2018-89 (June 20, 2018), I was struck by his frequent use of short sentences. Really short. Kinda like he was really irritated. And why wouldn’t he be? Mr. Gaskin had filed admittedly fraudulent tax returns but now wanted to contest the fraud penalties! Mr. Gaskin thought he should escape fraud penalties because he had later filed amended returns that had, in his view, cured the fraud.  Judge Buch's opinion teaches an important lesson we should all learn. I call it the “one return rule.” It’s a short lesson. You will find it below the fold.

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Is The Mayo Clinic’s Primary Activity Health Care Or Education? Millions In Taxes Ride On The Answer.

Nonprofit Quarterly:  Mayo Clinic’s Primary Activity Could Cost It Millions in Taxes, by Michael Wyland:

When people think of the Mayo Clinic, they think of doctors and nurses providing health care to patients from all over the world. Mayo is also well known for its rich history of medical research and education. A seemingly minor provision of the US Tax Code, however, makes it very important to define which aspect of the organization is its primary activity.

Here’s the details: 501c3 organizations that make money on debt-financed real estate investments typically owe unrelated business income taxes (UBIT) because that income is unrelated to their charitable purpose. However, educational institutions are exempted from this provision and do not owe the tax.

Mayo Clinic claims its primary function is as an educational institution. They have 3,800 enrolled students and provide part-time instruction for up to 100,000 health care professionals annually. Mayo says it meets the legal standard for an educational institution: “a regular faculty and curriculum for a regularly enrolled group of students attending at a place where teaching is normally carried out.” Based on this, Mayo is seeking more than $11 million in refunds of taxes paid since the early 2000s on its debt-financed real estate investments.

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More Commentary On The Supreme Court's Wayfair Online Sales Tax Decision

Following up on my previous posts:

• Law Profs Weigh In On Supreme Court's Wayfair Decision Clearing The Way For Sales Tax Collections From Out Of State Online Retailers (June 21, 2018)
• Hayes Holderness (Richmond), South Dakota v. Wayfair — The More Things Change (June 22, 2018)

Additional commentary:

• Accounting Today, The Long-Term Consequences of Wayfair
• Ryan Anderson (McAfee & Taft, Oklahoma City), States to Benefit From Collection of Online Sales Taxes
• Joyce Beebe (Baker Institute for Public Policy, Rice University), How Did the Supreme Court Change Online Sales Taxation?
• Bloomberg BNA, Wayfair to Cause ‘Explosion’ of Accounting Challenges
• City Journal, Why Wayfair Isn’t Fair
• Forbes, Dissecting The Supreme Court's Internet Sales Tax Decision
• Ruth Mason (Virginia), Why the Supreme Court Leveled the Playing Field on E-Commerce
• Roger McEowen (Washburn), State Taxation of Online Sales
• Politico, Life After Wayfair
• Adam Thimmesch (Nebraska), More Post-Wayfair Thoughts: Sales Tax?

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Lesson From The Tax Court: Into The Weeds on COGS

I avoid inventory accounting in my basic tax class. It is taxing enough (pun intended) to teach students the basics of depreciating business equipment and business realty and the interplay of §167, §179, §168(k) and §168(a) (in that order). I remind them that they are learning to be tax lawyers and not tax accountants: if they cannot do the numbers, hire a CPA. So I only mention cost of goods sold (COGS) concepts in passing. Also, I’m pretty clueless about the subject.

In real life, however, inventory accounting can be crucial, and you had better have good representation when the IRS questions your numbers. That is the lesson I see in the recent case of Laurel Alterman and William A. Gibson v. Commissioner, T.C. Memo. 2018-83 (June 13, 2018), a case involving poor representation of a medical marijuana business. Disclaimer: not only do I not teach COGS but I also never practiced it, so if you dive below the fold, you may catch me out in error. I know for some readers that is actually an incentive to read on---kind of like waiting for a crash on the racetrack. But if you find yourself guffawing at something, please do not hesitate to publicize the error in the comments section. And remember, at least I’m not representing anyone!

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Holderness: South Dakota v. Wayfair — The More Things Change

Following up on yesterday's post, Law Profs Weigh In On Supreme Court's Wayfair Decision Clearing The Way For Sales Tax Collections From Out Of State Online Retailers:  TaxProf Blog op-ed:  South Dakota v. Wayfair: The More Things Change, by Hayes Holderness (Richmond):

After the better end of fifty years, the physical presence rule is out. That rule, originally established in the 1967 National Bellas Hess case, prevented a state from compelling a vendor not physically present in the state to collect the state’s sales and use taxes. Though the Court reaffirmed the physical presence rule in its 1992 Quill decision (largely on stare decisis grounds), the rule had been constantly derided by commentators, states, and Main Street retailers as failing to achieve the goals of the Commerce Clause and as providing an unfair advantage to mail order and internet vendors. Yesterday, the Supreme Court issued its decision in South Dakota v. Wayfair and made clear that those critics had been heard.

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Lesson From The Tax Court: Where Is A Retiree's Tax Home?

The last couple of weeks have seen Tax Court cases with several interesting lessons. The one I choose today is Roger G. Maki and Lilane J. Gervais v. Commissioner, T.C. Summary Op. 2018-30 (June 6, 2018). It teaches a lesson about what constitutes travel “away from home” for purposes of the §162 deduction. I posted a basic lesson (here) on this issue late last year. The wrinkle in today’s case is that the taxpayer was retired and traveled from his home in the Seattle metro area to a house he had inherited, ostensibly to manage the surrounding land for eventual timber sales. The Tax Court decided the travel was deductible. I question whether that’s the right outcome here — it seems to me this was just a commute — but notice this is just a Summary Opinion. That means it can still teach a lesson, even if it carries no precedential weight.

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The Tax Court's Constitutional Home

Allen Madison (South Dakota) & Sharyn M. Fisk (California State Polytechnic), The Tax Court's Home, 157 Tax Notes 1249 (Nov. 27, 2017):

This article analyzes issues related to the Tax Court’s constitutional status. Although the issue has been debated for decades, recent litigation has revived the issue. In Battat v. Commissioner, [148 T.C. No. 2 (Feb. 2, 2017),] the primary issue before Tax Court was whether the President’s limited removal power over tax judges violates the Constitution’s separation of powers. In addressing this issue, the Tax Court outlined the background on the Tax Court’s status to show the Tax Court is not in the Executive branch. Further, the Battat opinion holds that even though the court exercises judicial power, the Tax Court does not exercise the “judicial power of the United States” reserved for Article III courts. Thus, the President’s limited removal power presents no separation of powers violation. The Tax Court did not reach an ultimate answer as to which branch of the government it resides, but it does provide background showing that it lies outside the Executive branch.

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Lesson From The Tax Court: What Makes Tax Law Complex

Tax reminds me of the children’s poem that starts “I have a little shadow.” Tax is the shadow (sometimes not so little) that follows all of us throughout life. Put another way, every activity in life throws a tax shadow. And life is not simple. I submit that much of tax complexity is a reflection of life’s complexity, including people’s relationships with one another. And we all know how relationships can get complicated. Last week’s case of Joseph Engesser v. Commissioner, TC Summary Opinion 2018-29 (June 4, 2018), not only illustrates this idea, but it also shows how certain parts of the Tax Code’s complexity hits lower income taxpayers particularly hard. They must deal with one of the gnarliest tax issues in the Code: §152, the section that defines who is a dependent.

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Lesson From The Tax Court: A Haunting

Four cases from the last couple of weeks illustrate the continued fallout from the Tax Court’s recent about-face in its reading of §6751(b)(1). Graev v. Commissioner, 149 T.C. No. 23 (Dec. 20, 2017)(commonly called Graev III because it was the Tax Court’s third published opinion regarding Mr. Graev’s case). The good folks at Procedurally Taxing have been following Graev III’s impact here, here and here (to name a few). These four cases add a new wrinkle.

In all four cases, the Service had failed to produce evidence in the initial trial that it had complied with §6751(b)(1). And for good reason. All four cases had gone to trial before the Court issued its opinion in Graev III. At the time of trial the Tax Court’s fully reviewed position on §6751(b)(1) was that consideration of penalty approval was premature when contesting an NOD.

In all four cases the Service asked the Tax Court to re-open the record to allow it to introduce the theretofore-unrequired-but-now-required evidence. The cases were heard by three different Tax Court judges. In two cases, the Court allowed the record to be reopened and in two cases the Court refused. Taken together, the cases illustrate how the fallout from the Tax Court’s Graev decision continues to elevate procedure over substance. As a result, similarly situated taxpayers receive very different outcomes based both on which IRS attorneys work the cases, what information the attorneys have, perhaps most importantly, which Tax Court judge decides. Four cases, three judges, two opposing outcomes, all in one discussion, waiting for you below the fold.

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Tax Court Judge Gets His Moment In Michael Jackson Case

Wall Street Journal, Taxman in the Mirror: Judge Gets His Moment in Michael Jackson Case:

Mark Holmes writes pithy tales of failed marriages and booming businesses, weaving in F. Scott Fitzgerald, historical digressions and groan-aloud puns.

Now he’s working on a much-anticipated thriller (get it?) about the late pop superstar Michael Jackson.

Mr. Holmes is no best-selling author. In fact, his work is free. Mr. Holmes is a federal judge known for the clear, colloquial writing style he brings to arcane rulings on the U.S. Tax Court.

He’s handling the final phases of the hugely complicated court case stemming from Mr. Jackson’s estate-tax return. An unusual combination of music fans and tax nerds is anticipating the end of the five-year court battle, and Mr. Holmes is poised to apply his distinctive voice to one of the most recognizable voices of the 20th century.

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Lesson From The Tax Court: A Tax Truism

A truism is a saying that is so commonly accepted as true that it needs no further explanation.  For example: "never get involved in a land war in Asia.”  Today’s lesson shows us a tax truism: never take tax advice from the person selling you the deal.  In RB-1 Investment Partners, Eric Reinhart, Tax Matters Partner v. Commissioner, T.C. Memo. 2018-64 (May 14, 2018), the taxpayer received millions of dollars from the sale of a business and invested in a complex transaction that the promoter promised would magically wipe away the gain with no actual economic loss (except fees).  When the taxpayer got caught, it conceded the merits, but attempted to avoid imposition of a 40% penalty under §6662 by arguing reasonable reliance on an opinion letter from the law firm promoting the scheme. I explain below the fold the taxpayer’s argument, why it failed, and what we can learn.

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Lesson From The Tax Court: The Role Of State Law In Federal Taxation

The United States Legal system is as hard to learn as the English language. One of the more difficult aspects of the system is the existence and interplay of 51 sovereignties. The Tax Code is not immune from that difficulty. Even though federal tax is governed in the first instance by federal law, state law can still be quite important to the resolution of a federal tax controversy, whether the dispute is about the amount of tax owed or the collection of an undisputed amount. The recent case of Vincent C. Hamilton and Stephanie Hamilton v. Commissioner, T.C. Memo. 2018-62 (May 8, 2018) teaches a lesson about the role of state law in determining a federal tax liability.

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Hemel: Justice Alito, State Tax Hero?

Daniel Hemel (Chicago), Justice Alito, State Tax Hero?:

I had been waiting with bated breath for the Supreme Court’s decision in Murphy v. NCAA, formerly Christie v. NCAA. (Sorry, Chris Christie: You won’t have your name attached to the winning side of a landmark constitutional case — your successor will.) Anyhow, it came down yesterday — and it’s way more interesting than I anticipated. In a nutshell: Not only did the Supreme Court strike down the federal law at issue, which had stopped states, counties, and cities from legalizing sports gambling within their borders, but it also appears to have invalidated a broad swath of congressional limitations on state tax authority. (Oh, and it also saved sanctuary cities.) ...

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Lesson From The Tax Court: The Reach Of Equity

Justice Holmes famously said that people “must turn square corners when they deal with the government.” It is no coincidence that he said that in this 1920 tax case. Tax law has many sharp corners that frustrate both taxpayers and the IRS alike. For an example of where the sharp corners of procedure caused the IRS to lose a $10 million assessment, see Philadelphia-Reading Corp. v. Beck, 676 F.2d 1159 (3rd Cir. 1982).

But equity can sand down some of those sharp corners. Last week's post looked at the innocent spouse case of the Commie L. Minton a.k.a. Connie L. Keeney v. Commissioner, T.C. Memo. 2018-15 (Feb. 5, 2018). That case illustrated how Congress had inserted a statutory command for the IRS and the Tax Court to use equity to relieve a spouse of an otherwise jointly owed liability. This week, the case of Emery Celli Cuti Brinckerhoff & Abady, P.C. v. Commissioner, T.C. Memo. 2018-55 (Apr. 24, 2018), teaches another lesson about equity in the Tax Law. Here, there is no Congressional command to use equity. Instead, the Tax Court uses a long-standing principle of equity created and apply by the courts. It is called equitable recoupment.

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Lesson From The Tax Court: The Role Of Equity

For various reasons that legal historians can drone on about for hours, the United States legal system started out in 1789 as not one system of courts but two systems of courts. One was system was made up of courts of law, staffed by folks with titles like “Judge” or “Justice.”  The other system was made up of courts of equity, staffed by folks with titles like “Chancellor” or “Vice Chancellor.”  The basic idea was that each system had its own set of powers and you could only get to the equity courts if the law courts lacked the power to give you the relief you sought.

This was a really awkward relationship and a constant source of embarrassment and confusion.  The great legal historian F. W. Maitland put it this way in his 1910 Lectures On Equity:  “I do not think that any one has expounded or ever will expound equity as a single, consistent system, an articulate body of law.  It is a collection of appendixes between which there is no very close connection.”  (p. 19)  And in this 1913 law review article, Professor Wesley Newcomb Hohfeld discussed the difficulty of teaching equity as a system of rules separate from legal rules.

One awkwardness was that often the same individual would wear both hats.  For example, you might file an action at law and have proceedings before the “Judge” sitting as a court of law.  The Judge had power to award damages but did not have power to order depositions.  So you would need to file a completely separate proceeding in equity, seeking a “Bill of Discovery” from the Vice Chancellor because the Vice Chancellor had the power to order depositions (but had no power to award damages).  But you would file that in the same building and be heard by the same individual. So one day the “Judge” would say “I have no power to order discovery” but the next day the very same individual, sitting as “Vice Chancellor,” would suddenly have the power to grant your Bill.

I tell you all this because although the two systems have been merged in federal courts since 1938 (although some states, such as Delaware and Mississippi, keep the two systems separate) federal judges still tend to compartmentalize the two.  The Tax Court in particular has wrestled with the role of equity from its inception.  Two recent Tax Court cases teach useful lessons about the role of equity in Tax Court proceedings.  This week I will look at the innocent spouse case of the Connie L. Minton a.k.a. Connie L. Keeney v. Commissioner, T.C. Memo. 2018-15 (Feb. 5, 2018).  Next week I will discuss the very interesting case of Emery Celli Cuti Brinckerhoff & Abady, P.C. v. Commissioner, T.C. Memo 2018-55 (Apr. 24, 2018), a case that will introduce us to the doctrine of equitable recoupment.

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Field: Tax Implications Of The Dynamex Worker Classification Ruling

Following up on Paul Caron's previous post: California Supreme Court Deals Major Blow to Gig Economy Business Model, Treats Workers as Employees Rather than Independent Contractors: Heather Field (UC-Hastings) at Surly Subgroup: Tax Implications of the Recent Dynamex Worker Classification Ruling 

Greetings from San Francisco, the epicenter of the gig economy, where workers-rights advocates are celebrating Monday’s California Supreme Court decision in the Dynamex case. The ruling, which cites an article by my colleague Veena Dubal, is expected to make it harder for businesses in California to classify gig economy workers (and others) as independent contractors rather than employees. As a result, these workers are more likely to be protected by rules about minimum wage, overtime, rest breaks, and other working conditions, although there are open questions about exactly how these rules will apply to gig workers.

But what is good for workers for employment/labor law purposes may not be so good for workers for federal income tax purposes. As readers of this blog know, independent contractors can generally deduct their business expenses above-the-line and may be able to take the new Section 199A deduction equal to up to 20% of qualified business income (significantly reducing the effective tax rate). Employees, on the other hand, can do neither. Thus, the employment/labor law win for workers in the Dynamex case may come with some unexpected and unwanted tax losses for these same workers. This is especially true for workers with non-trivial amounts of unreimbursed business expenses (although the amount of a worker’s unreimbursed expenses may decline if the worker is classified as an employee because California Labor Code 2802 generally requires employers to reimburse significant business expenses of employees).

So, taking tax into account, is independent contractor status or employee status better for workers? This question involves complicated employment/labor law and tax law tradeoffs. For example, despite the tax disadvantages of employee classification mentioned above, employee status can benefit workers for employment tax and tax compliance purposes. Others (including Shuyi Oei here, Shuyi Oei and Diane Ring here, here and here, and Kathleen DeLaney Thomas here) have written extensively on worker classification/taxation topics, and at least some of them have additional articles forthcoming on these topics. I will defer to them for more details as I am not an expert (at least right now) on worker classification or its tax implications. But even I know that, when analyzing the implications of the Dynamex case, it will be important for commentators to consider the tax, not just employment/labor, consequences.

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Lesson From The Tax Court: The Cohan Doctrine Cannot Always Save You

One of the first clients I had after graduating from law school in 1987 was a fellow in the construction business. I forget what dispute brought him to us, but I will never forget the “records” he brought: a truckload of paper bags. Turns out that each year he would set a paper grocery bag on the floor and, as the year went by, he would dump anything he thought important into the grocery bag ... if he remembered to do so. You can guess who got to go through all his paper bags.

I am sure many of you have encountered clients with similar, if not more pathetic, record-keeping practices. Readers well know that taxpayers bear the burden of production to show why they are entitled to claimed deductions. To do that they need to keep good records.

If taxpayers don’t keep good records, however, they can sometimes get lucky under what is commonly called the Cohan doctrine. For those interested, my blog here explains the doctrine and its history.  Basically, the doctrine says that if the taxpayer can prove the fact of an expense, but not the exact amount of the expense, the Tax Court will make its own estimate of the amount, “bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making.” Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930).

Two weeks ago I blogged here about a taxpayer who got lucky when the Tax Court judge spotted an issue that both the taxpayer’s attorneys and the IRS attorneys had overlooked, saving the taxpayer some $42,000 in taxes.  This week we look at a case, Stanislav Antoniev Dimitrov v. Commissioner, T.C. Summary Opinion 2018-21, that teaches a lesson about the limits to getting lucky under the Cohan doctrine.

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5,000 Pastors Rally To Defend Housing Tax Break Ruled Unconstitutional

Christianity Today, 5,000 Pastors Rally to Defend Housing Tax Break Ruled Unconstitutional; Appeal: Exemptions Do More Than Just Save Pastors $800 Million a Year:

When a pastor responds to late-night prayer request or invites congregants to his home for Bible study, is he just doing his job or going beyond the call of duty?

The lawsuit over the longstanding benefit, launched by the Freedom from Religion Foundation (FFRF) seven years ago, has entered another round of appeals. The Christian defendants, represented by Becket, filed their written appeal in the Seventh Circuit Court of Appeals late last week.

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Lesson From The Tax Court: It's Still An Adversarial Process

Several features of the Tax Court make it a unique institution in U.S. law.  For example, no other court has (or needs) the Golsen rule. Here’s a post where I explain why.  And no other federal court uses the Tax Court’s quasi-en banc process. Kandyce Korotky over at Procedurally Taxing has a nice post here describing how that process sometimes produces opinions where more judges join the concurrence than the opinion of the Court.

But the Tax Court still hews to that greatest feature of the U.S. legal tradition: the adversarial process, where each side takes responsibility for presenting its own case and the Court simply judges between the cases presented. That is the lesson I see in last week’s decision in Aaron Keith Nicholson v. Commissioner, T.C. Summary Opinion 2018-24 where the taxpayer was representing himself and the IRS was represented by not one but FIVE attorneys of record. Really. I think the case should have been a lesson about the hobby loss rules, but it turns into a lesson that tax litigation rests on an adversarial process where the parties’ concessions, no matter how lame they appear, will bind them.   This is true even in the small case procedure. Here, it benefitted the taxpayer.

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Christian Who Cites Opposition To Abortion For Not Paying Taxes Wins Round 1 In Federal District Court

The Oregonian, Man Who Cites Opposition to Abortion For Not Paying Taxes Wins Round 1 in Court:

A federal judge has dismissed a felony tax evasion charge against a man who describes himself as a Christian who refuses to give money to the government to support abortion.

U.S. District Judge Michael W. Mosman ruled that the government's indictment failed to provide any evidence that Michael Bowman tried to conceal or mislead government officials by simply cashing his checks and keeping a low bank balance so tax collectors couldn't garnish his account to pay taxes.

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Lesson From The Tax Court: Better Lucky Than Good

Most of us who are either preparing our returns last week (or today), or reviewing the returns prepared for us, honestly want to get it right. We try to be good. But just as life is complex, so is the tax shadow created by life activities and decisions. Last week’s decision in Stacey S. Marks v. Commissioner, T.C. Memo. 2018-49, is not so much a lesson about being good as it is a lesson that sometimes—just sometimes—you can get lucky.

Details below the fold.

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Lesson From The Tax Court: One Year At A Time

Last week the Tax Court issued 19 opinions, including one articulate opinion on Collection Due Process that teaches an interesting, albeit esoteric, lesson about the bulk-processing nature of tax administration.  I will save that case, Scott T. Blackburn, v. Commissioner, 150 T.C. No. 9, for another week, or perhaps our colleagues over at Procedurally Taxing will blog it.

In today’s post I want to look at two of last week’s opinions that I think teach a more basic lesson about the important way in which each tax year is separate from all others.  The two cases are: (1) Shane Havener and Amy E. Costa v. Commissioner, T.C. Sum. Op. 2018-17 (Apr. 4, 2018); and (2) Gary K. Sherman and Gwendolyn L. Sherman v. Commissioner, T.C. Sum. Op. 2018-15 (Apr. 2, 2018). 

Notice that both of these are what are called “Summary” Opinions.  That means the taxpayer in each one elected the small case procedures allowed by IRC §7463 and implemented by Tax Court Rules 170 et. seq.  As most readers no doubt know, the upside of that election is relaxed procedural rules (notably rules of evidence) and the downside is that the loser may not appeal to a higher court.  The idea is that these are cases where the dispute between the taxpayer and the IRS is really one about factual matters and not about the law. That is why when you access these cases through the Tax Court website, the website pops up the following message in all-caps: “Pursuant To Internal Revenue Code Section 7463(b), This Opinion May Not Be Treated As Precedent For Any Other Case.” 

The very reason why these cases make for lousy precedent, however, is why they often make for good lessons about basic tax concepts.  The lesson I see in these two cases is about the appropriate accounting period, a particularly timely lesson this week since April 16th (the deadline for filing returns this year since April 15th falls on a Sunday) is right around the proverbial corner. 

To economists, the most accurate accounting period is one’s lifetime.  That is, the best measure of income is what happens over our lifetime.  But because governments need revenue sooner, because not all taxpayers die (think corporations), and because even if tax revenue would even out in the long, long, long run, the transition costs to a lifetime accounting period would be untenable, Congress created a yearly accounting period for income tax (and shorter accounting periods for excise taxes such as the employment tax). 

That yearly period ends on December 31st for most of us mere mortals.  The yearly questions we ask are “how much income did I have during the last year?” and “what expenditures did I make that I can deduct from the income I made?”  The point of today's lesson is that we must ask those questions every year and just because we get a wrong answer in one year does not entitle us to continue using that wrong answer in later years. 

More below the fold.

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