Lesson From The Tax Court Repost: Ipse Dixit Cannot Fix It

[Author's Note: I am preparing exams and so take a break this week from writing a new Lesson.  I offer a reposting of a Lesson from 2019 that I really liked, but one that did not get a lot of views when originally posted.  I hope you enjoy it!]

Mitchel Skolnick and Leslie Skolnick, et al. v. Commissioner, T.C. Memo. 2019-64 (June 3, 2019) (Judge Lauber), teaches an important lesson about the proper use of expert witnesses.  In Skolnick, the Tax Court rejected the taxpayer’s expert witness valuation of of 153 horses at two points in time 7 years apart because the expert did not adequately disclose the facts and methodology used to value each horse.  Judge Lauber held that the taxpayer could not fix the value of the horses through expert’s ipse dixit.

The form of the lesson is also instructive.  The opinion merely grants an interstitial motion, called a motion in limine, to exclude the expert’s report from the evidentiary record at trial, held in April 2019.  The 68-page final decision was issued in December 2019 (you can read it here) and the taxpayers lost, as you might expect. They then took an appeal to the Third Circuit...and lost again. Skolnick v. Commissioner, 62 F.4th 95 (3rd Cir. 2023).

One might ask why the Court would take the time to issue an opinion on just one aspect of a case after the bother of a trial.  Why did not the Court just issue an opinion on the merits of the dispute?  After all, if the expert’s opinion is worthless enough to exclude from evidence, it is unlikely to really be helpful in deciding the merits of the case. 

I give my thoughts on both lessons below the fold, although I won’t blame you if you prefer to just watch this classic Monty Python sketch “The Argument Clinic.” Ipse Dixit is the form of argument that predominates in the sketch and is part of what makes it funny.  In real life, however, taxpayer representatives who do not heed today’s lesson will not be laughing.

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Lesson From The Tax Court: Taxpayers Cannot Invoke The 'Augusta Rule' With Unplayable Lie

In the past few years there have apparently been a lot of excited Tik Tok posts about how closely held businesses can use the “Augusta Rule” to get a double tax benefit: a deduction for the business under §162 and tax free income to the business owner under §280A(g).

In Kunjlata J. Jadhav and Jalandar Y. Jadhav v. Commissioner, T.C. Memo. 2023-140 (Nov. 21, 2023) (Judge Vasquez), the taxpayers get lured by the promise of tax free income under the August Rule into making what turned out to be an unplayable lie on their tax returns.  They did not get a mulligan.  They did get penalties.  The problem was these taxpayers were unable to show that the rental payments their S Corp made to them and their sons were “ordinary and necessary” under §162.  That requirement is not usually a difficult one to meet but when you are trying to play the system, it can be tricky to get through the rough and avoid the hazards to make the hole.

Details below the fold.

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Lesson From The Tax Court: A Lesson In Pathfinding

I cannot say it enough: the IRS is not an entity.  It’s a vast organization with various offices that perform various functions.  And one key idea is that taxpayers may have multiple paths to get to a successful result.  If one office cannot help you perhaps a different one can.  At the IRS that often means if you cannot get good results in Exam or Collection you might get them in Appeals.  And sometimes you can get to Tax Court from Appeals.  But sometimes not.  It's path dependent as we learn today.

In Rita Renee Pilate v. Commissioner, T.C. Memo. 2023-136 (Nov. 9, 2023) (Judge Gustafson), the IRS was seeking to collect a tax liability.  The taxpayer was able to obtain a CDP hearing.  That path put her in front of the Office of Appeals.  She said she wanted to make an Offer In Compromise (OIC).  But she did not submit one to Appeals as part of the CDP hearing.  She did not choose that path.  After Appeals closed her CDP hearing, Ms. Pilate timely petitioned the Tax Court for review.  She also now submitted an OIC but, since her CDP case had closed, that submission put her on a different path.  The OIC was accepted but a dispute later arose on whether she complied with its terms and Appeals issued a letter defaulting her.  Since her CDP petition was still before the Tax Court, she asked the Court to review the Appeals decision to default her OIC.  The Tax Court said it could not make that review, because an OIC outside of CDP is not on the correct path for judicial review.

Details below the fold.

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Lesson From The Tax Court: Merely Winning Does Not Entitle Taxpayer To Attorneys Fees

Section 7430(a) permits a court to award “reasonable administrative costs” and “reasonable litigation costs” (the largest being attorneys fees) to a taxpayer who is a “prevailing party” in a dispute with the IRS.  I use all those scare quotes to emphasize that these are all terms of art.  And the scariest, or artiest, one is perhaps “prevailing party.”

Today’s lesson teaches us that a taxpayer is not going to be a prevailing party just because they win a remand in the Court of Appeals and then win in Tax Court on the remand.  The case is Champions Retreat Golf Founders, LLC v. Commissioner, T.C. Memo. 2023-143 (Nov. 8, 2023) (Judge Pugh).  It is the coda on the taxpayer’s 13 year slog to claim a $10.8 million charitable deduction for a conservation easement on a golf course.  The Tax Court initially found that the easement was not a qualified charitable contribution.  It got reversed by the Eleventh Circuit.

The parties then battled over the proper valuation of the donation and, again, the taxpayer won, although Judge Pugh cut down the contribution amount by about $3 million. See Lesson From The Tax Court: Fake It Till You Make It, TaxProf Blog (Oct. 24, 2022) (“The lesson is kind of like the old joke that you don’t have to outrun the bear: a taxpayer’s valuation does not have to be the best possible; it just has to be better than the IRS’ valuation.”).

Now the taxpayer is back, asking for the Court to make the government pay its litigation costs per §7430 because it claims to be a prevailing party.  Well, without the scare quotes, that may seem intuitively right.  After all, the taxpayer won in the Circuit Court and then in Tax Court on remand!

But the lesson we learn is that even a winning taxpayer is not entitled to litigation costs when the government’s losing position was “substantially justified.”  Again with the scare quotes!  That’s because, dear readers, this term is yet another term of art.  We learn today that the term is a facts and circumstances determination.  While winning is an important factor, winning isn’t everything.  Details below the fold. 

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Lesson From The Tax Court: §6662 Is Sometimes Multiple Penalties For Supervisory Approval Purposes But Sometimes Not

This week we learn a lesson about the interplay between the supervisory approval requirement in §6751(b) and the §6662 penalty regime.  While §6662(a) seems to impose a single penalty for accuracy-related error, we learn that if the IRS is either careful or lucky, it can cure one defective §6662 approval by later asserting in Tax Court a seemingly different §6662 penalty and getting the proper supervisory approval for that second bite at the penalty apple.

In Stephen R. Kelley and Isabelle Kelley v. Commissioner, T.C. Memo. 2023-126 (Oct. 23, 2023) (Judge Copeland), the NOD asserted a §6662(a) penalty for substantial understatement.  But the IRS employee had not obtained the appropriate supervisory approval before the NOD went out.  So when the case got to Tax Court, the IRS conceded the substantial understatement penalty and the IRS Chief Counsel attorney asserted a §6662(a) penalty for negligence or disregard of rules or regulations.  The taxpayers argued that the penalty imposed by §6662(a) is singular and so the failure to obtain supervisory approval for the NOD precluded any later assertion of penalties under §6662(a).

The Tax Court rejected the taxpayer’s argument and held that the §6662(a) penalty for substantial understatement was different than the §6662(a) penalty for negligence or disregard.

This decision seems in tension with a prior precedential Tax Court opinion, Jesus R. Oropeza v. Commissioner, 155 T.C. 132 (2020), where the Tax Court seemingly held that it would treat §6662 as imposing a single penalty for §6751(b) purposes.  I blogged that in Lesson From The Tax Court: §6662 Penalties Treated As One For Supervisory Approval Requirement, TaxProf Blog (Oct. 19, 2020).

Judge Copeland does not mention Oropeza in her otherwise very comprehensive 19 page opinion, much less seek to distinguish it.  I think the cases are reconcilable but it makes for an awkward lesson: sometimes §6662 imposes a singular penalty and sometimes it imposes multiple penalties for supervisory approval purposes.  This awkwardness seems unavoidable under any interpretation of §6751(b).  It comes from the ambiguity of §6662 and not the nonsensical text of §6751(b).

Details, as always, below the fold.

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Lesson From The Tax Court: The Rules For Penalty Approval Depend On Geography

Tax law is supposed to be uniform.  The thousands of pages of statutes and regulations are supposed to be applied to taxpayers living in Texas in the same way as taxpayers living in California.  The IRS is a single federal agency charged with applying the law uniformly.  And the Tax Court is a single national trial court that can and does travel to every corner of the United States to resolve most disputes that arise between taxpayers and the IRS.

But tax law is not uniform.  One reason is because there are 11 geographic Circuit Courts of Appeals (Circuits 1-11 plus the D.C. Circuit) in the federal system.  Their decisions are binding within the geographic boundaries of the Circuit, but are not binding on the other Circuits.  So when one Circuit Court of Appeals disagrees with another on how to interpret a tax statute, the law is not uniform.  Under what is known as the “Golsen rule” the Tax Court will generally follow the law of the Circuit to which a taxpayer would take an appeal.

Today we learn another reason tax law is not uniform: the Tax Court itself.  In Wolfgang Frederick Kraske v. Commissioner, 161 T.C. No. 7 (Oct. 26, 2023) (Judge Gale), the taxpayer was arguing that the IRS could not assert penalties because the penalties were not properly approved under §6751(b).  That argument was a winner under the Tax Court’s interpretation of that statute, but was a loser under the interpretation given by every one of the four Circuit Courts of Appeals to interpret the statute, including the Circuit to which the taxpayer would take an appeal.  This might have been a good case for the Tax Court to change its interpretation and bring uniformity to tax administration.  Sadly, that did not happen.  Instead Judge Gale applied the Golsen rule, which teaches us another good lesson: the Golsen rule is not automatic!

Details, as usual, below the fold.

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Lesson From The Tax Court: What Makes A NOD Invalid?

When the IRS determines a deficiency of tax, it is then “authorized to send notice of such deficiency to the taxpayer.”  §6212(a).  That’s called a Notice of Deficiency (NOD).  The taxpayer generally has 90 days from the date of the NOD to petition the Tax Court to ask for a “redetermination of the deficiency.” §6213(a).

The procedures outlined in §§6212 and 6213 carry several important consequences.  First, the IRS is prohibited from sending a second NOD for the tax year(s) covered by the NOD. §6212(c)(1).  Second, the IRS is prohibited from assessing the proposed deficiency until after the Tax Court has issued a decision and it has become final. §6213(a).  Third, the statute of limitations for the IRS to make an assessment is suspended for the same period during which the IRS is prohibited from assessing, plus 60 days. §6503(a).

None of those consequences happen if the NOD is invalid.  If a taxpayer convinces the Court that the NOD is not valid, the Tax Court will dismiss the case.  That dismissal hurts the IRS because, almost always, the limitation period for assessment will have expired, barring the IRS from re-doing the NOD.

So what makes an NOD invalid?  It is not what many taxpayers think.  Taxpayers may think that an indecipherable NOD is invalid.  Or taxpayers might think that if the process leading to the NOD was defective, then the NOD is invalid.  Today we learn that is not the case.  The lesson comes from Michael J. Watson and Tracy L. Watson, et al. v. Commissioner, Docket No. 12220-21 plus five others (Aug. 31, 2023) (Judge Weiler). Note that this is an unpublished order, so the link takes you to the Docket Sheet and you have to scroll down to find the Order.

But even though this is just an unpublished order, I think it’s worth attention because it is very well written and can teach us something about how the Tax Court evaluates the validity of an NOD.

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Lesson From The Tax Court: The Limits Of Collection Due Process

One lesson I teach my students is that taxpayers are generally best off resolving issues with the IRS before seeking judicial help. Another lesson is that taxpayers have multiple opportunities to work with the IRS in the collection process.  So just because one opportunity fails does not mean the taxpayer is out of options.

Today we see a great example of both lessons in Eric Wilfred Olson v. Commissioner, T.C. Memo. 2023-123 (Oct.10, 2023) (Judge Weiler).  There, the taxpayer attempted to use the Collection Due Process (CDP) opportunity to stave off enforced collection of some $77,000 of tax liabilities.  He was also trying to get spousal relief for his wife.  The Tax Court gave him no relief because he had failed to properly try and resolve these issues at the administrative level.  However, just because CDP relief was not available did not mean the taxpayer was out of options to obtain the relief he appears to have sought.

The case also shows the limits of CDP’s delay benefit.  While delay is certainly a common benefit of the CDP process, that benefit was limited in this case for two reasons.  First, this was a tax lien CDP case, which mean the IRS had already established the priority of the tax lien by filing a Notice of Federal Tax Lien (NFTL) before the CDP process started. §6320(a).  So the CDP process in such cases does not affect the IRS ability to use its lien powers.  Second, the taxpayer here filed his Tax Court petition in October 2022 and Judge Weiler issued his decision less than one year later.  That’s awesomely fast for a CDP case.  See Lesson From The Tax Court: The Long And Short Of CDP, TaxProf Blog (Apr. 6, 2020).  No wonder Lew (“Don’t Contact Me”) Taishoff gives Judge Weiler the cognomen “Speedy”!

Details below the fold. 

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Lesson From The Tax Court: The Designated Payment Rule

Payroll taxes present particularly prickly problems.  The problems often arise from a failure to make timely deposits of the correct amounts.  That can happen for lots of reasons, some innocent, some willful.  But once the employer gets too messed up, fixing the problem can be tricky because the IRS will take whatever payments are made and apply those payments in the best interest of the government.  That may not always be in the best interest of the taxpayer.

Today we learn a lesson that will help taxpayers mitigate payroll tax goofs: a voluntary payment allows taxpayers to designate how the IRS should apply the payment.  It's a useful lesson for any kind of tax but especially for payroll taxes.  In Raymond S. Edwards v. Commissioner, T.C. Summ. Op. 2023-29 (Sept. 27, 2023) (Judge Panuthos), the taxpayer got crosswise with the IRS on unpaid payroll taxes and sent in payments that he specifically designated to cover only the taxes owed for five specified quarters, not the accrued interest and penalties, which he wanted to contest.  But the IRS instead applied the payments to interest and penalties.  Judge Panuthos explains why the IRS must honor a taxpayer’s designation of voluntarily remitted taxes.  Not sure this was more than a pyrrhic victory, but it makes for a good lesson.

Details below the fold.

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Lesson From The Tax Court: Equitable Tolling During Government Shutdown?

Like winter, a shutdown is coming.  And last week, the Tax Court issued a really important reviewed decision about equitable tolling of CDP hearings.  The two are connected because the Tax Court lesson may become very useful for taxpayers faced with an inaccessible IRS during periods of government shutdown

For those of us having a hard time keeping track, this Wikipedia entry gives a useful history of federal government shutdowns.  Going in reverse chronological order, it appears that top three were: (1) during the Trump administration—one at the start of 2018 and then also a long 35-day shutdown from the end of 2018 into 2019; (2) during the Obama administration—16 days in 2013; and (3) during the Clinton administration—21 days in in 1995–1996.  We may well be on the way to another one when the 45-day Continuing Resolution passed yesterday expires.

Last week's opinion in Organic Cannabis Foundation v. Commissioner, 161 T.C. No. 4 (Judge Goeke), may help taxpayers who must deal with a closed IRS during the next shutdown.  In that case, fourteen of the sitting Tax Court judges interpreted §6320 to permit equitable tolling of the 30-day period that taxpayers have to request a CDP hearing after the IRS files a Notice of Federal Tax Lien (NFTL).  Three judges thought that interpretation squarely conflicted with the applicable Treasury Regulation and wanted to hear arguments on the validity of the regulation.  The Court’s reasoning applies as much to §6330 CDP hearings as well, making it even more consequential.

What makes this a really useful decision is the idea that a government shutdown might indeed qualify taxpayers for equitable tolling.  Details below the fold.

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Lesson From The Tax Court: Supervisory Approval Of Automated Penalties

Section 6751 requires the IRS to ensure adequate supervisory approval of tax penalties before those penalties are assessed.  But it does not require such approval for any “penalty automatically calculated through electronic means.” §6751(b)(2)(B).

Today we learn a surprisingly nuanced lesson about what constitutes a penalty automatically calculated through electronic means.  In Piper Trucking & Leasing v. Commissioner, 161 T.C. No. 3 (Sept. 14, 2023) (Judge Foley), the IRS assessed penalties against the taxpayer, under §6721, for Piper’s alleged failure to file required information returns.  The initial letter proposing such penalties was automatically generated, based on information received from the Social Security Administration.  But the proposed penalties were the most severe of several alternatives, alternatives that depended on the facts.  Yet no IRS employee was supposed to review the penalty unless and until the taxpayer responded to the initial letter in time.  In this case, the taxpayer made no timely response.  For that reason, the Tax Court held that these penalties fell within the statutory exception and required no human decisionmaker.

This lesson is just another reason why taxpayers need to be sure to respond to all correspondence received from the IRS.  Details below the fold.

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Lesson From The Tax Court: When 'My CPA Did It' Is No Defense To Penalties

Life is complex.  Tax shadows life.  So it is no wonder that Tax law is complex.  And the more complex a taxpayer’s financial life becomes, the more likely they will goof up.  While Congress imposes penalties for errors, it also recognizes the complexity of tax law by allowing taxpayers to avoid most penalties if they can show they had reasonable cause for their errors.  A common defense against penalties is that the taxpayer reasonably relied on the advice of a competent professional.

Sometimes, however, taxpayers think that relying on a professional to prepare the return absolves them of responsibility for any subsequent errors.  Today’s lesson puts the lie to that thought.  Relying on a CPA’s return preparation services is not the same as relying on a CPA’s advice and provides no protection from the various penalties in §6662.

In John R. Johnson, et al. v. Commissioner, T.C. Memo. 2023-116 (Sept. 13, 2023) (Judge Nega), the taxpayer was hit with §6662(b) penalties for substantially understating his income tax liabilities for four years in a row.  That’s a lot of error.  He argued that he had reasonable cause for the errors because he had used a CPA to prepare his returns and he had provided that CPA all the relevant information.  He even put his CPA on the stand.

The failure of that argument provides the lesson.  We learn that to avoid penalties taxpayer must do more than show they relied on a CPA to properly prepare the return, especially when the taxpayer is sophisticated.  Details below the fold. 

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Lesson From The Tax Court: The Boundary Waters Of Equity

Every birthday gives me the opportunity to appreciate the luck I've had in my life.  Last week was my 63rd.  I fondly remembered my summers at  Camp Chippewa, a wonderful summer camp just outside of Bemidji, MN.  One focus of that camp was canoe trips, including trips exploring the Boundary Waters in upper MN and lower Canada.  Those 1-2 week trips were amazing adventures.  Long before cell phones and GPS, we were cut off from any easy access to population centers.  Only if you were careful with your maps would you even know whether you were in the U.S. or in Canada!  And yes, I will connect that up with Today’s Lesson.

These particular reminiscences were sparked by my reading William H. Evenhouse and Nelle L. Evenhouse v. Commissioner, T.C. Memo. 2023-113 (Sept. 7, 2023) (Judge Lauber), because we learn there how the Tax Court interprets §6213 generously to allow certain lucky taxpayers up to 150 days to petition for review of a Notice of Deficiency (NOD).  While the particular taxpayers in this case were not able to get the extra time, the case gives us a good lesson in how the Tax Court decides when a taxpayer gets the 150-day period rather than the usual 90-day period to petition for review of an NOD.  In my mind, it’s a lesson in equity.  That could be very useful if and when taxpayers are able to start arguing for equitable tolling of the usual 90 day period.

Details below the fold.

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Lesson From The Tax Court: Cannot Use CDP To Contest Trust Fund Recovery Penalty

Unpaid employment taxes are a substantial problem for both the government and taxpayers. From the government’s perspective this Treasury website tells us that “employment tax violations represented more than $91 billion of the gross Tax Gap and, after collection efforts, $79 billion of the net Tax Gap in this country.”

From the taxpayer’s perspective, dealing with payroll taxes is a real pain.  It’s all too easy to get the tax accounting and quarterly reporting misaligned with the IRS, and resolving those disputes takes time and energy.  Especially when the IRS believes taxes are not being paid, the IRS may start to look at assessing a personal liability against the owners and operators of the business under §6672, the Trust Fund Recovery Penalty (TFRP).

Today we learn that once the IRS assesses a TFRP liability against a taxpayer, that taxpayer will not be able to contest their liability during a later Collection Due Process (CDP) hearing.  In Mark P. Hafner v. Commissioner, T.C. Sum. Op. 2023-27 (Aug. 29, 2023) (Judge Weiler), the taxpayer got hit with a proposed TFRP penalty and contested it in the Office of Appeals.  He lost and the TFRP was assessed against him.  In a later CDP hearing the taxpayer again tried to contest his liability, but both the Office of Appeals and the Tax Court refused to even hear his arguments.  He was not able to use CDP to get pre-payment judicial review of his liability.  Details below the fold.

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Lesson From The Tax Court: Tax Protesting—A Hobby That Eats

Everyone should have a hobby.  Generally, hobbies are good for you, as this Utah State University Mental Health Education post explains.  But some hobbies become cancerous, becoming all-consuming.  Those hobbies are not good for you.  As Benjamin Franklin reportedly put it: beware the hobby that eats.

Protesting your taxes is a hobby that eats.  Bob Wood once wrote this great blog post about stupid tax protest arguments. The legal term for “stupid” is, of course, “frivolous.” Bob rightly says it’s one of the worst names you can be called in the tax world.  I really love his line: “In IRS lingo, it’s about as bad as you can get, just shy of the other “f” word, fraudulent.”

That is why I call tax protestors “hobbyists.”  They simply advance stupid reasons for not paying taxes, to the point where their hobby consumes them and others, at great cost.  That’s the lesson we learn in  Lawrence James Saccato v. Commissioner, T.C. Memo. 2023-96 (July 25, 2023) (Judge Lauber), where the taxpayer failed to file returns for some 14 years.  When caught, he persisted in protesting that he was exempt from income tax because, among other stupid reasons, he was “ a citizen of the State of Oregon” and not a “federal citizen.”  The Court’s reaction was to impose a §6673 penalty on top of a deficiency topping $200k.  His hobby was eating him up.

The sad details are below the fold.  

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Lesson From The Tax Court: Tax Consequence For Discharge Of Non-Recourse Debt

One of the hard concepts to teach students is the different tax treatments for recourse loans and non-recourse loans.  It gets especially confusing when the sale of underwater property includes a Discharge of Indebtedness (DOI) as part of the sale.  In Michael G. Parker and Julie A. Parker v. Commissioner, T.C. Memo. 2023-104 (Aug. 10, 2023) (Judge Nega), we learn that discharge of non-recourse debt as a result of a property sale cannot generate DOI income (and thus cannot qualify for exclusion under §108) but must instead be used in calculating gain from the sale.

In today’s case the taxpayer’s S Corporation sold some underwater property and the deal included a discharge of part of the unpaid debt.  They argued that they were insolvent at the time of the deal and thus attempted to exclude the DOI from income under the insolvency exclusion allowed by §108(a)(1)(B).  But because the cancelled debt was non-recourse, the taxpayers could not use §108.  Instead, the amount discharged had to be included in the calculation of gain and thus §108 could not apply.  It’s a basic, yet complex, lesson.  Details below the fold.

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Lesson From The Tax Court: Gotta Get Physical For Casualty Loss Deduction

Individuals generally cannot deduct casualty losses, at least through the end of 2025.  §165(h)(5). But Congress continues to permit individual taxpayers to deduct casualty losses if they are attributable to a federally declared disaster. Id. 

And we are having more and more disasters.  Call it climate change, call it a banana, the brutal fact is that “the number of natural disasters per year has increased significantly in recent years.” That quote is from this June 2023 Forbes Advisor article, which goes in to great detail explaining that conclusion.  And there has been a corresponding increase in FEMA disaster declarations over time as well.  See Congressional Research Services “Stafford Act Declarations 1953-2016: Trends, Analyses, and Implications for Congress,” (Aug. 28, 2017). 

So today’s lesson is still useful even if Congress never restores the general casualty loss deduction.  In Thomas K. Richey and Maureen P. Cleary v. Commissioner, T.C. Memo. 2023-43 (Mar. 28, 2023) (Judge Holmes), we learn the basic, but vital, lesson that that a taxpayer must prove that some identifiable event caused actual physical damage to their property.  Just because there is a storm and you then spend money on your property does not prove the storm caused damage to your property.  In today’s case the taxpayers reported casualty losses of some $820,000 for damages to their vacation home and boat.  But they were unable to prove the claimed losses arose from a casualty event.  Details below the fold.

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Lesson From The Tax Court: An Object Lesson On Adequate Business Records

[Author’s Note: this past week I joined the 77.5% of Americans who been infected with COVID.  So tired .... zzzzz ** what?  So this week’s lesson may reflect my COVID-fogged brain.  If you find more errors than usual, I humbly apologize and promise to do better next week.]

Some of my Lessons From Tax Court address substantive tax rules.  Some are about practice and procedure.  Today we have an object lesson: when a taxpayer has a bona fide business but fails to keep adequate records of their business activity, bad things happen.

We all know that taxpayer’s need good records to substantiate claimed deductions. See e.g. Lesson From The Tax Court: Receipts Are Not Enough, TaxProf Blog (Sept. 21, 2020).

This week we also learn that: (1) the failure to keep records allows the IRS to use the bank deposits method to determine income and (2) the same failure also gives the IRS a slam-dunk basis to impose §6662(a) accuracy-related penalties.

The case is Greg A. Ninke and Jane M. Ninke v. Commissioner, T.C. Memo. 2023-88 (July 19, 2023) (Judge Halpern).  Again, nothing really new here.  But it's a useful object lesson. Details below the fold.

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Lesson From The Tax Court: Size Does Not Matter

In Janet R. Braen et al. v. Commissioner, T.C. Memo. 2023-85 (July 11, 2023) (Judge Urda), we learn that there is no charitable deduction for a bargain sale done to settle a lawsuit, even though it was a huge bargain sale.  There, the taxpayers claimed a $5.2 million charitable contribution deduction from a bargain sale they had made with a New York town called Ramapo.  Judge Urda needs every one of 39 pages to explain the complex facts and apply them.  But the basic Lesson I see in the case is this: even a big bargain sale to a charity requires donative intent.  Without a donative intent, there is no §170 deduction, no matter how big the bargain.  Intent is determined by objective facts surrounding the transaction.  Here, those facts showed that the taxpayers’ intent was not to be charitable; their intent was to settle a lawsuit they had filed against the town.  By settling they avoided the risk of a more adverse outcome had the lawsuit proceeded, and they regained their right to develop the land they did not sell.  I confess this is not quite the way Judge Urda sees the case.  So see what you think.  Details below the fold. 

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Lesson From The Tax Court: Creating Your Best Administrative Record

When the Tax Court reviews an IRS Collection Due Process (CDP) decision about collection, it always uses an abuse of discretion standard of review.  That is, it does not simply substitute its judgment for that of the Office of Appeals Settlement Officer (SO), but instead looks to see whether the SO committed an error of law or made a decision that was whacko.

However, in conducting its abuse-of-discretion review, the Tax Court does not always use the same information set.  It depends on where the taxpayer would take an appeal.  If the taxpayer would take an appeal to the 1st, 8th, or 9th Circuits, the Tax Court will base its review solely on the administrative record provided by the IRS.  No new information will be allowed.  However, for appeals to any other Circuit, the Tax Court will also consider any additional information the parties bring up at trial.

Today’s case involves the administrative record review and teaches us what the practitioner can do during the CDP hearing to maximize chances in Tax Court if a petition becomes necessary.  In Duane Whittaker and Candace Whittaker v. Commissioner, T.C. Memo. 2023-59 (May 15, 2023) (Judge Holmes), the taxpayers used their 2019 CDP hearing to submit an OIC.  They not only provided detailed information but they also offered to provide additional substantiation if asked.  Then COVID happened.  In 2020 the taxpayers sent in additional information to show how their financial situation had deteriorated.  Again, they offered to substantiate their claims if asked.  They were not asked.  That turned out to be key because it resulted in information gaps which, if filled, might have led the SO to a different conclusion.

It was these gaps in the administrative record that caused the Tax Court to find an abuse of discretion and remand the case back to Appeals to fill in the gaps.  The Tax Court faulted the IRS for the gaps because the IRS had not asked for more information.  Details below the fold.

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Lesson From The Tax Court: Freedom, Taxes, And Hobbies

We have great freedoms in this country.  Freedom to express ourselves.  Freedom to fish.  Freedom to write blog posts.  Freedom to pursue any lawful activity to make money.  Truly ours is a great civilization well worth tomorrow's celebration.

But.

To riff on a well worn aphorism: with great freedom comes great responsibility.  In particular, as the Sainted Justice Holmes told us: “Taxes are what we pay for civilized society.... The constitutional right...to earn one's livelihood by any lawful calling certainly is consistent, as we all know, with the calling being taxed.” Compania General de Tabacos v. Collectorv, 275 U.S. 87, 100 (1927).

Three recent cases on Hobby Loss rules teach us about the responsibility of paying taxes to support our freedoms: you cannot lower your taxes by deducting the costs of your personal hobby.  The basic lesson is the importance of record-keeping.  That means more than keeping proper records.  It means properly using the records in a business-like manner.  In contrast, having “meticulous” records may just rescue a taxpayer who erroneously mashes up their hobby with a legitimate business activity on the same Schedule.

Two of the three cases present garden variety fact patterns where taxpayers attempt to disguise personal expenditures as business expenses.  In Donald E. Swanson v. Commissioner, T.C. Memo. 2023-81 (June 29, 2023) (Judge Pugh), the taxpayer was an emergency room doctor and amateur musician who created a vanity website for his music.  In Joseph William Sherman v. Commissionerv, T.C. Memo. 2023-63 (May 17, 2023) (Judge Jones), the retired taxpayer was an avid fisherman who also sometimes hired himself out as a guide, generating some hobby income to reduce his hobby expenses.

The third case is twisty.  In Leslyn Jo Carson & Craig Carson v. Commissioner, Dkt. No. 23086-21S (May 18, 2023) (Judge Morrison), the taxpayers mashed up a hobby activity (kids doing rodeos) with a business activity (ranching).  What triggered the audit was that the ranch was owned by the taxpayer’ wife's mom and they had an agreement that all ranching income would be allocated to Mom and all ranching expenses would be paid for and deducted by the taxpayers.  So the taxpayers essentially reported massive ranching expenses against modest hobby income.  However, these taxpayers' great recordkeeping overcame their poor reporting, winning a no-harm-no-foul ruling from the Tax Court. 

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Lesson From The Tax Court: How To Calculate Insolvency For The §108 Exclusion

While not as certain as death and taxes, small businesses failures are highly probable events.  This webpage from the Bureau of Labor Statistics goes into the gnarly. 

When a small business fails, that often means it cannot repay loans.  A lender will often write off the loan as a bad debt, discharging the borrower from the obligation to repay.  That discharge is taxable income to the borrower, unless they qualify for an exclusion.  Today’s lesson involves the insolvency exclusion in §108(a).  To qualify for that, one has to be (duh) insolvent!  Insolvency is tested at the time of the discharge.  Section 108(d)(3) defines insolvency as "the excess of liabilities over the fair market value of assets."  But nothing in the statutes or regulations defines the term "liabilities."

Katrina E. White v. Commissioner, T.C. Memo. 2023-77 (June 21, 2023) (Judge Paris), teaches a lesson about what types of obligations count as liabilities in determining insolvency for §108(a) purposes.  We learn that a liability which is legally enforceable, and due and owing at the time of the discharge, counts even if the lender takes no action to actually collect or enforce the debt.  Details below the fold.

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Lesson From The Tax Court: The Administrative Record Rule In Whistleblower Cases

Law is a slow-moving conversation.  I tell my students that one law year is seven human years, kinda like one human year is seven dog years.  So it was only a couple of years ago, in 2006, that Congress created the current whistleblower award program in the Tax Reform and Health Care Act of 2006, 120 Stat. 2922, 2959.  The provisions are codified in §7623.  Since then, the Tax Court has been in a slow-moving conversation with the D.C. Circuit and Treasury to develop the law.

Today we see how the Tax Court engages with Treasury regulations to apply something called the administrative record rule to the specifics of the IRS whistleblower program.  In Jeremy Berenblatt v. Commissioner, 160 T.C. No. 14, (May 24, 2023) (Judge Copeland), the unhappy whistleblower wanted the Tax Court to force the IRS to disclose information that the IRS said was outside the administrative record.  Judge Copeland’s excellent and nuanced opinion explains what constitutes the administrative record and the limited circumstances where a litigant can make the IRS add to the administrative record.  It’s complicated.  But we can find at least two lessons worth noting.  First, the IRS enjoys a very strong presumption that what it provides as the administrative record is complete.  Second, the Treasury regulations defining what constitutes the administrative record also enjoy a strong presumption of completeness.  Even a litigant as well represented as Mr. Berenblatt could not overcome those presumptions.  That is because a litigant must show more than some set of documents were available to the IRS; they must show that the documents or materials were considered, either directly or indirectly by the IRS office making the decision.  Details below the fold.

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Lesson From The Tax Court: The IRS's Substantial Justification Defense To §7430 Fee Awards

Getting an award under §7430 is hard, even if the taxpayer totally wins.  The major stumbling block is a statutory escape hatch called substantial justification.  If the IRS’ shows that its position was substantially justified at the relevant time, the taxpayer is not entitled to fees and costs even if the taxpayer wins on the merits.  But the relevant time may be different depending on whether the taxpayer is seeking recovery of administrative costs or litigation costs.  In Josefa Castillo v. Commissioner, 160 T.C. No. 15 (June 5, 2023) (Judge Kerrigan), we learn that the IRS must be able to show substantial justification at two different points in the process.  There, the Court found the IRS was substantially justified at the litigation stage.  But the IRS may not have been substantially justified at the administrative stage.  That may be why the IRS conceded a §7430 award as to administrative costs, even while successfully resisting an award of litigation costs.  The ultimate result reflects well on the taxpayer’s representative, Professor Elizabeth A. Maresca and her team at the Fordham Low Income Taxpayer Clinic.

This case involves the time period in §6330(d)(1) for taxpayers to seek Tax Court review of an adverse Collection Due Process (CDP) decision.  For decades the IRS and Tax Court believed that 30-day period was a jurisdictional requirement.  The Tax Court simply did not have the power to hear a late-filed petition.  The Supreme Court, however, held otherwise in Boechler v. Commissioner, 596 U.S. ___ (2022).  Today’s lesson concerns the consequences of the Boechler decision on the recovery of costs and attorneys fees under §7430.  It’s a surprisingly nuanced lesson.

Alert readers should note that this is a potentially important lesson for deficiency petitions.  That is because the IRS and Tax Court have a similar long-standing belief that the 90-day period in §6213 for NOD petitions is jurisdictional.  And that position, too, may be soon be rejected, at least by the Third Circuit.  The case to watch for is Culp v. Commissioner.  In this recent oral argument before the Third Circuit, the taxpayer was fortunate to have the terrific advocacy skills of Oliver Roberts and Professor Keith Fogg.  While one never knows until the opinion issues, one gets a sense that the Circuit Court panel was quite sympathetic to the argument that §6213 is not jurisdictional.  The panel even went to the extraordinary length of asking Professor Fogg to give additional oral argument!  For more on the Culp case, see Carl Smith’s post here over at Procedurally Taxing.  But for the lesson on how substantial justification works, the details are below the fold.

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Lesson From The Tax Court: Substantiating Gambling Losses On Per-Casino Basis

The old saying “you win some, you lose some” is not true for most recreational gamblers.  For them, the saying is more like “you win some, you lose more.”  But proving that proves a problem.  In Jacob Bright v. Commissioner, Docket No. 10095-22 (May 4, 2023), Judge Buch teaches us how taxpayers can use their player cards to substantiate their wagering losses.  There, Mr. Bright reported some $241,000 of wagering gains on his 2019 return, and an equal amount of losses.  However, he apparently did not follow best practices—as very nicely explained in this article—of keeping daily contemporaneous records.  When audited, the IRS accepted his self-reported income (natch!) but disallowed all the losses for lack of substantiation (double natch!).

In Tax Court, Judge Buch allowed Mr. Bright to introduce reports of his player card activity, from each of the three Casinos he gambled at in 2019.  That created a sufficient basis for the Court to use the Cohan rule, albeit differently for each Casino.  The Court used this method to estimate $191,000 of losses.  In taking this approach for calculating wagering losses, Judge Buch gives us a new idea of “per session” netting worth considering, not only for proving up wagering losses, but also for calculating wagering gains.  I would call it a “per establishment” approach.  It makes a good bit of sense.  Details below the fold.

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Lesson From The Tax Court: On Time Is Late

In law, even more than in comedy, timing can be critical.  In comedy you just lose a laugh.  In law, you lose a case.  In Roy A. Nutt and Bonnie W. Nutt v. Commissioner, 160 T.C. No. 10 (May 2, 2023) (Judge Buch), we learn why a petition seemingly submitted on time will be rejected as late.  There, the Nutts electronically submitted their Petition to the Tax Court on the last day they could file.  Now we all know you really don't want to ever do that.  But sometimes it just happens.  And the last day to file is just as timely as the first day to file.  The Nutts submitted their Petition at 11:05 p.m.  So they seemed to be on time.

The problem was that they were filing from Alabama (Central Time) and the Tax Court’s Clerk’s office is in Washington D.C. (Eastern Time).  Thus, even though they submitted on time, Judge Buch holds that their Petition was filed late, because 11:05 p.m. in Alabama was five minutes after midnight in Washington D.C.  Thus, sticking to its increasingly archaic view that the timing rules for filing a Petition are jurisdictional, the Tax Court dismissed the Petition.

Note this is another precedential opinion issued in a case with unrepresented taxpayers.  Here, the IRS moved to dismiss and briefed the issue, but there was no responding brief to counter the government’s view.  These pro-se taxpayers probably did not know about all the Tax Court precedent applying equitable principles to rescue seemingly late-filed petitions.  I give a close review of those cases in Bryan Camp, Equitable Doctrines and Jurisdictional Time Periods, Part 2, 159 Tax Notes 1581 (June 11, 2018).

To his great credit, Judge Buch has, in a similar case, asked for amicus briefs on the issue.  I hope the Tax Court there comes to a different conclusion.  It’s always a balancing act: weighing the need for taxpayer access to judicial review with the need to obey statutory limits. Perhaps the Tax Court might reconsider how that balance should work for electronically filed documents.  However, as Professor Book puts it in this post over at Procedurally Taxing, after this case taxpayers now have a steeper hill to climb. You will find the sad details below the fold, along with my modest thoughts on how to strike a better balance. 

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Lesson From The Tax Court: Allocating Between Excludable Child Support and Includable Interest

As inflation rises so does interest in interest.  Certainly when my 1-year CD matures next month I will be looking for a rate better than the 2% rate that seemed so great last year!  If I get a 4.5% I will be happy ... but who knows what my dollars will be worth next year?

And that’s how we typically think of interest: it’s all about inflation, the old idea that “dollars tomorrow will be worth less than dollars today.”  But the concept of “interest” is a bit more nuanced than just being compensation for the diminished value of dollars in the future.  It is also a compensation for risk: the risk that the money will not in fact be repaid—think junk bonds.  And interest also compensates for opportunity costs: a lender is giving up the ability to use (consume or invest) that money now.  In short, interest is compensation for multiple consequences of the use or forbearance of money, similar to how rent is compensation for several different sticks of property rights given up by the lessor.

It is for these reasons that interest has always been taxed as a separate item of income, separate and apart from the underlying loan or deferred payment.  We see that lesson again today in Susan D. Rodgers v. Commissioner, T.C. Memo. 2023-56 (May 9, 2023) (Judge Gale), where the taxpayer received periodic payments from the State of Alabama in 2015 that it had collected from her ex-spouse to satisfy a court judgment for child support arrearages, plus interest.  She treated all the payments as excludable child support despite receiving a 1099-INT from Alabama that treated all the payments as interest on the arrearages.

Thus this case also presents a lesson in allocation.  How should a taxpayer decide how much of a given payment represents taxable interest or non-taxable child support?  And on that issue, dear readers, I think the Tax Court may have been misled by the State of Alabama into ignoring federal law to find that all of each payment was interest.  Details below the fold.

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Lesson From The Tax Court: Exclusion Rules For Disability Payments

A tax break is just another way of saying “government subsidy.”  Most folks do not even think about that when they get a medical bill.  They are generally just upset about the size of the co-pay!  But Congress subsidizes medical care by allowing taxpayers to exclude from income everything the health insurance plans pay the medical providers above the co-pay.

The scope of that subsidy, however, depends on who pays for the insurance in the first place.  If the taxpayer pays for the insurance, the exclusion is governed by §104(a)(3).  That provision does not just exclude payments for actual medical services.  It excludes any and all amounts paid on account of physical injury or sickness.  In contrast, if the taxpayer’s employer pays for the insurance, then the exclusion is governed by §105(b) and that is a more restrictive exclusion.  The §105 exclusion is limited to actual reimbursements (or payments) for identified medical care.

The differences between the §104(a)(3) exclusion and the §105(b) exclusion are most apparent when a taxpayer receives disability payments, as we learn in Cynthia L. Hailstone and John Linford v. Commissioner, T.C. Summ. Op. 2023-17 (Apr. 24, 2023) (Judge Leyden).  There, the taxpayer received disability payments and attempted to exclude those from income.  That might have worked under §104(a)(3) if the taxpayers had paid for the insurance, but since the payments at issue came from an employer-paid plan, the exclusion was not permitted, per §105(b).  Details below the fold.

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Lesson From The Tax Court: Better Deals With Appeals

One recurring lesson I teach in Tax Practice and Procedure is that you generally serve your client better by resolving their issues at the lowest level.  That requires helping them be realistic in understanding the range of potential outcomes.  It requires an understanding that IRS offices, such as the Office of Appeals, generally have more discretion than does the Tax Court to resolve problems.  It also requires understanding that when the Tax Court reviews an IRS discretionary action, it will only change that action when it is convinced the IRS decision was bonkers or, in the dry technical terms of the law, the decision was an “abuse of discretion.”  And, no, the Tax Court will not make a taxpayer’s argument for them, as we recently learned in Lesson From The Tax Court: The Tax Court Is Not Your Advocate, TaxProf Blog (Feb. 6, 2023).

Today I present a case where pro se taxpayers learned that lesson the hard way.  In Ronald Powell and Cynthia Powell, T.C. Memo. 2023-48 (Apr. 17, 2023) (Judge Lauber), the taxpayers did not like the Installment Agreement offered them by Appeals.  They thought they could do better in Tax Court.  They thought wrong.  Details below the fold.

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Lesson From The Tax Court: Prepare Once, File Twice

Most of us don’t think about what it means to file our tax return.  We may rely on software or a hired return preparer to transmit our return to the IRS. The returns are either snail-mailed to the applicable Service Center, or they are e-filed to that amorphous “cloud.”  We know it is important to file our returns in order to trigger the 3-year limitation period for assessment in §6501(a).  But once we send them in, we’re done.

But most of us do not claim to live in the U.S. Virgin Islands (USVI).  Taxpayers who do may need to file twice, as we learn in David W. Tice v. Commissioner, 160 T.C. No. 8 (Apr. 10, 2023) (Judge Pugh). a reviewed Tax Court opinion.  In holding that the taxpayer was obligated to file his returns with both the USVI and the IRS, the opinion reverses the Court’s prior approach, which we learned about in Lesson From The Tax Court: Forms Follow Function In Return Filing, TaxProf Blog (Jan. 5, 2018).  Previously, the Court had focused on the passive voice of §6501(a) to decide that filing only once with USVI triggered the three year limitation period when the USVI sent a couple of pages of the return to the IRS.  Today’s opinion reads the active voice of §932(a)(2) as imposing a more robust obligation.  Intervening Treasury Regulations might comfort those who believe they only need file once.  However, more cautious advisors may still want to prepare once and file twice.  See what you think.  Details below the fold.

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Lesson From The Tax Court: The Actual Payment Doctrine

Today is a lesson in timing.  When I teach timing I emphasize to my students that they must analyze income items separately from deduction items.  Today is an example of how the analysis applicable to inclusion can be different from the analysis applicable to deductions.

As to income, we all know about the constructive receipt doctrine.  Even if a taxpayer has not actually received some slug of money, they are deemed to have constructively received it if the money was made available to them in the year and there was no legal restriction on their accessing it.

Today’s lesson teaches that the deduction analysis is different.  To take a deduction the taxpayer must make an actual payment.  There is no such thing as constructive payment.  In Edwin L. Gage and Elain R. Gage v. Commissioner, T.C. Memo. 2023-47 (Apr. 12, 2023) (Judge Holmes), the taxpayers purchased a cashier’s check in December 2012 to settle a lawsuit and gave it to their attorney.  They took a 162 deduction for 2012, even though their attorney did not deliver the cashier's check to to the opposing party until March 2013.  In holding that they could not deduct that payment in 2012, Judge Holmes explains why their commitment to pay and their actual purchase of a cashier’s check did not amount to making an actual payment in 2012.  Details below the fold.

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Lesson From The Tax Court: It Takes More Than Putting In The Hours To Avoid §469 Restrictions

Tax Day approaches.  I know many folks are putting in the hours on preparing tax returns this week ... or else putting in the minutes filing Form 4868.  But we all know—especially when unhappy clients come to us to fix a return messed up by some whack-a-doodle preparer—just putting in hours in filing tax returns does not make one a tax professional.

In Robert L. Drocella and Pamela M. Drocella v. Commissioner, T.C. Summ. Op. 2023-12 (Apr. 3, 2023), Judge Leyden teaches us, and our clients, that simply putting in the hours working on one’s rentals does not make one a real estate professional for §469 purposes.  There the hard-working taxpayers were not allowed to escape §469’s prohibition on taking passive activity losses against active income even though they together put in over 1,500 hours in working their six rental properties.  We learn today there are two other tests to being a real estate professional and these taxpayers failed one of them:  they were unable to show the Court the how the hours they worked their rentals related to the hours they spent earning wages.  Details below the fold.

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Lesson From The Tax Court: Attend Carefully To Your Entity Baskets

Easter approaches.  On that day our church grounds will be overrun with children scampering to collect eggs into the various baskets, bags, and other containers they bring (or we give them if they need).  They do not have to worry about what kind of container they use to collect their eggs.  The candy will taste just as sweet.

You can think of business entities as being like Easter baskets.  They are containers taxpayers use to collect their income.  But unlike the happy children, taxpayers must take care in their choice of container.  That choice can affect the amount of income collected.  And it can leave a sour taste when the basket chosen is not the proper form.  In today’s Lesson, we learn how a taxpayer’s choice of business containers affects their ability to take deductions, and even affects their ability to litigate in Tax Court.

In Greatest Common Factor v. Commissioner, T.C. Memo. 2023-39 (Mar. 23, 2023) (Judge Kerrigan), the individual taxpayer chose to collect income through a C corporation and that choice affected the deductibility of the individual’s home office expenses.  In Techtron Holding, Inc. v. Commissioner, T.C. Memo 2023-29 (Mar. 9, 2023) (Judge Vasquez), the individual taxpayers collected income through ever-changing, multiple baskets of various kinds of business entities.  When the IRS audited and found deficiencies in one of the entities, the Tax Court decided it had no jurisdiction over that entity’s petition because the entity no longer existed at the time the petition was filed.  Details below the fold.

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Lesson From The Tax Court: The Whistleblower Who Blew Too Hard

Section 7623(b)(1) says that the IRS must reward whistleblowers when the information they provide causes the IRS to start “any administrative or judicial action” to collect unreported or unpaid taxes.  In such cases, whistleblowers can get an award of up to 30% of the proceeds actually collected from such actions.  Id.  So what happens if the whistleblower's information does not lead to an administrative or judicial action against the particular taxpayer fingered by the whistleblower, but instead prompts the IRS to create a general administrative program to target taxpayers like the one fingered by the whistleblower?

That was the claim in Thomas Shands v. Commissioner, 160 T.C. No. 5 (Mar. 8, 2023) (Judge Greaves).  There, the whistleblower claimed entitlement to 30% of some $1 billion collected from the IRS’s second Offshore Voluntary Disclosure Initiative (OVDI) in 2011.  His theory was that his blowing the whistle on one particularly influential tax evader prompted both the creation of the second OVDI and a rush by taxpayers to voluntarily disclose under the program.

The Tax Court ruled that Mr. Shands’ claim was overblown (pun totally intended).  Both the statute and implementing regulations make it clear that the relevant “administrative or judicial action” is one against particular identified taxpayers.  The creation of a general administrative program such as OVDI was not the kind of action that triggered a mandatory award.  Therefore, under the newly restricted reading of its authority to review whistleblower petitions, the Tax Court held that it lacked jurisdiction to review whether his information really did or did not contribute to OVDI.  The IRS simply had not started a requisite administrative or judicial action.  Details below the fold.

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Lesson From The Tax Court: Another Reason To Keep Good Records

Last week’s Lesson looked at the inherent unreliability of third-party information returns.  Taxpayers need to keep good records to refute those errors.  This week’s Lesson continues that theme: keeping good records can help avoid a bank deposits analysis.  When the IRS is forced to reconstruct income using the bank deposits method, it puts taxpayers in the hard place of having to prove why every bank deposit should not be counted as gross income for that year.

A pair of opinions issued by Judge Buch on the same day gives us a lesson on the unhappy consequences to taxpayers when their poor record-keeping leads the IRS to use a bank deposits method to reconstruct income.  In both Kevin B. Cheam and Julie Lim v. Commissioner, T.C. Memo. 2023-23 (Feb. 27, 2023), and Lundy Nath and Tanya Nath, T.C. Memo. 2023-22 (Feb. 27, 2023), the taxpayers’ failure to keep adequate books and records forced the IRS to conduct a bank deposits analysis, thus putting the burden on the taxpayers to show which bank deposits represented something other than gross income.  In neither case could the taxpayers show the Court nontaxable sources of income for the deposits the IRS asserted were unreported income.  And their record-keeping failures also hurt them in the usual way on the deduction side as well.  Details below the fold.

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Lesson From The Tax Court: The Inherent Unreliability Of Third-Party Reporting

Third-party reporting has long been crucial to tax administration.  Empirically, it helps taxpayers comply with their reporting duties.  Congress first starting requiring information returns in 1917 and keeps expanding the concept to reach new economic situations, such as the rise of the gig economy and on-line marketplaces.

But third-party information returns are inherently unreliable because they report payments, not income.  That is the lesson we learn in Tanisha Trice v. Commissioner, T.C. Memo. 2023-15 (Feb. 13, 2023) (Judge Gustafson).  In this case we learn the lesson with respect to Social Security Disability reporting.  There, the Form SSA-1099 reported payments to Ms. Trice of $15,365.  Judge Gustafson explains why that alone was not enough to support the Notice of Deficiency as to the payments that Ms. Trice denied receiving.  As to those, the IRS was required to produce additional evidence under §6201(d) because Ms. Trice had reasonably objected to that amount and had fully cooperated with the IRS.  Details below the fold.

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Lesson From The Tax Court: Fill Out The Damn Form

The fuss has focused on FBARs.  The FBAR requirements and penalty provisions have been hotly litigated.  Recently the Supreme Court issued an opinion in Bittner v. U.S., deciding that the penalties were not as harsh as the government thought they should be.

But forget FBAR.  Today’s lesson is about a different, yet equally important, foreign account reporting requirement: the one found in 26 U.S.C. §6048 that relates to foreign trusts.  The FBAR stuff is over in 31 U.S.C. §5314.  Completely different title.

And today’s lesson is not about penalties.  It’s about the assessment limitations period.  In Leigh C. Fairbank and Barbara J. Fairbank v. Commissioner, T.C. Memo. 2023-19 (Feb. 23, 2023) (Judge Weiler), we learn that a failure to comply with the §6048 reporting requirement by never filing the proper form---not even during audit---extends the time in which the IRS can assess really old tax deficiencies.  How old?  Try 15 years old.  Regardless of the outcome in Bittner, folks need to learn this lesson!  Details below the fold.

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Lesson From The Tax Court: The New Evidence Rule In Spousal Relief Cases

When a taxpayer requests spousal relief under §6015, the IRS must decide whether to grant it.  If the IRS denies relief, the taxpayer can petition the Tax Court. §6015(e).  In 2019 Congress created a modified administrative record rule for how the Tax Court is supposed to conduct that review.  Taxpayer First Act, 133 Stat. 981, 988.

It’s awkward.  Congress tells the Court to review the IRS decision de novo but, at the same time, tells the Court to do that using only a limited information set consisting of (a) “the administrative record established at the time of the determination” and (b) “any additional newly discovered or previously unavailable evidence.”  §6015(e)(7).

Sydney Ann Chaney Thomas v. Commissioner, 160 T.C. No. 4 (Feb. 13, 2023) (Judge Toro), is a reviewed opinion where a unanimous Tax Court interprets the phrase “newly discovered or previously unavailable evidence” broadly rather than narrowly, thus creating a new evidence rule (pun intended) that robustly protecting its ability to conduct the required de novo review.  Ironically, the decision worked against the taxpayer in this case because it was the IRS that here wanted to introduce new information (the taxpayer’s social media posts).  The taxpayer objected that those posts had been publicly available during the administrative proceeding; therefore they were not newly discovered or previously unavailable.  The Court rejected that argument and admitted the posts as evidence.

Today’s case is also an illustrative contrast to the T.C. opinion I discussed in last week’s post.  That was a case where the taxpayer was proceeding pro se.  And there the Court had no benefit of briefing from both sides.  I think the Court’s opinion showed it.  In today’s case, the taxpayer was (eventually) represented by one of the best tax attorneys I know, Megan Brackney.  Thus the Court had the benefit of a well-presented taxpayer argument.  The Court also had the benefit of a strong amicus brief submitted jointly by the Center for Taxpayer Rights, the Community Tax Law Project, the UC-SF LITC and the Villanova LITC.  That made the Tax Court’s opinion all the more robust, which is what it will need if and when its decision is reviewed in turn by a Court of Appeals.

Spoiler alert.  This post is a little longer than normal.  Sorry, Lew.

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Lesson From The Tax Court: The Limited Review Of Passport Revocation Certifications

Today’s lesson is about §7345, created by Congress in 2015.  The idea behind §7345 is simple.  If you owe taxes and the government threatens to take your passport, you are more likely to pay up.  But its operation is complex.  It requires the IRS to first certify to the State Department that a taxpayer has a “seriously delinquent tax debt.”  Then the State Department is authorized to take certain actions based on that certification.  Section 7345 permits taxpayers to seek Tax Court Review of IRS Certifications.

The Tax Court does not get many passport cases.  According to the Court’s FY 2024 Budget Request, of the 29,000 petitions filed in 2022, only 25 were §7345 petitions.  For those who are interested in learning more about the Court’s budget request, Keith Fogg posted this great review over on Procedurally Taxing.

So when the Tax Court gets a passport case, it often uses it to shape its §7345 jurisprudence by issuing precedential Tax Court opinions.  Today’s case is one of those. Blake M. Adams v. Commissioner, 160 T.C. No. 1 (Jan. 24, 2023) (Judge Toro), teaches two lessons.  First, the Court holds that it will not look behind the IRS certification to redetermine the merits of the tax liabilities that make up the certification.  Second, the Court also decides it lacks authority to determine whether the assessment underlying the Certification was procedurally defective.

Note that this is a case where the taxpayer was unrepresented.  While the Court’s desire to settle important §7345 issues is understandable, I question whether doing so in a pro-se case is desirable. Next week we will see a case where the Court wrote a much stronger opinion after first suggesting that the pro se taxpayer find counsel (who then filed briefed the issue) and also accepting an amicus brief. I offer my thoughts on this below the fold.

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Lesson From The Tax Court: The Tax Court Is Not Your Advocate

Today I present two lessons.  First, we learn why diabetes is not a per se disability sufficient to avoid penalties for early 401(k) distributions.  Second, we learn that pro se litigants cannot rely on the Tax Court to consider potential arguments they could have raised, but did not.

Diabetes is a well-known and widespread disease, afflicting some 37.3 million people in the U.S., according to the CDC’s 2022 National Diabetes Statistics Report.  That’s just over 11% of the US population.  Medical complications abound, as detailed in this report from the Diabetes Institute Research Foundation.

Managing diabetes and its attendant complications can be difficult and expensive.  In recognition of that, Canada gives this tax credit to Canadians who must manage the disease.  And in the U.S., many of the costs associated with diabetes qualify for the medical expense deduction under §213.  See e.g. IRS Publication 502 (2021) at p. 7 (explaining that cost of blood sugar test kit for diabetes is a qualifying medical expense).

In Robert B. Lucas v. Commissioner, T.C. Memo. 2023-9 (Jan. 17, 2023) (Judge Urda), the unemployed taxpayer took an early distribution from his 401(k) plan to help make ends meet, which included helping to manage his diabetes.  The issue was whether he had to pay the §72(t) 10% penalty for early distributions.  He could avoid the entire penalty if his diabetes qualified as a disability, and he could avoid some of it if the distribution was used for expenses allowable as a §213 deduction.  As to the first, Judge Urda teaches us why diabetes is not, in and of itself, a disability sufficient to escape the 10% penalty.  As to the second, Judge Urda notes the issue but, because the taxpayer did not raise it, “[w]e accordingly deem the issue forfeited.”  Op. at 4.  In doing that, Judge Urda teaches an important lesson on the role of the Tax Court.

Details below the fold.

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Lesson From The Tax Court: Corporations In The Bardo

Lincoln in The Bardo is not a book for everyone.  It’s main characters (none of whom are Lincoln) are caught in the bardo, an indeterminate space between death and final after-life, whatever one conceives that to be.  But they are slow to realize it, clinging to a belief in their continued existence as they were.  Filled with unreliable narrators and casually vacillating in time and space, the novel is not an easy read.  But it is well worth the effort, being a lovely meditation on the meaning of life and the meaning of death.

XC Foundation v. Commissioner, T.C. Memo. 2023-2 (Jan. 5, 2023) (Judge Lauber), is an easy read about a corporation in the bardo.  It teaches a practical lesson: always ensure that your corporate client is fully alive and well under state law before you try to file a petition.  There, a corporation attempted to file a petition to contest an IRS decision to revoke its 501(c)(3) status.  Well, actually, the corporation did not file the petition.  It couldn’t.  It was caught in a kind of bardo, an indeterminate space between corporate life and permanent corporate death.  California, the state that had given it life, had suspended its charter, killing its capacity to sue and be sued.  But like the characters in the novel, it ignored its own death and tried to convince the Tax Court to do so as well.  It turns out that taxpayers in the bardo cannot file petitions that the Tax Court can hear, just as Lincoln could not hear the pleas of the novel's characters.  They are the pleas of ghosts.  Details below the fold.

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A Year Of Lessons From The Tax Court (2022)

Here is a chronological listing of all the Lessons From The Tax Court I posted in 2022, with links to the Lesson, the primary case discussed, and its author.  I have also listed the primary Code sections mentioned or discussed in the Lesson.  At the end of the chronological listing, you will find a table listing the posts by which Tax Court Judge authored the Court's opinion.

January 18: The Tacit Consent Rule, Om P. Soni and Anjali Soni v. Commissioner, T.C. Memo. 2021-137 (Dec. 1, 2021) (Judge Copeland) — §6013, §223, §51(b), §301(d), §6061(b), §6651, §6662

February 7: The Innocence Requirement In § 6015(c) Proportional Relief, Tara K. Tobin (Petitioner) and Jeffrey Tobin (Intervenor) v. Commissioner, T.C. Summ. Op. 2021-36 (Nov. 16, 2021) (Judge Guy) — §6015(c) 

February 14: The Proper Baseline For Offers In Compromise, Edmund Gerald Flynn v. Commissioner, T.C. Memo. 2022-5 (Feb. 3, 2022) (Judge Urda) — §7122

February 22: The Tax Liabilities You Leave Behind, Estate of Anthony K. Washington v. Commissioner, T.C. Memo. 2022-4 (Feb. 2, 2022) (Judge Toro) — §6323

 

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Lesson From The Tax Court: Taxpayers Behaving Badly 2022

This will be my last new post until January. Next Monday, December 19, my annual Year Of Lessons From The Tax Court will appear in this space. It is a chronological listing of all the Lessons I posted in 2022, with links to each Lesson, the primary case discussed, and the judge who wrote the opinion. You can find last year's edition here.

I will be spending my days (except for Christmas Day) grading exams.  Grades are due Monday, January 2 and then I resume teaching on January 11, so you will not likely see my next Lesson From The Tax Court until January 23 (the week after the MLK holiday).

As is now customary, my last new 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), here (for 2019), here (for 2020), and here (for 2021).  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.

And again this year I am giving out a Norm Peterson Award.  You will find more explanation below the fold.

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Lesson From The Tax Court: It’s Not Income If You Pay It Back In Time

We all know that taxpayers do not have to report loans as income.  But it's not clear why.  It has something to do with the obligation to repay.  It might be the obligation to repay burdens other assets so the loan does not represent an actual increase in wealth.  Or it might be the obligation to repay creates an open transaction that crosses tax years and, for good administrative reasons, we simply presume the loan amount will be repaid in full.  For more details, see Lesson From The Tax Court: The Phantom Of The Tax Code—Discharge Of Indebtedness, TaxProf Blog (Feb. 19, 2018).

But what about when a taxpayer simply receives a payment that is not a loan, but appears to be a payment the taxpayer has a right to keep?  When it later turns out to be erroneous, and the taxpayer repays it, was it even income to start with?  Today we learn that if repayment of an erroneous distribution occurs in the same tax year as the distribution, there is no income to report.  That was good news for the taxpayers in Elijah Servance and Corliss Severance v. Commissioner, T.C. Summ. Op. 2022-23 (Nov. 21, 2022) (Judge Copeland), who received disability payments from Hartford Life Insurance Co. that they repaid in the same year.  The IRS said the payments were income.  The Tax Court held for the taxpayers.  Sure, the taxpayer lost the other, bigger, issue in the case—the one that got the Tax Analyst Headline of “Couple Could Not Exclude Retirement Benefits From Income.”  But this smaller issue about their disability insurance payments gives us two great lessons: one in tax law and one in tax procedure.  Details below the fold.

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Lesson From The Tax Court: An Object Lesson For Tax Professionals

It is not always easy to follow the advice you give others. A common question I get is "how long should I keep my tax records?" My somewhat snarky reply is “as long as you need to.” The response is not entirely snarky because even though each tax year stands alone, events that occur in one year might have tax repercussions many, many years later.

In Betty Amos v. Commissioner, T.C. Memo. 2022-109 (Nov. 10, 2022) (Judge Urda), the taxpayer failed to keep records as long as she needed to is.  It is an object lesson for all of us. Ms. Amos was a highly successful tax practitioner, a CPA, who had decades of high-level business experience.  On her 2014 and 2015 returns she reported about $100,000 of IRA income against which she claimed over $4 million of net operating losses (NOLs) that dated back to 1999. While she could produce her 1999 tax returns showing the NOLs, she could not produce the underlying records substantiating what she had then reported, causing Judge Urda to write “It beggars belief that she would be unaware...[of] her responsibility to demonstrate her entitlement to the deductions she claimed.” Op. at 11.  Details below the fold. 

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Lesson From The Tax Court: The Impact Of De Novo Review In Spousal Relief Cases

I don't just inflict misery on tax students.  I also teach a class in Civil Procedure to first year law students.  One recurring lesson there concerns the different standards courts of appeals use when reviewing trial court decisions.  I want my students to learn to that the applicable standard of review matters.  It not only makes a huge difference in the outcome of the current case, but it also can make a huge difference in the precedential effect of that case on later cases.

We learn today how the different standards of review affect both outcomes and precedential value of old spousal relief cases.  We also learn how the Tax Court might be induced to finesse the bastardized administrative record rule in §6015(e)(7).  In Pia O. Bacigalupi v. Commissioner, Docket No. 20480-21 (Order of Oct. 27, 2022) (Judge Holmes), the IRS Office of Appeals decided Ms. Baciglupi should be held to the joint liability she had agreed to bear when she signed the joint returns.  They were unmoved by her present circumstances and denied her request for §6015(f) equitable relief.  Despite the record review rule, Judge Holmes allowed her to testify, and on the basis of that testimony disagreed with the IRS about two crucial factors for spousal relief.  Under an abuse of discretion review, that disagreement would not have mattered but under the de novo review, it made all the difference.  The de novo review standard also allowed Judge Holmes to ignore certain precedents unfavorable to Ms. Baciglupi.  Notice, however, this is just an unpublished bench opinion, so don’t get too excited.  For more about that, I recommend Keith Fogg’s excellent post from last week on bench opinions in general and this case in particular.  Meanwhile, you will find today's lesson in more detail below the fold. 

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Lesson From The Tax Court: Fake It Till You Make It

Today’s lesson is how to win a valuation dispute with the IRS.  I don’t teach much about valuation in my basic tax course. When we work problems involving property, the problems generally tell students to assume a certain fair market value (FMV) for the property.  For example, when I teach the deductions allowed by §170 for contributions of property to a charity, what I want students to learn is the reduce-to-basis rule.  To work that particular rule, those problems just assert an FMV because I’m trying to get them to focus on what kind of property is being donated and to what kind of charity.  See e.g. last week’s lesson “The Reduce-To-Basis Rule For §170 Deductions,” TaxProf Blog (Oct. 17, 2022).

I tell students that in real life, valuation is often open to dispute.  That is because facts matter.  And facts may often be disputed.  Moreover, assumptions matter as well.  And assumptions may often be questioned.

This week, we learn a great lesson from the Tax Court on how to win a valuation dispute against the IRS: have a better expert.  While that is easy to say, the 43-page opinion in Champions Retreat Golf Founders LLC et al. v. Commissioner, T.C. Memo. 2022-106 (Oct. 17, 2022) (Judge Pugh), teaches how it is not always easy to do. Today’s case involves the valuation of a conservation easement.  The taxpayer’s expert was not the best, but the IRS’s expert was worse.  So the taxpayer won.  The lesson is kind of like the old joke that you don’t have to outrun the bear: a taxpayer’s valuation does not have to be the best possible; it just has to be better than the IRS’ valuation.  Details below the fold.

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Lesson From The Tax Court: The Reduce-To-Basis Rule For §170 Deductions

Basis is probably the most important concept I teach in my intro income tax course.  I like thinking of basis as the tax history of a piece of property.  It tracks what ought not to be taxed upon eventual sale or exchange of that property under the calculations required by §1001.  But a proper understanding and tracking of basis can also be important for other reasons, such as determining the amount of a §165 loss ... or calculating the amount of a §170 deduction for  charitable donations.

Donald Furrer and Rita Furrer  v. Commissioner, T.C. Memo. 2022-100 (Sept. 28, 2022) (Judge Lauber), teaches a lesson on the importance of basis in determining the amount of a §170 deduction for the donation of property to charity.  We also learn a cautionary lesson on the use and mis-use of Charitable Remainder Annuity Trusts (CRATs).  The taxpayers here were farmers who donated crops to a CRAT and then attempted to claim a §170 deduction based on the fair market value of the donated crops.  That ran afoul of the reduce-to-basis rule.  Details below the fold.

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Lesson From The Tax Court: Know Your TMP

In my now 22 years of teaching tax, I have assiduously avoided teaching partnership taxation.  With any luck, I’ll never have to.  Inside and outside basis still confuse the heck outta me.  But I do teach tax procedure, so I’ve been forced over the years to learn something about the rules governing audits of partnerships.

If there is one stand-out lesson I’ve learned, it’s the one Judge Buch teaches us in Trevor R. Pettennude v. Commissioner, T.C. Memo. 2022-79 (July 18, 2022): individual partners are often at the mercy of their Tax Matter Partner (TMP) when it comes to participating in partnership-level determinations.  The burden is on each partner to know their TMP, and to ensure they are in the loop on important partnership matters.  That may even more true post-TEFRA.  In today’s case, Mr. Pettennude was a tiny partner in a large coal tax credit shelter partnership.  The IRS caught on and audited the partnership.  No one told Mr. Pettennude about either the audit or its results (not happy ones) until the IRS told him he owed about $850,000 in additional taxes.  He tried to contest that in a CDP hearing.  It did not go well.  Details below the fold.

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Lesson From The Tax Court: Don’t Confuse Dummy Returns With Substitutes For Returns

The act of filing a return is central to tax administration. Section 6011 sets out the general requirement: “any person made liable for any tax imposed by this title” must file a return “according to the forms and regulations prescribed by the Secretary.”  Section 6012 gets more granular and gives more specific requirements and exemptions from filing.

When a taxpayer fails to file a return, even after being reminded to do so, the IRS can simply send the taxpayer a Notice of Deficiency (NOD), and let the taxpayer either agree to the proposed tax liability or petition Tax Court.  Or the IRS can follow the §6020 Substitute For Return (SFR) process whereby it creates a return for the taxpayer either with or without the taxpayer’s cooperation.

Regardless of how the IRS deals with the non-filer, an IRS employee first needs to create an account in the computer system for the relevant tax period.  They do that by inputting the proper Transaction Code and preparing what is called a “dummy return” to support it.  But there is one important difference between dummy returns used to set up the NOD process and dummy returns used to set up the SFR process: the §6651(a)(2) failure to pay penalties only apply to the failure to pay taxes shown on a “return.”  Thus, the penalties do not apply to bare NODs.  They do apply to SFRs.  That’s why today’s lesson is useful.

In William T. Ashford v. Commissioner, T.C. Memo. 2022-101 (Sept. 29, 2022) (Judge Vasquez), we learn what to look for in the IRS files to see whether a dummy return used by the IRS leads to a proper SFR or not.  We also learn why you cannot always trust the advice you see on the IRS website.  Details below the fold.

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