Friday, December 31, 2010

Evidence of Ferengi Infiltration of IRS

CCA 201049034

Once you have their money...never give it back.
 Rule 1 - Ferengi Rules of Acquisition

The imagined future of Star Trek is one in which humans have advanced not only technologically, but also morally.  They are less greedy and not racist or sexist and trying to be very benign to other cultures they encounter what with the Prime Directive, which Kirk only rationalized violating every other episode.  That could have made for really boring stories.  The solution was to project the less endearing, though more entertaining character traits of humanity onto alien humanoids. 

The Ferengi, although distinguished for their sexism (Rule 139 - Wives serve, brothers inherit.) are best known for their greed which is religious in nature and embodied in the rules of acquisition.  There is actually some sound advice (Rule 8- Small print leads to large risk.) mixed in with a commentary on the voracious nature of unrestrained capitalism (Rule 97 - Enough is never enough.)  The rules provide significant grist for reflection, the most troubling being perhaps Rule 284 (Deep down everyone's a Ferengi.)  CCA 201049034 highlights the Ferengi influence in the office of chief counsel of the IRS.

I am reproducing the CCA almost in full, but for those of you who don't relish the original sources as much as I do here is a plain English transaction:

We levied somebody's wages.  After the underlying liability was fully paid the employer kept sending us money.  We kept taking it.  The taxpayer never noticed.  Now so much time has gone by even if they asked for it back we couldn't give it to them.  You know how it is statute of limitations and all that yada, yada, yada.  Oh darn.  Guess we have to keep it.

From: ———————— Sent: Wednesday, October 27, 2010 4:52:12 PM To: ——————————— Cc: —————————————————- Subject: #4741721 - Request for Review of Opinion —————

We have completed our review of the Counsel opinion issued in the above-referenced matter, with which you have expressed disagreement. To summarize the salient facts, the Automated Collection System (“ACS”) issued a continuous wage levy that was served on the taxpayer's employer. The employer remitted levied wages that satisfied each of the several tax year liabilities listed on the levy. However, ACS failed to issue a release of the levy. The employer continued to make remittances and the Service applied such latter remittances to other tax years that were not listed on the levy and for which the taxpayer has not filed any returns. The latest of such latter remittances occurred more than three years ago. The taxpayer has not filed any claims for refund.

Although we might have analyzed the matter differently, our conclusion is the same, to wit, that the Service is now prohibited from returning the latter remittances to the taxpayer. Assuming that the latter remittances resulted in overpayments, the limitation on the allowance of a refund contained in section 6511(b)(2) would prohibit the Service from making a refund, because no amounts were remitted within the last three years. Accordingly, were the taxpayer to timely file a claim for refund today (e.g., a Form 1040 for a year in which no return had yet been filed), the three-year lookback period would not extend back far enough to encompass any (involuntary) payments. As we discussed, our answer might be different if the taxpayer had made an informal claim for refund. In that event, the question would be whether the informal claim was made within two years of any of the latter remittances. However, you indicated that you were not aware of any writing that could be viewed as a request for refund.

We understand that the situation you describe might involve Service actions that would not conform to its policies or procedures. For example, the continuous wage levy likely should have been released after the listed liabilities were satisfied. You also indicated that, according to transcripts, some involuntary payments might have been misapplied. Finally, you questioned whether the Service may apply levied proceeds to tax liabilities for which no notices have been issued (including a CP 504 or a Collection Due Process levy notice described in section 6330). None of these procedural irregularities, if taken at face value, would trump the section 6511(b)(2) statutory limitation. Additionally, note that IRM Part (08-24-2010) accurately describes surplus levy proceeds as subject to offset. Accordingly, section 6330 would not be implicated. This taxpayer should have been aware of the amounts of his tax liabilities that properly were subject to the wage levy. He also presumably was aware that his wages were being levied. Although the Service should have released the levy once the listed liabilities were satisfied, the taxpayer had ample time in which to raise an objection and ask that the Service both stop levying and refund the surplus proceeds. While we do not know what prompted the taxpayer to approach the Taxpayer Advocate Service at such later time, the statute does limit the time in which a taxpayer may request a refund, and more importantly, it places limits on the amounts that the Service is authorized to refund.

Be sure to check out today's edition of The Wandering Tax Pro.  Robert Flach has been doing a series of interviews with tax bloggers and I understand this one is something really special.

Wednesday, December 29, 2010

Ready, Fire, Aim

JAMES A. HILL, JR. v. COM TC Memo 2010-268

There were a number of issues in this case, not all of them interesting.  For example, you have to report your share of S corporation income even though you don't receive any distributions.  One issue was of some interest though.  M. Hill and his wife had formed an LLC to purchase property that they intended to develop.  The LLC was treated as an S corporation.  (This gets me a little suspicious of the quality of the advice they were getting.  One of my themes is that the partnership form is generally superior, particularly in real estate, but I don't have enough facts to second guess them here.) Mr. Hill also filed a schedule C for his real estate brokerage business.

Mr. Hill found a likely property for Parkwood and contracted to buy it.  At the closing things got a little complicated::

Petitioner attended the real estate closing on February 7, 2003, in his dual capacity as broker and as the purchaser's representative. At the closing, Robert Garrison (Mr. Garrison), the closing attorney, credited to Real Estate North's account $10,000 in earnest money that Real Estate North had been holding in escrow from Parkwood. Mr. Garrison also tendered a check to petitioner, payable to Real Estate North, for $90,000. Petitioner informed Mr. Garrison that he did not want to accept a commission on the sale, and he asked Mr. Garrison to redraft the closing agreement to eliminate Real Estate North's commission. Mr. Garrison refused to redraft the closing documents. Instead, he asked petitioner to endorse the $90,000 check to Mr. Garrison's escrow account. Mr. Garrison then applied the $90,000 to the purchase price of the Huntington Park property. A February 7, 2003, closing statement signed by petitioner indicates that Real Estate North received a $100,000 commission in the transaction. Petitioner, however, did not report the $100,000 commission on his 2003 Form 1040, U.S. Individual Income Tax Return.

The IRS determined that Mr. Hill should recognize the $100,000 commission as income on his schedule C.  Mr. Hill argued that he should be able to treat it as having been used to reduce his cost of the property purchased.

The Court sided with the IRS :

First, the record is clear that petitioner did, in fact, realize the commission. Petitioner testified that he asked Mr. Garrison to redraft the closing documents to eliminate the commission, but Mr. Garrison refused. Whatever discussions occurred at the closing, the fact remains that petitioner was tendered a $90,000 commission check and signed the closing statement affirming that Real Estate North received a $100,000 commission in the transaction. The commission was not subject to any limitations or restrictions. Thus, the commission was income when tendered. .....The fact that petitioner did not deposit the check into his or Real Estate North's bank account is immaterial. Petitioner cannot alter the tax consequences of the transaction by claiming, after the fact, that he did not want to accept the commission. ....

Second, both this Court and the U.S. Court of Appeals for the Eleventh Circuit have rejected the argument that a commission paid to a broker or agent who is purchasing for his own account is a purchase price reduction and is not income to the recipient. ..... Thus, even if petitioner had not received the $100,000 commission but instead transferred his rights to the money to Parkwood, the transfer would constitute an anticipatory assignment of income. ......

Finally, we note that “the Commissioner may bind a taxpayer to the form in which the taxpayer has cast a transaction.” ........Petitioner deliberately structured the purchase of the Huntington Park property so that Real Estate North would receive a $100,000 commission. Petitioner cannot avoid paying tax on the income by attempting, after the fact, to recharacterize the commission.

The moral of the story is to not wait till closing to do the tax structuring of a transaction.


Monday, December 27, 2010

Nasty Surprise Brewing for Winner of Employee Classification Suit

CCA 201049027

If the 'skeeters don't get him. then the 'gaters will.

I'm making this a bonus post.  One of the things that I worry about a lot is 1099 compliance (I have to take a break from global warming every once in a while).  It was the topic of one of my earliest posts.  An insidious observation in several IRS audit manuals, including the one for auto body repair shops, is that there might be more money in penalties for failing to file 1099's and backup withholding then in disallowing deductions.  You see if you were supposed to send somebody a 1099, then you were supposed to have  asked them for their ID number.  Since you didn't ask they didn't give it to you.  Therefore, you should have withheld from their payment and remitted it.  You can get out of the backup withholding by getting them to sign an IRS form that says they reported the income.  Good luck.

CCA 201049027 lays out an even more insidious tactic.  Suppose the IRS launches an effort to characterize service providers as employees.  These things can take a long time.  The Cheryl Mayfield decision which I wrote a post about was decide in October 2010.  It concerned proposed employment taxes for 2003 and 2004.  Well of course if they had really been employees, you wouldn't be subject to back-up withholding.  But let's say, for the sake of argument, that you win on that issue in Tax Court.  Now, after all that time does the Service have the ability to assess back-up withholding if your 1099 compliance has been less than perfect.  According to this CCA, they can.  On top of that, the Tax Court does not have jurisdiction on the issue of back up withholding.

Issue 1:

The Tax Court does not have jurisdiction under § 7436 to determine the application of backup withholding liability for any workers determined to be independent contractors.

Issue 2: If a Taxpayer filed Forms 945 and thus started the running of the period of limitations on assessment with regard to backup withholding, the issuance of the NDWC may nonetheless suspend the period of limitations with respect to the backup withholding.

I get the sense that they feel they may not be on firm ground with this interpretation :

We recognize the potential incongruity in noting that the Tax Court does not have jurisdiction over § 3406 taxes in a § 7436 proceeding while also asserting that the proper issuance of the NDWC suspends the period of limitations with respect to § 3406 taxes. However, due to the unique nature of employment taxes, there is no perfect analogy in the deficiency arena to apply to the operation of § 6503(a), a provision involving income tax deficiencies, in the employment tax arena. The principles we distill above from §§ 6213 and 6503 are especially apt in light of the uniqueness of the situation where assessing one type of employment tax (e.g., backup withholding on non-employees) is inconsistent with assessing another type of employment tax (e.g., social security and Medicare tax on employees). Furthermore, these principles only apply to situations where the period of limitations for assessment of § 3406 taxes is open at the time the NDWC is issued.

Also they were not anxious to release it.


This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call Ligeia Donis at (202) 622-0047 if you have any further questions.

I was thinking of giving Ms. Donis a call and make her the blog's first interview, but I'm passing on it.  If this serves as a timely warning thank RIA Checkpoint and the Freedom of Information Act.  You can thank me too.

Grandma's Wedding - Grandpa Celebrates

Michael Walter Bragg v. Commissioner, TC Summary Opinion 2010-172

In some recent posts, I've taken to rooting for one side or the other.  As I was reading the facts in this one, I was definitely with the taxpayer.  He was in tax court representing himself over a $937 deficiency.  At issue was an alimony deduction of $6,340 (which locates Mr. Bragg right in the 15% bracket I guess).

Here is the story.  Michael Bragg was divorced from Rosalie Bragg in 2002.  Although the decree called for him to pay $9,600 per year she had informally agreed to accept a lesser amount.  After the informal agreement they probably didn't communicate all that much.  At some point in 2006, she remarried.  She did not mention that to her ex-husband.  Finally, in December 2007, her grandson ratted her out (The court didn't put it that way, but I think it adds to the drama).  Mr. Bragg ceased making payments.
Under the law in the state of Washington, the obligation to make spousal support payments automatically ceases when the spouse being supported remarries (I think that that may be true in all states).

The IRS disallowed Mr. Bragg's alimony deduction for the year 2007, because he was not under any legal obligation to make the payments.  There isn't any mention of whether they issued the former Mrs. Bragg a refund (Of course maybe she wouldn't be entitled to one.  Much as we accountants like everything to balance, the tax law does admit of asymmetrical results.) So how would you rule ?  I want you to share the suspense for a moment.  This one had me on the edge of my seat.

The IRS argument was :

Despite the fact that petitioner falls within the provisions of the applicable Federal statute, respondent argues that because Ms. Bragg remarried in 2006, petitioner's legal obligation to pay spousal maintenance terminated as a matter of Washington State law; thus, respondent contends that the payments were not received under a divorce instrument as required by section 71(b)(1)(A).

The Tax Court found for Mr. Bragg :

Respondent's (IRS) legal argument has as its foundation old law and does not reflect amendments to the statute. Although there certainly have been cases holding that voluntary payments made outside a written instrument incident to divorce are not alimony, those cases have generally dealt with situations where there was no proper divorce decree or separation agreement, where a payment was made before the operative document went into effect, or where the older version of section 71 applied to the particular case.

The more recent regulation requires only that alimony payments meet the following requirements: (a) That payments be made in cash; (b) that payments not be designated as excludable from the gross income of the payee and nondeductible by the payor; (c) that payments be made between spouses who are not members of the same household;

The court's finale is beautiful:

More than 25 years after the enactment of the amended statute, there is no reason to assume that Congress meant anything other than what it said in enacting the present version  Equip. Corp. v. Commissioner, 98 T.C. 141, 149 (1992). of section 71. It is not the Court's place to support respondent's attempt to include language Congress itself did not.

We have no way of knowing whether the former Mrs. Bragg is still speaking to her grandson. For the life of me, I can't figure out why the IRS bothered with this case. 

Saturday, December 25, 2010

PAOO Reaches 100 - Merry Christmas

For I was hungry and you gave me food, I was thirsty and you gave me drink, I was a stranger and you welcomed me,  I was naked and you clothed me, I was sick and you visited me, I was in prison and you came to me.’  Then the righteous will answer him, saying, ‘Lord, when did we see you hungry and feed you, or thirsty and give you drink?  And when did we see you a stranger and welcome you, or naked and clothe you?  And when did we see you sick or in prison and visit you?’  And the King will answer them, ‘Truly, I say to you, as you did it to one of the least of these my brothers, you did it to me

I've got three posts scheduled for next week, but as I was poking around.  I realized that the next post to go up will make 100 published posts.  From the reports that I  get from Google I can safely say that my readership can be numbered in the scores.  I am grateful to each and every one of you.  I realize that most of you are not clicking on the ads, because you are afraid that the flood of revenue might motivate me to quit my day job.  Don't be concerned, it is the furthest thing from my thoughts.  You can click in peace.

My goal in this blog is to highlight tax developments either because they are interesting, practical or funny.  I am most pleased when I highlight something that has otherwise been largely overlooked.   I feel particularly pleased when I do a google search and find that PAOO is near the top.  Here are some to try:

PMTA 2010-058

parsonage second home

does land need to have business purpose to be part of flp  (make bottom of page 1 on this one - not an elegant query, but somebody used it and found me)

Early in December I shared with you what the greatest hits have been.  There has not been much change except for my post on people who have been strongly encouraged to get out of the tax preparation business moving into the top five.

I took down most of the non-tax posts I made early in the blog (the ones taken down do not count as part of the 100), but I left a couple.  One in particular is timely for the Christmas season.  I have heard that things are working out well for the homeless fellow that my friend "James" helped out back in May.  I should no longer do even simple math in my head, but I'm taking a chance here and saying that it is only 82 days to St. Patrick's Day.  In some circles, this is thought to be a holiday to be celebrated by drinking to excess.  A nascent movement known as San Patricios Against Hunger stands for the proposition that Americans of Irish descent are more than likely descended from famine refugees and that they should celebrate the holiday by donating to hunger fighting charities.

I haven't commented at length on the recent tax compromise and probably won't.  I did mention a peculiar opportunity with respect to the generation skipping tax that requires action this week.  My other observation is that with respect to income taxes things have been pretty much left intact, which means that general principles of tax planning are back in full effect.  One of the general rules is to accelerate deductions (This was much more significant when money actually earned interest).  People were holding back on this thinking that rates would be higher next year.  So first thing tomorrow get out your check book or its electronic equivalent and make some charitable contributions.  Now because of the material I work with this blog will often teach you more about what not to do.  If you want to get a tax deduction don't give to an organization that has had its exempt status revoked like the Free Fertility Foundation.  Also, although I think its a wonderful thing to invite homeless people to lunch and its probably quite rewarding to watch the ushers gasp when you drop a couple of C Notes in the collection plate as was the habit of Hardy Ray Murphy, you won't get any deductions. (Buy the homeless guys lunch anyway).  So on a more positive note I'll suggest a couple of qualified organizations that will provide you with a proper acknowledgement.

I divide my practice between Central Massachusetts and Central Florida.  The two regions seem to be at peace with one another.  A Unitarian minister from Worcester once led a regiment that occupied Jacksonville, but many of the men in Thomas Wentworth Higginson's First South Carolina Volunteers were native to Florida.  I don't like basketball so I really don't need to get passionate about either the Celtics or the Magic.  I am however passionate about supporting two charities Grace Medical Home which is a marvellous model of how to provide medical care to the working poor and Jeremiah's Inn which provides substance abuse recovery and runs a neighborhood food pantry.  Moving beyond the local I would recommend Just Detention International, the only human rights organization devoted exclusively to ending sexual abuse of prisoners.  It happens that I am the longest serving board member of JDI and the only current member recruited by Stephen Donaldson.  I hope you will consider those three as you are making out your checks this week.

So Merry Christmas.  And be sure to not shoot your eye out.

Friday, December 24, 2010

What's New With The Chief Counsel ?

There have been quite a few items of interest from the chief counsel's office.  Here is what I think was worth noticing through mid December.  I've got next week ready to go and these will start getting stale, so I'll make this a Merry Christmas bonus post.

CCA 201049041

The IRS will not transfer or redesignate a payment that has been applied to a taxpayer's account to satisfy a different liability of the taxpayer if the payment was applied according to the taxpayer's instructions. If the IRS applies a payment contrary to a taxpayer's instructions, the IRS will, upon request by the taxpayer, transfer the payment to the intended tax liability.
A corporation that believes it will have overpaid its estimated tax for the tax year may apply for a quick refund on Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, before the 16th day of the 3rd month after the end of the tax year at issue, but before it files its income tax return, if the overpayment is at least 10% of the expected tax liability and at least $500. A corporation should not file Form 4466 before the end of its tax year.
If you run into cash flow problems it would be nice if you could apply estimated income tax payments to payroll tax deposits, which have much more ferocious penalties.  No such luck though.  An estimated income tax payment is gone at least until after the end of the year in question.

CCA 201049040

As we discussed, we agree with your conclusion. Lines 3 and 8 of Form 6251 do not apply to taxes incurred in connection with a trade or business. See § 56(b)(1)(A), (b)(1)(D); Reg § 1.62-1T(d)

There is an AMT preference for taxes, but it would not apply, for example, to real estate taxes on Schedule E for a rental property.  I don't think the principle extends to state income taxes attributable to a Schedule C activity.

CCA 201049035

The email responds to your request for assistance. You asked for advice regarding whether there is any limitations period applicable to reducing tax liability based on a net operating loss (NOL) carryback.

Section 6511(a) provides that a “[c]laim for credit or refund of an overpayment . . . shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later.” Section 6511(d)(2) provides an additional special period of limitation with respect to a claim for a refund or credit relating to an overpayment attributable to a NOL carryback. The relevant portion of section 6511(d)(2) provides, in lieu of the 3 year period of limitation prescribed in section 6511(a), the period shall be the period ending 3 years after the due date of the return (plus extensions) for the taxable year of the NOL.

In this case, the Service disallowed the taxpayer's purported claim for credit because it determined that it was untimely. However, you provided that the NOL carryback, if allowed, would not result in an overpayment which would generate a credit or refund but would simply reduce the taxpayer's outstanding tax liability. Even though there are restrictions on the time within which the Service may allow a claim for credit or refund, no such statutory impediments exist to prevent the carryback of an NOL to reduce a taxpayer's outstanding tax liabilities.

This might be of interest to someone dealing with collections who has had things go from bad to worth.  Possibly a carryback from a subsequent disastrous year can alleviate an outstanding debt.

CCA 201049030

 Subject: Filing joint return after filing of substitute for return ————

You asked whether a taxpayer can elect joint status after the Service has filed a substitute for return under section 6020(b) and has issued a notice of deficiency to the taxpayer. The Tax Court held in Millsap v. Commissioner, 91 T.C. 926, 936-937 (1998), acq. in result, AOD-1992-03, that a taxpayer is not foreclosed from electing joint status after the Service has prepared a return under section 6020(b) because the return does not constitute a “separate return” filed by the individual for purposes of section 6013(b). Because the taxpayer has not previously filed a separate return in this case, section 6013(b) does not apply, therefore, the taxpayer may file a joint return provided that none of the exceptions in section 6013(a) apply.

Section 6013(a)(2) states that “in the case of death of one spouse the joint return may be made by the surviving spouse . . . if no return for the taxable year has been made by the decedent, no executor or administrator has been appointed, and no executor or administrator is appointed before the last day prescribed by law for filing the return of the surviving spouse.” The facts that you provided did not state whether an executor or administrator had been appointed. Thus, if an executor or administrator was not appointed, the taxpayer may file a joint return with respect to himself and his deceased spouse. See IRC section 6013(a)(2). 

If you are married and he Service does your return for you it will be married filing separately.  You may be able to reduce the tax if your spouse will consent to a joint return.  If your spouse happens to be dead, you might be able to consent for them.  Definitely has the makings of a Law and Order episode.

How Much Process Do We Really Need ?

Susan Fay Mostafa v. Commissioner, TC Memo 2010-277 , Code Sec(s) 6330.

In my professional life, I represent taxpayers.  So my general inclination is to root for them.  Sometimes, though, I really wonder if we have too much process.  Susan Fay Mostafa did not file her 1996 return (Sometimes I have this time warp thing where I will type 1995 where I really mean 2005.  That's not the case here.  I really mean 1996).  The IRS issued a notice of deficiency which Ms. Mostafa appealed to Tax Court.

In her first round in Tax Court (TCM 2006-106) she brought up some unique arguments.  She argued that the IRS was barred from assessing her by the statute of limitations (You have to file a return to start the statute).  She had blown an IRA rollover by just 4 days but had no explanation.  She also asked for attorneys fees. The court indicated that she hadn't made the motion properly.  Regardless, you don't get attorney fees when you lose.  They didn't even mention that she was representing herself.

Having lost in tax court, she still didn't pay.  So the IRS proposed to levy her assets.  Of course she got out trusty old form 12153 and requested a collection due process hearing.  She also mailed a check to the IRS for $701 with the notation "Endorsing this check accepts 1996 tax return paid in full".  (The tax liability was $1,377 with a 25% non-filing penalty tacked on. I don't want to think about how much interest there must be.)  The check was processed.

The appeals officer did not buy her argument that processing her check compromised the liability:

The Tp wanted to bring up liability issue but I explained to her that the hearing is to setup a collection alternative, such as a OIC as that is the box she marked on form 12153. TP states she has been to tax court but disagrees with amount owed and stated she was told that if she sent in the payment $701.00 that the account would be full paid and she said she stated that on her check (if check was cashed that would be agreeing account was full paid) On November 19, 2008, the Appeals Office issued a notice of determination sustaining the proposed levy. The notice of determination stated that Mostafa had attempted to raise the issue of her underlying tax liability but that she could not do so because she had received a deficiency notice.

So Ms. Mostafa decided to go to Tax Court, again.  And, being experienced now, she represented herself, again.

The Tax Court did not buy her argument,  It noted that she did not make her offer in compromise on the approved form and the IRS did not inform her it had been accepted.

There are a couple of practical points here.

If you are anywhere near owing tax you should file a return even if you think you don't owe tax.  That will get the statute of limitations working for you in the event you are mistaken.  (If you are married and not filing a joint return, you should always file a separate return since you can be deemed to have consented to a joint return you didn't sign.)

A friend of mine who does collections indicates that when he does form 12153, he always checks all the boxes, which includes "Doubt as to Liability".  If Ms. Mostafa had done that maybe the Appeals officer would have considered her argument.  It's like if you are accused of murdering somebody you say you weren't there and if you were there you didn't do it and if you did it it was self-defense and anyway you're insane.

Finally, the paid in full trick on the check is really clever, but it does not work.

On a policy level, my question is whether somebody should really be entitled to two trips to Tax Court on the same liability which will be almost 14 years old if it finally is collected.  It appears to me that for some people, the income tax really is voluntary.

Wednesday, December 22, 2010

Year End Estate Move - Other Than Plug Pulling

Sunday, I did a brief post, on an opportunity created by the recent tax compromise.  I pointed to an article in Forbes, which explains it in some detail.  It concerns the Generation Skipping Tax.  My limited study of the GST forces me to conclude that its true role is a white collar jobs program.  Simplistically it is designed to insure that substantial pools of wealth get taxed at least once in every generation.  The tax can be triggered by a direct gift to grandchildren or a direct bequest to grandchildren.  The other trigger would be when wealth put into trust is distributed to grandchildren.  Of course it is vastly more complicated than that and has big enough exemptions that you don't have to worry about buying your grandchildren computers for Christmas.  Unless you were thinking about a Cray.

Regardless, the recent tax bill has created a limited window of opportunity with respect to the generation skipping tax.  Like the estate tax, the generation skipping tax had been repealed for 2010 to be reinstated in 2011.  The problem was that nobody could figure out exactly what that meant, what the best way to deal with it was and whether there might be a retroactive reinstatement.  The tax compromise reinstated the estate tax for people dying in 2010, although it allows them to elect out of the estate tax at the price of living with carryover basis (I suppose "living with" might not be quite the perfect choice of words).  So plug pulling remains a viable strategy for the ultra wealthy and promises to be a interesting plot twist in TV cop shows and mystery novels for the next several years. More significantly and less macarbly the act also retroactively reinstated the generation skipping tax.  There is a special wrinkle though.  For 2010, the GST rate is 0%.

So the strategic move to make is to trigger the generation skipping tax in 2010.  Who should be thinking about this ?

1. If your net worth is greater than $5,000,000 and you have not yet used up your $1,000,000 in lifetime taxable gifts now is the time to do it and the gift should skip over your children. 

2.  If your net worth is even higher and you are thinking dynastically you could make a major gift on which you will pay gift tax, but which will skip your children.  Frankly if you are such a person, you are probably hearing from your advisers about this already, but you never know, so I'm mentioning it.

3. If you are involved in any way with a trust that was established since 1986 that is not GST exempt, you should be looking to see if a triggering transfer would make sense.  I'm particularly thinking about irrevocable life insurance trusts.

4. If you are related to an estate tax attorney and you are wondering why they are not going to be at home much this Christmas season, now you know why.

Much like picking a Christmas gift, it is always difficult to pick the best wealth transfer gift.  I would not suggest setting up a family limited partnership inside a week.  Too many ways to screw up.  My suggestion is a gift of cash to an intentionally defective grantor trust.  You can spend some time next year designing the perfect vehicle, which you can then sell to the new trust.

It is critical that you use a good estate tax attorney in trying to execute anything like this.  Your accountant might also be able to help you in selecting assets and running scenarios.

Some Items of Interest

I've got quite a few developments that I'd like to share that I can't seem to work into a full length treatment.  In rough chronological order they are :

NEW PHOENIX SUNRISE CORP. v. COMM., Cite as 106 AFTR 2d 2010-7116, 11/18/2010

Tentative title was "How Sweet it Is ?".  This was similar to the currency swap I wrote about in October. This deal had a business purpose fig leaf.  Even though the transaction on which millions of dollars of losses were claimed was almost guaranteed to have a loss of around $100,000 there was a chance of an enormous return :
The fourth possible outcome would occur if the spot rate for one of the option pairs “hit the sweet spot,” meaning that the long option and the short option comprising one of the option pairs expired in the money and out of the money, respectively. This would happen if the spot rate on December 12 were 127.75 or 127.76 yen per dollar, or if the spot rate on December 18 were 128.75 or 128.76 yen per dollar. Then, Capital would earn a profit of $73,500,000 on its net investment of $131,250 because it would have an additional receipt of $73,631,250 on either December 14 or December 20. The final possible outcome would occur if both option pairs hit the sweet spot. Then, Capital would earn a profit of $147,131,250 on its net investment of $131,250 because it would have additional receipts or $73,631,250 on both December 14 and December 20.

According to the IRS expert that the Court accepted there actually was no chance of the sweet spot being hit since the counter party had enough discretion and market clout to prevent it.

CC 2011-004

The following steps should be taken when a taxpayer is alleging, in an appeal to the Tax Court from a notice of determination sustaining a levy action, that the levy should not proceed because it would cause economic hardship: 1) the administrative record should be reviewed to determine whether the taxpayer raised economic hardship and whether the facts support the assertion that the levy would prevent the taxpayer from meeting necessary living expenses; and 2) if a credible argument of economic hardship was raised, but the settlement or appeals officer did not address the issue, a motion should be filed requesting that the case be remanded to Appeals so that the settlement or appeals officer can consider properly whether the levy action is inappropriate because the taxpayer would suffer an economic hardship if a levy is served.

This is a change in IRS policy regarding levies where taxpayers are not in current compliance.  Regardless of the current compliance, the appeals officer must consider hardship.  A study of collection cases sometimes makes me think that the income tax really is voluntary.

Hardy Ray Murphy, et ux. v. Commissioner, TC Memo 2010-264

Tentative title was "Brother Can You Spare a Deductible Dime". This was a substantiation case.  Taxpayer was taking a deduction for lunches that he bought for some homeless men that he befriended.  For a period of time he and his wife were regular churchgoers

Mr. Murphy claims he contributed between $100 and $200 each time he went to church for a total of $300 to $500 each week. While Lake Avenue Church did provide envelopes for contributions, petitioners did not use them. In addition to contributions to Lake Avenue Church, petitioners contend they made small contributions to San Gabriel Union Church and St. Mark's Episcopal School. Both Mr. Murphy and his daughter attended St. Mark's Episcopal School. Mr. Murphy asserted that the total amount of tithing to the two churches and the school was approximately $20,000.

The Tax Court pointed Mr. Murphy to the substantiation rules for charitable contribution.  I'd like to believe Mr. Murphy, but I don't recall any news reports of church ushers dying from shock when they found portraits of Benjamin Franklin in the collection plate so I'm a little skeptical.

U.S. v. BOWDEN, Cite as 106 AFTR 2d 2010-7195, 11/30/2010

Tentative title for this one was "King David Headed for the Clink".

Wesley David Bowden appeals his conviction on six counts of attempted tax evasion and his six concurrent prison terms of 24 months each. The Government has moved to dismiss the appeal as frivolous or for summary affirmance or, alternatively, for an extension of time.

Bowden asserts that the only issue on appeal is whether the district court had jurisdiction to convict him. He contends that it did not because he is a sovereign and not subject to the laws of the United States.

The Court found his appeal to be frivolous.  So maybe he should try jester rather sovereign.

NEVADA PARTNERS FUND, LLC v. U.S, Cite as 105 AFTR 2d 2010-2133, 04/30/2010

At the October 2, 2001, meeting, Williams and his attorneys met with KPMG agent Donna Bruce, who understood that the purpose of the meeting was to alleviate large gains arising from the B.C. Rogers note exchange, having been informed that the gain would amount to nearly $20,000,000.00. She told Williams that KPMG had been recommending to its clients facing the imminent prospect of large ordinary and capital gains a new strategy to be pursued through an investment advisor experienced in financial structure, hedge funds and more exotic forms of investment designed to provide tax benefits. Bruce named several investment advisors to be considered by Williams, including a hedge fund called Bricolage, LLC, in New York City, an entity owned and managed by one Andrew Beer.

Another convoluted KPMG deal that didn't work out as intended.  I think I'm going to stop studying these things as I might get confused by them.

CCA 201048043

Tentative title was "Say What ?" I really don't know what they are talking about here.  I suppose if I ran down the references I would have a clue, but I don't think I'll bother.  Hope it is nothing important.
UIL No. 6227.00-00
Release Date: 12/03/2010
ID: CCA_2010102109152937
Release Date: 12/3/2010 Office: —————

UILC: 6227.00-00

From: —————————- Sent: Thursday, October 21, 2010 9:15:31 AM To: —————————— Cc: —————- Subject: RE: TEFRA question ————-

Correct. If an NBAP has been issued, then any AAR issues would be resolved in the FPAA and no separate petition of the AARs could be filed. I.R.C. 6228(a)(2)(B). In addition, we cannot issue any affected item notices of deficiency until after the partnership proceeding is complete. GAF v. Commissioner.


Mr. Owens is a corrections officer in a state system.  The way the judge in this decision kept emphasizing that he had signed one return under pains and penalties or perjury and then an amended return with a significantly different position also under such pains and penalties, I was thinking the judge was hinting that he could end up in a federal facility in a capacity other than as corrections officer.  His original return had $22,921 in unsubstantiated schedule A job related deductions.  The amended return moved them to Schedule C.  They remained unsubstantiated and thus non-deductible.  Fairly typical tax court case, but I found it a little amusing.

Well, I'm back to studying the tax bill.  You won't be learning about it here unless there is something quirky that is not being heavily noticed.

Sunday, December 19, 2010

Something to Keep Busy With

The tax compromise that is closing out the year doesn't really seem all that exciting.  The tax rates next year will be pretty much unchanged.  The estate tax change is significant, but it seems like you can wait to do whatever seems best next year.  For a small group of people though the bill confirmed an opportunity that will vanish at the end of the year.

For 2010, there is a generation skipping tax in effect, but the rate is 0.  So trusts that have non-exempt portions may want to trigger the 0% tax in the next two weeks.  An article by Janet Novack in Forbes explains the issue in detail.  I give myself credit for noticing this as I was studying the bill but I figured there was some sort of language I wasn't seeing that would knock out transfers at the end of the year.  I discussed it with an attorney though and he pointed me to the Forbes article.

Parsonage Exclusion - Shouldn't Enough be Enough ?

Philip A. Driscoll, et ux. v. Commissioner, 135 T.C. No. 27

Foxes have holes, and birds of the air nests; but the Son of man hath not where to lay his head.

Robert Harris's book 101 Things Not to Do Before You Die is a fantastic blend of humor and wisdom.  One particular piece of advice which actually caused me to change my regular behavior was:

Don't accumulate nonfunctional pens.

Following the form of most of his advice he describes a person who reaches into a jar of ballpoint pens, tests the pen to see if it works, finds it doesn't  and then puts it back.  What do you say about such a person ? Don't be one of them !

Check your pens and let go of the ones that no longer serve you - even if it is painful.  Keep only the ones that you can reach for with confidence.  This way when you feel the urge to write or draw or doodle, you can get started without needless delay and frustration.

There is another piece of advice, one  that I generally don't follow.  Although he is referring to sports on TV, I think it has broader implications.  That advice is :

                                           Don't be a passive spectator

When you're watching two teams, always pick one to pull for.  Cheer and boo.  Laugh and cry.  Eat and drink.  And experience not just the game, but the competition.

In my blog, I have adopted an attitude of - It is what it is.  Before long it will be something different.  Deal with it.  Other tax bloggers seem to enjoy advocating for one side or the other.  The Tax Court's decision in Phillip A. Driscoll has motivated me to finally do some serious booing.  The issue is the parsonage exclusion.  I have previously written about an effort to have the exclusion declared unconstitutional.  I think my post on the constitutionality of the parsonage exclusion took a pretty balanced view.

The case of Phillip Driscoll is another matter.  Reverend Driscoll heads Mighty Horn Ministries.  The ministry is not apparently classified as a church since it files Form 990.  If you look at the website, it strikes one more as being a record label, albeit one that specializes in religious music.  Since 2007, perhaps coincidental with the Reverend's visit to a federal facility because of a misunderstanding about taxes, the organization has been officially known as Phil Driscoll Ministries. Their 990 is available on (registration is free). In 2009, it had gross receipts in excess of $3,000,000.  Officers salaries were fairly modest $77,440 to President Phillip Driscoll, $5,700 to Jamie Driscoll the VP and $31,700 to Lynn Driscoll.  The Reverend Phil, however, had expense accounts and "other allowances" totalling $283,032.  This nicely ties with the item in other expenses labelled parsonage.  If you know anything about airplanes, take a look at the depreciation schedule on page 21 of the adobe file and you can let me know if I should get cranked up about that.  The mission of Phil Driscoll Ministries (a/k/a) Mighty Horn is:

Spreading the gospel of Jesus Christ to approximately 500,000 people annually through concerts and other ministry opportunities.

As occasionally happens to me further research has shown that a case I have found of interest is actually a late act in old news.  Reverend Driscoll did time in 2007 for tax evasion.  At least one commentator believes the real villain in that case was the IRS.  In his post Welcome Home Phil, James Paris speculated that Phil was being persecuted for his Christianity.  You can find similar comments in the Christian music realm of the blogosphere.  Apparently Reverend Driscoll is quite a celebrity with even Bill Clinton trying to help him avoid prison time.  It will be interesting to see if this tax court decision is seen as something of a vindication of him.

At issue were parsonage exclusions covering the years 1996 to 1999 totalling just over $400,000.  The largest being $195,778.72 in 1999.  This was not Reverend Driscoll's entire parsonage allowance.  This was the portion attributable to his second home (for parts of 1998  it was "second homes").  Just a little bit of tax history here.  The parsonage exclusion goes back to the Revenue Act of 1921.  It excludes from income the rental value of a residence provided to a "minister of the gospel".  This exclusion might have been rendered redundant by the subsequent creation of an exclusion from income for lodging provided to employees for the convenience of the employer.  In the classic "parsonage" or, if you are Catholic, "rectory", situation, presumably the convenience of the employer standard would be met.  It's convenient for the congregation to have the minister living next to the church in a house maintained by the church.  Maybe not so convenient for the minister's spouse or the minister's kids.

Here is where we get into the tension between the establishment clause and the free exercise clause.  Some denominations and congregations might think, perhaps with some encouragement from the clergy, that it is not such a good idea to have the minister live in a house owned by the church.  Since you wouldn't want to treat them differently than other denominations or congregations the parsonage exclusion was expanded to include "rental allowances".  There is no dollar limitation on such rental allowances and no limit on the relationship that they can bear to taxable compensation.  The money just has to be spent on providing housing.  If the housing allowance is used to pay deductible expenses they are still deductible. 

The question the tax court had to decide in this case was whether a parsonage allowance should be allowed with respect to a second home.  In 2002, the Code was amended to limit the exclusion to the fair rental value of a home.  Prior to that it would presumably have been legitimate to have a $500,000 parsonage exclusion that was used to be buy a house.  Since the parson would have basis in the house it could be subsequently sold for $500,000 with no taxable income.  The case which prompted the Code change was not nearly that extreme.

Interestingly the question of whether the parsonage allowance can apply to a second home has never been addressed before.  The court was left to try to figure out what Congress was up to when it first enacted this thing in 1921.  They didn't get very far:

One commentator has suggested that the in-kind exclusion grew out of “the general respect held by Congress and the public for churches,”

What they came down to was statutory construction.  The language in Section 107 says "provide a home", but when you go to the definition section of the Code you find :

In determining the meaning of any Act of Congress, unless the context indicates otherwise— words importing the singular include and apply to several persons, parties, or things;

So providing a home includes providing two or, in this case for part of the time, three places to live.  And of course Reverend Driscoll in 2007 had free housing provided by the federal government, although that was just for himself.

I really don't think this type of thing does the cause of religion much good.  I doubt that it is good for the clergy to have their own special tax gimmick that while appearing modest can be gamed to exclude from income tax as much as 100% of above average incomes in some cases.  If 107 were simply repealed it would not cause the taxation of clergy who are provided a place to live by their congregations.  They would be covered by the convenience of the employer exception even if the residence had a theoretically high rental value (conceivably a bishop's residence or the like). 

There is another option, which as far as I know is original with me, although whenever I think that it turns out that I am wrong.  Code Section 134 excludes from income a number of military benefits including a housing allowance. A rationale similar to that for the parsonage exclusion can be made here.  Members of the military are frequently and perhaps more so traditionally provided with housing at a place convenient to the employer, think Fort Apache. It is reasonable that a cash allowance in lieu of that benefit would be exempt.  From a policy viewpoint the military housing exclusion is less troubling, since there is nothing disturbing about the federal government deciding who is entitled to it (Unless you are a far out militia type).  Perhaps more significantly, since it is paid by the federal government, it is limited.  The allowance varies by whether the service member has dependents, by region and as you might expect rank.  If you look at the table, though, you will see that the variation by region is the most dramatic with junior enlisted ranks in Alaska having housing allowances greater than a general in Alabama.  My recommendation is that the parsonage allowance be limited to no more than the highest military allowance anywhere.  You could come up with something more complicated than that.  The important thing is that there be some dollar limit.

Dropping back to my normal persona as amoral tax advisor congregations and ministers might consider whether there is an opportunity here to further pump up housing allowances.  I don't know how many clergy members own multiple homes, but I will predict that as word of this decision gets out, the number will increase.  A cautionary note.  The Tax Court was divided on this opinion.


Friday, December 17, 2010

Making Room for the New

I explained my blogging method in a recent post and that wasn't even the first time.  One of the byproducts of the method is a host of items that deserve mention, but not perhaps an entire post.  Things had been pretty quiet on the fronts that I observe. Yesterday and today though produced a flurry of interesting items.  Before I get to them though I will pass on the developments that are starting to get stale and will not get a lengthy treatment.

Private Letter Ruling 201044019, 11/05/2010

This ruling is an adverse determination on exempt status.  They were seeking to be recognized as a church.  The church had one minister, its founder:

She was ordained by B. B is not a tax-exempt organization under section 501(c)(3). You operate out of your founder's personal residence.

As of yet it did not have a lot going on :

You state that your regularly scheduled religious services will consist of a weekly online discussion centered on a topic that will be posted by your minister. Visitors to your website will be able to discuss the topic by posting comments. To date, you have not posted any topics or engaged in activities using your website. Based on your representations, your only activity thus far, except for establishing your website, has been to distribute funds to individuals

With respect to your program of distributing funds to the needy, neither your application nor your subsequent submissions describe this program, specify the criteria you will use to determine whether an individual is needy or indicate how individuals are referred to you.

With respect to the operation of a church, you describe your creed or statement of faith as follows, "We are all sons and daughters of the same universe. Our doors are open to all. We make no demands of our members. We offer freedom of faith. We seek to unite and instill the truth that everyone is equal." You describe your formal code of doctrine and discipline as follows, "Do unto others as you would have them do unto you." You indicate that your form of worship consists of meditation and communication.

It is troubling that we have the IRS saying what is or is not a church.  It seems to be problematic with the establishment clause of the First Amendment.  You need however to look at the whole sentence:

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof;

In order to not interfere with "free exercise", you have to define when it is that people are exercising religion.  It is still disturbing.  As I mentioned in a previous post on The Foundation for Human Understanding, Jesus and his apostles would not easily fit into the IRS definition of a church.

FlextronicsAmerica, LLC v. Commissioner, TC Memo 2010-245

I did a few posts on Fidelity International Currency, one of which, is one of my all time greatest hits.  That was a partnership designed by KPMG which went spectacularly bad.  In this one a KPMG design that the IRS did not like was blessed by the Tax Court.  It was fiendishly complicated and due to legislative changes probably doesn't work anymore so I won't go into it.  There was, however, a significant quote in it:

Respondent emphasizes KPMG's role with respect to the inventory transactions. Certainly Canadian Parent and KPMG contemplated different ways to bolster the appearance of a business purpose relating to the inventory transactions. There is no doubt KPMG fervently encouraged the use of the planning technique. Receiving KPMG's advice did not, however, nullify petitioner's bona fide business purposes for the transactions. KPMG was simply advising a client on different ways to minimize the tax consequences of a proposed transaction—precisely what tax accountants are paid to do.

The difference between this case and Fidelity International is the KPMG was figuring out the most tax efficient way to execute a legitimate business transaction rather than creating entities to engage in transactions to shelter unrelated income.

Gregory Q. Teeters v. Commissioner, TC Memo 2010-244

This was pretty much a run of the mill protester case.  I've studied this topic quite a bit, having once found myself between a protester and the IRS, resulting in 12 years of torture in the probate court.  Some of the arguments are fairly well crafted in that all the citations will check out (You just have to ignore that they are taken wildly out of context).  I have trouble believing that the people who craft them think that they are valid.

To support his objection to the deficiencies and additions to tax, petitioner relies predominantly on a single frivolous legal argument; viz, that he did not receive wages under section 3401(a). Petitioner is wrong. The companies that issued him Forms W-2 were his employers under section 3401(d) and he was their employee under section 3401(c). Thus, the remuneration those companies paid him for his services was wages under section 3401(a). Those provisions are clear on their face. See, e.g., United States v. Latham, 754 F.2d 747, 750 [55 AFTR 2d 85-846] (7th Cir. 1985) (the argument that “under 26 U.S.C. § 3401(c) the category of `employee' does not include privately employed wage earners is a preposterous reading of the statute”). Moreover, petitioner received several letters from respondent explaining that his position was frivolous and suggesting that he seek advice. At trial, although petitioner acknowledged that seeking advice would have been reasonable, he conceded that he did not do so. Instead, petitioner persisted in advancing the same frivolous argument. We find that petitioner did not have a good faith misunderstanding of the law. Petitioner timely filed Federal income tax returns for 1990, 1991, 1992, 1993, 1994, 1995, 1997, and 1998. Petitioner knew of his legal duty and sought to avoid it.


This was a case of someone suing an insurance company because they had unexpected income when they cashed in an annuity.  They thought they had basis in it, but it turned out there had been a previous roll overs that confused matters.  The insurance agents advising them had not been aware of it.  The insurance company was granted summary judgement.

CCA 201045023

Individual wrongfully convicted and incarcerated for crime who served several years in prison before being exonerated, may exclude from gross income, under IRC Sec(s). 104(a)(2) , compensation received as result of state-enacted legislation for wrongful conviction and physical injuries and sickness suffered while unjustly incarcerated. But, if individual receives title to/constructive or economic receipt of corpus or assets used to fund future periodic payments, then some portion of future periodic payments may not be excludable. And, punitive damages and interest are included in gross income.

I had once looked at this issue for somebody and had concluded that incarceration, in and of itself, is not a physical injury under 104 (Don't yell at me that that doesn't make sense.  It's not a requirement).  The facts here are just a little different.  Human rights attorneys should pay attention to this.

Gail P. Drayer v. Commissioner, TC Memo 2010-257

I write a lot about taxpayers not being able to prevail on innocent spouse status.  There are two reasons for this.  One is that there seem to be more cases in Tax Court where the taxpayer loses.  The other is that those cases reinforce my advice to be cautious in signing joint returns.  Don't just think about the tax savings.  Consider the implications of joint and several liability.  This does not mean that seeking innocent spouse relief is not worth doing.  I'm sure it is frequently granted by the IRS, which is not going to show up in Tax Court.  Also sometimes taxpayers do win in Tax Court.

Mrs. Drayer had 5 of the eight factors in her favor, one against and two neutral as determined by the Tax Court.  Mrs. Drayer was under the mistaken assumption that she was legally required to file a joint return, which is not one of the factors.  Most dramatic was the abuse factor:

Times were tough for the Drayers, and their marriage became increasingly rocky. Mr. Drayer would often get very angry and had frequent outbursts, particularly in the context of discussions about finances and taxes. Petitioner worried about unpaid tax liabilities, but Mr. Drayer would furiously insist that he would handle the problem and would submit another offer- in-compromise to the Internal Revenue Service. Petitioner provided specific examples of angry outbursts, including a time when Mr. Drayer threatened to hit her and broke specific items. He also, after one such incident, told petitioner that he had intended to commit suicide. Mr. Drayer called petitioner derogatory names and publicly humiliated her. He also regularly drank a lot of alcohol and often smoked marijuana.

Realistically I know that I will probably never run out of material.  It feels good to have a backlog, although I may feel obligated to do some bonus posts for the sake of timeliness.

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.

Wednesday, December 15, 2010

Health Care Reform Constitututional ?


This is barely within the ambit of my blog and also is something that everybody else is going to be discussing, another reason for me to not weigh in, but I will anyway since my brief sampling on the commentary already out indicates that something might be missing.

Commonwealth of Virginia v. Sebelius is on the constitutionality of the portion of the health care bill that calls for a tax or penalty on someone who does not purchase health insurance :

First, the Commonwealth contends that the Minimum Essential Coverage Provision, and affiliated penalty, are beyond the outer limits of the Commerce Clause and associated Necessary and Proper Clause as measured by U.S. Supreme Court precedent. More specifically, the Commonwealth argues that requiring an otherwise unwilling individual to purchase a good or service from a private vendor is beyond the boundaries of congressional Commerce Clause power. The Commonwealth maintains that the failure, or refusal, of its citizens to elect to purchase health insurance is not economic activity historically subject to federal regulation under the Commerce Clause.

Alternatively, the Commonwealth contends that the Minimum Essential Coverage Provision cannot be sustained as a legitimate exercise of the congressional power of taxation under the General Welfare Clause. It argues that the Provision is mischaracterized as a tax and is, in actuality, a penalty untethered to an enumerated power. Congress may not, in the Commonwealth's view, exercise such power to impose a penalty for what amounts to passive inactivity.

Lastly, the Commonwealth asserts that Section 1501 is in direct conflict with the Virginia Health Care Freedom Act. Its Attorney General argues that the enactment of the Minimum Essential Coverage Provision is an unlawful exercise of police power, encroaches on the sovereignty of the Commonwealth, and offends the Tenth Amendment to the U.S. Constitution

The District Court for the Eastern District of Virginia agreed with the Commonwealth

On careful review, this Court must conclude that Section 1501 of the Patient Protection and Affordable Care Act—specifically the Minimum Essential Coverage Provision—exceeds the constitutional boundaries of congressional power.

It did not, however, issue an injunction since nothing is really happening with this until 2013, which is why I wouldn't normally pay attention to it.  What I've seen missing from the comments on this is that two other courts have ruled that the act is constitutional:

LIBERTY UNIVERSITY, INC v. GEITHNER, Cite as 106 AFTR 2d 2010-7174, 11/30/2010

The conduct regulated by the individual coverage provision is also within the scope of Congress' powers under the Commerce Clause because it is rational to believe the failure to regulate the uninsured would undercut the Act's larger regulatory scheme for the interstate health care market

These guys also raised religious and free speech arguments all of which went nowhere.  This decision was the by the District Court for the Western Division of Virginia.

THOMAS MORE LAW CENTER v. OBAMA, ET AL., Cite as 106 AFTR 2d 2010-6720, 10/07/2010

In this case the court found that the insurance requirement was within the realm of the Commerce Clause.  I managed to find something amusing so I posted on that decision a while ago.  The Thomas More decision was by the Eastern District of Michigan.
There is also:

STATE OF FLORIDA v. U.S. DEPT. OF HEALTH & HUMAN SERVICES, Cite as 106 AFTR 2d 2010-6761, 10/14/2010

That suit withstood a motion to dismiss.  The latest I see on it is that it will be heard on December 16.

Flipping Properties

Wendell V. Garrison, et ux. v. Commissioner, TC Memo 2010-261

This case addresses an important issue that I run into from time to time.  How do you distinguish between investing in real estate or acquiring for use in a trade or business as opposed to being in the business of buying and selling real estate ?  If you are a pure investor your gain on sale will be capital gain, your loss will be capital loss and your expenses will be itemized deductions subject to a variety of limitations depending on which ones we are talking about.  If you are holding the property as a rental your gain will be a capital gain (with gain attributable to accumulated depreciation subject to a special rate) and your deductions will go against adjusted gross income.  If you have a net loss, it may be suspended by the passive activity loss rules.  Loss on the sale of a rental property is ordinary.  If you are in the business of buying and selling real estate all income and loss is ordinary and subject to self employment tax.

There is, of course, more to it than that.  Investors and rental property holders can do tax deferred like-kind exchanges.  Someone in the business of buying and selling can shelter some their income with a Keogh or SEP or something like that.  Not that they ever will.  Real estate flippers will only stop when they die or own all the real estate in the world (I used to include bankruptcy as another end point, but that is really just a brief interruption).  I am also leaving out owning the real estate involved in a business that you operate.  Frequently that ends up being a rental situation, although there are some special rules.

Wendell and Sharon Garrison filed returns that fell somewhere between investor and rental operation.  They didn't claim any operating expenses, but reported sales of property on Form 4797, which is the form for reporting sale of assets used in a trade or business (which for this purpose includes rental).  They claimed capital gain treatment.  Since most of the sales were short term I wonder what difference this made.  It can make a big difference to someone who has capital loss carryovers, but based on the rest of the facts that didn't seem that likely.  More significantly they did not pay self-employment tax on their earnings.

It seems like Mr. Garrison, more or less, shot himself in the foot:

Petitioner husband testified: “I'm in the business of buying material, fixing houses and reselling them.”

Still the court got into the factors to consider.

Typically, the factors in making this determination include:
(1) The taxpayer's purpose in acquiring the property;
 (2) the purpose for which the property was subsequently held;
(3) the taxpayer's everyday business and the relationship of the income from the property to the total income;
(4) the frequency, continuity, and substantiality of sales of property;
(5) the extent of developing and improving the property to increase the sales revenue;
(6) the extent to which the taxpayer used advertising, promotion, or other activities to increase sales;
(7) the use of a business office for the sale of property;
(8) the character and degree of supervision or control the taxpayer exercised over any representative selling the property;
 (9) the time and effort the taxpayer habitually devoted to the sales.

Petitioners engaged in at least 15 sales over 3 years, and most of the sales occurred within 4 months after they purchased the property.

That pretty much summed it up.  The case also got into substantiation of expenses.  They had nothing so the additional expenses they claimed were not allowed.  The Cohan Rule was not even mentioned.

My own rough guideline in this area is that when you do your third renovation sale your in the business of buying and selling property, particularly if the first two did not have any rental activity.  If you are doing this to scale it is worth consulting the Phelan decision (Timothy J. Phelan, et ux. v. Commissioner, TC Memo 2004-206).  By isolating different activities in different entities it is possible to get capital gains treatment on some of the economic return from a development even though related entities might be doing ordinary income type activities.  In order for this type of thing to work though it is critical that the entities be treated with respect.  As with family limited partnerships, the devil is in the details.

Monday, December 13, 2010

Survey Says - No Discount for Family Limited Partnership

   LEVY v. U.S., Cite as 106 AFTR 2d 2010-7205, 12/01/2010

Sometime in the last millennium there was a TV situation comedy called Angie.  It was about the early days of a marriage between a fellow from a very wealthy Philadelphia family and a waitress from a family of more modest circumstances.  In one of the episodes the two families compete on the game show Family Feud.  Family Feud is a wonderfully egalitarian contest.  Unlike Jeopardy, which requires you to come up with the one correct answer (Expressed in the form of a question)  the questions in Family Feud are matters of opinion.  If you get one of the top five or ten answers (something like that) that were determined by a survey you get some points.  The more common the answer you come up with the more points it is worth.

I forget how the Angie episode worked out in its entirety, but at least early on the husband's wealthy family (including the butler of course) was getting creamed.  People in the survey did not have champagne and caviar for snacks or start the day by checking stock prices.  At one point the host goes up and explains to them that the survey answers come from average people not the ultra wealthy.  They don't get it.  The lawyers for the Estate of Meyer Levy might have learned something from watching that episode, but they were probably studying hard in law school or taking polo lessons, the better to meet wealthy clients, while I was squandering my time learning life's lessons by watching television.

The case was a family limited partnership case.  Family limited partnerships can be a good idea for a multitude of reasons.  They are particularly attractive to people, who not, yet, having come up with a way to take it with them, want to control it all till they draw their final breath without having it all included in their taxable estate.  There's also the asset protection and as they say on Seinfeld yada yada yada.  The thing that people get excited about, though, is the discounts.  That's what the IRS gets excited about too.  Take a bunch of stuff and put it into a family limited partnership.  Say its a million dollars worth of stuff.  Now give 10% of the partnership to your kid.  How much is the gift worth ?  $100,000 ?  Do you think I would pay $100,000 for it ?  Of course not..  As a limited partner I don't get to vote.  On top of that your kid doesn't even have the right to sell it to me.  You have to hire a valuation expert to value the limited partnership interest (I sometimes think the estate tax is, in reality, a white collar jobs program).  She'll tell you its worth something like $65,000, more or less, depending on well yada yada yada. The IRS doesn't like this and is constantly attacking it.

Until recently they focused on poor execution which I discussed at length in one of my early blog posts.  Assets aren't really transferred to the partnerships.  Personal bills are paid directly by the partnership.  Distributions are not made in proportion to partnership ownership.  Tax returns are not filed or not done correctly.  In a more recent case, Fisher, discounts were not allowed for a single asset partnership, because it lacked business characteristics.  There was no discussion of flawed execution. 

No discount was allowed to the Estate of Meyer Levy for the sale of its Plano real estate that was in a partnership.  The estate appealed the verdict alleging error on the part of the trial court.

The Estate argues that the trial court erred when it allowed the admission of

 (1) evidence of the ongoing negotiations over the sale of the property, specifically the offers and proposals;
(2) evidence of the listing price of the property, and the ultimate sale price of the property;
 (3) valuation testimony by the Government's expert based on flawed methodology; and
(4) opinion testimony by a lay witness and hearsay testimony.

Wow.  In a valuation case they considered what people were offering for the property and what it actually sold for.  That's pretty outrageous.  You see the problem was it wasn't a judge that had to think about these things.  It was a jury.  Who ends up on a jury ?  I'm not sure exactly. I suspect that they have more in common with the people Family Feud surveys for its answers than the people I run into at tax conferences.

The Estate contends that the jury arbitrarily disregarded unequivocal, uncontradicted, and unimpeached testimony of an expert witness, bearing on technical questions of causation beyond the competence of lay people. The Government counters that the jury had the partnership agreement in evidence from which it could have determined that there was no lack of control or marketability.

The record contains ample evidence to support the jury's verdict valuing the property at $25 million. The Estate listed the property, and eventually sold the property, for $25 million. It was immediately resold for $26.5 million. Sophisticated developers with no stake in the current litigation engaged in ongoing negotiations for the property for prices in the $20–25 million range. The Estate's expert testified that the market in Plano remained relatively flat during the period between Levy's death and the sale of the property. Also Jordan testified regarding the value of the property. Any of these provides sufficient support for the jury's verdict on the property.

The jury verdict regarding the discount also finds support in the record. The partnership agreement itself would be sufficient evidence. The jury could have rationally found that no discounts for lack of control or marketability were merited because the Estate controlled the general partner interest, which had nearly unfettered control over the Partnership's assets. The trial court did not abuse its discretion when it denied the Estate's motion for new trial.

I'm not a lawyer and I don't even play one on TV.  I prepare and review tax returns and do tax planning.  I also represent people who are being audited by the IRS, but there I'm generally dealing with accountants.  If my clients end up in Tax Court and win I'll still think that I lost.  I am fairly certain though, that it was the choice of the estate's lawyers to bring this matter to a jury.  To have that privilege, they had to pay at least part of the tax in order to be able to sue for refund in district court.  They could have instead gone to Tax Court where they would have had people who dealt with "technical questions beyond the competence of lay people" all the time and frequently allow discounts.  Somehow though they thought they would do better with a jury.

Apparently though the government lawyers saw to it that the jury found out that the Estate got $25,000,000 and these simple minded people thought that might be indicative of whatever the estate had was worth.  I suppose there was some sort of trial strategy that would keep this information undisclosed.  In which case the jury would have had to weigh the government's yada, yada, yada against the Estate's yada, yada, yada.  There might have been some logic to that.  If I was playing Family Feud and the question was "Name a class of people that are very popular" I would venture neither multi-millionaires or IRS agents.  If the question was "Name a class of people that are despised"  I think I might score higher with "IRS agents".  I mean no disrespect to IRS agents, their unpopularity is inherent in their jobs. 

In  a refund suit in district court either the government or the taxpayer can ask for a jury.  I haven't been able to figure out which it was.  I did find that the executor had been a potential candidate for mayor of Austin Texas and the late Mr. Levy had established a fairly well known charitable foundation.  So there may have been a feeling that there was a home town advantage.  There was also a sense in which the Estate was playing with the house's money if it was the one that gambled on a jury, as is noted in a footnote:

Although we have declined to set aside the jury's verdict of zero discount, we note that the actual discount applied in taxing the Estate was thirty percent. Given the valuation found by the jury, it would have had to find a discount of larger than thirty percent for the verdict to make a difference to the judgment in this case.

I don't know whether this case will have a chilling effect on family limited partnerships or not.  My cumulative sense is that you should only do them if you think they are a good idea anyway.  Oddly enough, that will make it more likely that you will succeed on the discount issue.  I think the key planning point to take away from the case is the Court's comment that it would have been reasonable to find a zero discount because of the Estate's general partnership interest.

Auxilliary Legion of Super Posts

One of the more obscure pieces of DC trivia I recall is the legion of superheroes having an auxiliary.   It consisted of people who's super powers were too lame for admittance to the regular legion.  Among them were Bouncing Boy and Night Girl. Of course they let Batman in with no super powers, but what of it.  Anyway these people with lame super powers got together and they would save the regular legion from disaster without the regular legion realizing it.  I'm working on pure memory here so I may have the details wrong.  Doesn't really matter.  My memory of the auxiliary legion is what I am invoking.

I look at a lot of material to find things that I feel are blog worthy.  Generally I am looking for things that are not noticed by a lot of other people that are either of practical importance or kind of interesting or maybe funny.  I look at all federal court tax decisions and a multitude of IRS pronouncements which are a veritable alphabet soup.  If something is time sensitive I might put it up right away as a bonus post, but generally I stick with a MWF schedule.  If I have the next three complete and scheduled I feel pretty good.  Usually I'll have about 20 or so in some stage on incubation.  If they go much more than a month without getting completed, they are probably never going to make it, but I hate to consign them to the abyss without a chance, so here are a couple of developments that will never be complete posts unless I get some comments.  Yes, you the reader can promote any member of this sad group of auxiliaries into full membership in the Legion of Super Posts.

Johnny L. Dennis, et ux. v. Commissioner, TC Memo 2010-216

The tentative title was "Not Just Horsing Around".  It is a hobby loss case.  Raising horses is probably the poster boy for hobby losses.  This couple though was seriously trying to make a living raising horses.  Probably the most disturbing part of the case is that the Tax Court thought it was a plus that he did a cost benefit analysis on calling the vet when his horses had colic and determined it was not worth paying for the treatment.  They also got credit for not riding the horses that much. 

Rick Mahlum, et ux. v. Commissioner, TC Memo 2010-212

This is a collection due process case.  The taxpayers owed about $15,000.  They claimed the IRS abused its discretion in not considering their alternative.  They did not submit financial data or get in current compliance.  Their proposal was for the IRS to put their account in non-collectible status.  Reading some of these collection cases, I sometimes think Congress created a monster with the Taxpayer Bill of Rights.  Once it is determined that you owe the tax you are entitled to a hearing on any collection action the Service makes and you can then appeal the results of that hearing to the Tax Court.  I don't comment on tax policy though, except when I do.  Mr. Mahlum lost.

State Farm Mutual Automobile Insurance Company and Subsidiaries v. Commissioner, 135 T.C. 26

Tentative title was "Good Hands".  This concerned section 832.  Section 832 falls in Subchapter L, which is the Subchapter I know the least about.  The taxation of insurance companies is a field unto itself.  It was actually the story behind the tax controversy that was interesting.  One of State Farm's customers was in an accident and found liable.  The judgement against them was $185,849 and the limit on the policy was $50,000.  State Farm appealed.  The customer who had been found liable on the accident then teamed up with the other side, agreeing to give them 90% of his settlement, and sued State Farm for bad faith.  They won $1,000,000 in compensatory damages and $145,000,000 in punitive damages.  Ultimately State Farm ended up being out a little over $16,000,000.  The tax controversy was about what had gone into reserves in one of the years while this was being appealed.  Apparently you can't reserve against punitive damages.  It was more the whole business issue that fascinated me about this.  Not wanting to cut a check for $50,000 ending up costing them $16,000,000 plus whatever legal fees they spent and their exposure had been much higher.

Phu M. Au, et ux. v. Commissioner, TC Memo 2010-247

Title was "Gambling on Software".  I thought this was pretty interesting, but a couple of other bloggers picked it up first.  The first time I read about it, after identifying it myself, was in Rubin on Tax in a post titled Turbotax Defense Rejected.  I think I was pointed there, by Robert Flach, who of course delights in more proof of the unreliability of tax software.  The taxpayers had deducted gambling losses without having gambling winnings and blamed their software.  It reminded me of the time my brother generated himself a return with a large refund that he asked me to review.  I was sorry to have to point out that he had entered miles into his software in a field that called for dollars (That would less than double the deduction this year, but this event was quite a while ago.)  Now that I think about it that was probably the last time my brother had me check his return.  It also reminded me of a case I wrote about in August about taxpayers who were allowed an ordinary deduction for slot machine losses, because they were in the business of gambling.

CICCOLINI v. U.S., Cite as 106 AFTR 2d 2010-7081

Title was "Bless Me Father".  This is another one where the underlying story is more interesting than the tax issue which is pretty mundane.  It concerns a Catholic priest who apparently was embezzling from a charity that he ran :

The conduct underlying the charged offenses occurred during 2003 and 2004. From April 2003 to June 2003, the Defendant deposited $1,038,680 in cash into his bank accounts in 139 separate transactions of less than $10,000. The Defendant admitted that he structured the transactions to evade bank reporting requirements. 31 U.S.C. § 5324(a)(3). When asked where the money came from, the Defendant claims that he held more than a million dollars in cash in his room at the Immaculate Conception Church Rectory and that he only decided to deposit this money in 2003 because he was worried that changes to the appearance of U.S. currency would somehow diminish the value of his cash savings. Ciccolini also does not explain why he kept over $1 million in cash in his room during a time when he had other bank and investment accounts with millions of dollars. Nor could the Defendant explain why he structured the transactions to avoid the reporting requirements. Similarly, the Defendant is unable to explain where this large sum of cash came from, other than implausibly claiming he accumulated it through interest and savings.

An approximate calculation of the Defendant Ciccolini's legitimate after-tax earnings and inheritance to the time of sentencing totals about $1,506,000. By the end of 2003, his total legitimate earnings and inheritance totaled about $1,336,000. These figure fall far short of the $5,590,313 in liquid assets that Ciccolini accumulated by the time of his sentencing. Thus, even under the Court's generous calculations, it is quite clear that Ciccolini is unable to legitimately account for about $4,500,000.

However, with the exception of the $1,288,683 that he already admitted to embezzling from the Interval Brotherhood Home, Ciccolini denies that any of the money is derived from criminal activity. Instead, says that because he lived at the Immaculate Conception Church rectory he had no personal expenses and was able to save all of his earnings. Additionally, he says that because he was saving all of his money that his savings gained significant compounding interest over a thirty-year period.

Ah yes - the miracle of compound interest.

The case was about what his sentence for tax evasion should be.  It ended up pretty mild :

After a thorough consideration of the parties' arguments, the advisory guidelines range, and the other relevant 18 U.S.C. § 3553(a) factors, the Court choose to fashion a non-guidelines sentence. The Court finds that a sentence of one day imprisonment, a fine of $350,000, and a restitution order of $3,500,000 reflects the seriousness of the offense, promotes respect for the law, provides just punishment for the offense, affords adequate deterrence to criminal conduct, and protects the public from further crimes of the Defendant. See 18 U.S.C. § 3553(a)(2). The Court also orders a three-year term of supervised release and a special assessment of $200.

I wonder if he paid the $200 in cash.

Jack Townsend also picked this up in his federal tax crimes blog and is speculating whether there is a larger trend to call for restitution rather than prison time.  As the longest serving member of the board of Just Detention International , I don't joke about such things, but I have to think that the biggest problem a 68 year old priest would have in prison is convincing the other prisoners he is there for income tax evasion.  Maybe that was in the back of the judge's mind.

Their are more candidates for the legion, but that's enough for one post.