Some Stubborn People

Patrick M. Mooney v. Commissioner, TC Memo 2011-35
John A. Raeber v. Commissioner, TC Memo 2011-39
U.S. v. Mostler, 107 AFTR 2d 2011-847

In a fiduciary capacity I once found myself between a tax protester and the IRS. The result was me and the rest of his family being tortured in probate court for over a decade.  Thanks to that experience and a tendency to accumulate generally useless information that I find entertaining, I tend to follow protester type cases.  I have an admiration for stubborn independent thinkers.  There is a limit, though and these folks go well beyond it.


Patrick M. Mooney v. Commissioner, TC Memo 2011-35

 Mr. Mooney did some independent study on the Income Tax Code. He came up with something extraordinary which he shared with the world:

Petitioner operates his own Web site unlearning.org, on which he has published, among other things, an editorial entitled “Unlearning Pays! Hendrickson, Mooney and Others Bring IRS to (Code) in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. Heel.” In that editorial, he wrote: "[A] private sector worker's earnings are not legally subject to the federal tax on income. They never have been, and as long as we still have a Constitution, they never will be.” In that editorial, he also described his plans to request refunds for taxes withheld from his earnings in previous years and to assert that he is not subject to withholding in the current year. He wrote that his strategy is a “get out of income taxes free' Monopoly card” for life.

The website is still there although I didn't find the tax advice or any commentary on how it worked out for him. It was one of those really brilliant plans:

In accordance with the plan described on his Web site, petitioner submitted a Form 1040, U.S. Individual Income Tax Return, for his 2005 tax year with zeros in all boxes for reporting income. He claimed a refund of $2,647.48, which was the amount of Social Security and Medicare taxes that had been withheld from his paychecks. He attached to the Form 1040 two Forms 4852, Substitute for Form W-2, Wage and Tax Statement. In his testimony at trial, petitioner stated that his contention that he had zero income in 2005 is based on his belief that he did not participate in any taxable activity since he lives in the Commonwealth of Virginia and works for private corporations. During 2005, petitioner received $32,207 for services performed for Interstate Industries, Inc. (Interstate Industries), and $2,400 for services performed for the Centre, Inc. (the Centre). Petitioner submitted to both entities Forms W-4 on which he claimed to be exempt from income tax withholding because he expected to have no Federal tax liability. In consequence, the payors withheld no income tax from his compensation.

Despite its fearsome reputation in some circles, the IRS actually has a lot of patience with this type of nonsense:

Respondent also referred petitioner to documents on the Internal Revenue Service Web site titled “Why do I Have to Pay Taxes?” and “The Truth about Frivolous Tax Arguments”, which provided petitioner with specific legal citations explaining why frivolous tax-protester arguments similar to his own have been rejected. Petitioner read both documents.

My mother used to say "Patience is a virtue". I agree and also note that it doesn't always work:

Petitioner dismissed those warnings and respondent's letter, writing that respondent's position has “no merit in the law”, and he protested respondent's disallowance of his refund claim in a letter dated June 15, 2006.

The court found that his behaviour was fraudulent. 

Despite petitioner's being fully informed by respondent about the frivolous nature of his arguments, petitioner's correspondence with respondent has been filled with tax-protester arguments and has not addressed the factual accuracy of respondent's determination. Petitioner has also previously attempted to use similar arguments to dispute his tax liability before this Court, and he is aware that we consider such arguments frivolous and groundless. Petitioner was unsuccessful in his prior litigation before this Court. Yet petitioner has persisted in claiming that he is not subject to Federal income tax or income tax withholding.


I always think of fraud as requiring a little more cleverness than this mishegas.  On the other hand I think the Tax Court cut him a break on the penalty for wasting the Tax Court's time:

We have already imposed a $1,000 penalty pursuant to section 6673(a)(1) on petitioner in petitioner's prior case, during which he raised substantially the same arguments that he has now raised in the instant case. Apparently, the $1,000 penalty did not deter petitioner from making frivolous and groundless arguments before this Court. Accordingly, we shall impose a $2,000 penalty on petitioner pursuant to section 6673. If petitioner persists in raising frivolous arguments before this Court, wasting time and resources that should be devoted to taxpayers with genuine controversies, and continues to refuse to shoulder his fair share of the tax burden, we will not hesitate in the future to impose a significantly higher penalty. Petitioner should think carefully before he files another frivolous or groundless petition with this Court.

The maximum penalty is $25,000.

John A. Raeber v. Commissioner, TC Memo 2011-39

Mr. Raeber was not quite as wacky as Mr. Mooney.  He is probably not a "tax protester" in the classic sense.

In 2006 and 2007 petitioner worked as a self-employed consultant to various architects throughout the world. He operated his consulting business as a sole proprietorship and reported his income and expenses from the business on a Schedule C. Petitioner timely filed Forms 1040, U.S. Individual Income Tax Return, for 2006 and 2007, and attached Schedules C on which he reported gross income of $336,475 and $334,860, respectively, and business expenses of $252,013 and $253,490,  respectively.


Respondent audited petitioner's 2006 and 2007 returns and requested that petitioner substantiate all of his Schedule C business expenses. Petitioner refused to substantiate any of his claimed business expenses, arguing that the substantiation requirement violates his Fifth Amendment rights under the U.S. Constitution. Respondent then issued petitioner a notice of deficiency disallowing petitioner's deductions for business expenses claimed on his Schedules C.

I have some level of sympathy with his argument:


Petitioner argues that reporting his expenses on his 2006 and 2007 Schedules C and signing his returns under penalty of perjury constitute sufficient substantiation.

The Court does not:

We have long held that signing a return under penalty of perjury is not sufficient to substantiate its accuracy.

I think I get the Court's point much as I would like to live in a world where a man's word is his bond.

This is where I start losing sympathy for Mr. Raeber:

At trial the Court warned petitioner that his Fifth Amendment claim would not excuse him from his burden to substantiate his claimed business expenses and offered petitioner an additional opportunity to introduce evidence to satisfy his burden. However, petitioner continued to assert his Fifth Amendment privilege and offered no further evidence to substantiate his claimed business expenses. Accordingly, we sustain respondent's disallowance of petitioner's deductions for business expenses claimed on his Schedules C for 2006 and 2007.


So there you are in a court and the judge is explaining to you that the privilege against self-incrimination, one of the two things that you can learn are in the Constitution by watching television regularly, doesn't apply to tax returns.  (The other thing you learn is "separation of church and state", which actually isn't there).  Do you really think that you are the first person since 1913 to make this argument and that the system is going to see the error of its ways ?

U.S. v. Mostler, Cite as 107 AFTR 2d 2011-847

From a young age, Mostler claims to have held the belief that the payment of federal income taxes was voluntary. Despite this belief, Mostler paid his income taxes from 1982 through 2000. Following some additional research, largely conducted on the Internet, Mostler decided not to pay his taxes from the years 2000 through 2005. Although he was contacted by IRS agents, their refusal to respond to his letters with an affidavit of authority to collect taxes led him to conclude that he still did not have to pay. When an IRS agent arrived at his home, however, it caused some familial strife, and Mostler agreed to pay his back taxes and to continue to pay his taxes going forward. Despite this agreement, he still maintains his belief that the payment of federal income taxes is entirely voluntary.

In a recent post about abusive tax shelters, I observed that if you start talking about whether a six year statute of limitations applies, it is a sign that you have a really bad plan on your hands.  What could be worse ?   What is worse is when you start arguing about jury instructions.


Mostler first argues that the District Court's jury instruction on the issue of willfulness was confusing as a whole, although he concedes that no single statement by the District Court was incorrect. The District Court stated as follows:


The third element the Government must prove beyond a reasonable doubt is that the defendant acted willfully. Willfully means a voluntary and intentional violation of a known legal duty.... Defendant's conduct was not willful if he acted through negligence or a mistake or accident or due to a good faith misunderstanding of the requirements of the law. A good faith belief is one that is honestly and genuinely held. A good faith misunderstanding of the law or a good faith belief that one is not violating the law negates willfulness, whether or not the claimed belief or misunderstanding is objectively reasonable. A defendant's views about the validity of the tax statutes are irrelevant to the issue of willfulness and need not be considered by the jury. However, mere disagreement with the law or belief that the tax laws are unconstitutional or otherwise invalid does not constitute a good faith misunderstanding of the requirements of law. All persons have a duty to obey the law whether or not they agree with it. Any claim that the tax laws are invalid, unconstitutional, or inapplicable is incorrect as a matter of law.


 Mostler asserts that this instruction left the jury confused because although the issue of whether the tax laws actually did apply to him is irrelevant for the jury, the issue of whether he believed that the tax laws applied to him is at the heart of his defense. He argues that a reasonable juror easily could have concluded from this instruction that she was required to convict even if Mostler had a good faith misunderstanding of the mandatory nature of the tax laws.

Sadly the majority of us deluded people who believe that taxes are mandatory will be paying for Mr. Mostler to be closely supervised for 18 months.

Conclusion
As long as we continue to have a self-assessment system and a free country, there are going to be
cases like this.  Weak enforcement and the multiplication of procedural safeguards sometimes make me think that taxes are effectively voluntary for a lot of people.

Tax Court Sticking with Three Year Statute on Basis Overstatements

Carpenter Family Investments, LLC, et al. v. Commissioner, 136 T.C. No. 17

The fight over whether a six year statute applies to basis overstatements, which I posted on , earlier today continues.  The Tax Court has ruled that the three year statute applies.  This particular cases is appealable to the Ninth Circuit.


When enacting section 6501(e)(1)(A) in 1954, Congress could not possibly have foreseen the development of the tax shelter industry and the use of complex devices, such as Son-of-BOSS transactions, which seek to artificially inflate bases of partnership assets to achieve tax alchemy. Much as we may be tempted, we cannot speculate on how the Congress that enacted section 6501(e)(1)(A) would have meant it to apply in the present-day context. To paraphrase Justice Holmes, we do not inquire what the legislature would have meant. Cf. Holmes, “The Theory of Legal Interpretation”, 12 Harv. L. Rev. 417, 419 (1899), reprinted in Collected Legal Papers 207 (1920) (”We do not inquire what the legislature meant; we ask only what the statute means.”). In this case, we do not even ask what the statute means; we merely ask what the Court of Appeals for the Ninth Circuit and the Supreme Court have told us the statute means.


The Court of Appeals for the Ninth Circuit tells us that Colony controls the meaning of the phrase “omits from gross income” as it now appears in section 6501(e)(1)(A). Bakersfield Energy Partners, LP v. Commissioner, 568 F.3d at 778. And the Supreme Court has told us, in Colony, that this phrase does not include an overstatement of basis. We thus hold that only a 3- year limitations period under section 6501(a) applies here. Consequently, we hold the FPAA issued after the expiration of this 3-year period to be untimely. We further hold petitioner's and the partners' consents executed after the FPAA was issued to be invalid. We will therefore grant petitioner's motion for summary judgment. The Court has considered all of respondent's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.

Presumably, we haven't heard the last on this issue.

Should IRS Gets Extra Time to Nuke Abusive Shelters ?

HOME CONCRETE AND SUPPLY, LLC v. U.S. 107 AFTR 2d 2011-767
BEARD v. COMM. 107 AFTR 2d 2011-552
GRAPEVINE IMPORTS, LTD v. U.S., Cite as 107 AFTR 2d 2011-1288

Back in October I wrote about Fidelity International Currency, the epic story of EMC founder Richard Egan's doomed tax shelters.  One of the things that I highlighted in the case was attorney Stephanie Denby's meticulous documentation of the thought process that went into the transactions:

Denby also rated and commented with respect to the manner in which the tax loss was generated, noting a plus if the transaction was “harder for [the] IRS to find” and a minus if the transaction was “easier” for the IRS to find.

Denby also rated and commented with respect to their complexity, noting a plus if the complexity of the structure made it harder for the IRS to “unwind” or “pick-up” and a minus if the simplicity of the structure made it easier for the IRS to trace.
 
One of her comments concerned basis:
 
Secondly, some of the transactions focus on generating basis as opposed to capital loss. Basis is more discrete [sic] and less likely I believe to cross the IRS radar screen.
 
It reminded me of an apocryphal story about an accountant who advised his clients "Put in puchases.  They never look there.", whenever he encountered a disbursement of dubious deductibility.
 
One of the commnents on that post was:
 
Jeff said...
ignoring the effectiveness of the reg, this case certainly shows the need for reg §301.6501(e)-1T(a)(1)(iii).

What's that about besides proving that Jeff is even more of a tax geek than I am ? Here's the deal.  The statute of limitations is three years on tax returns.  That means that if you filed timely you can relax about 2007.  Of course there are exceptions.  There are always exceptions, except when there aren't any, which would be an exception.  The relevant one here is that if you omitted more than 25% of your gross income, the statute of limitations is 6 years.  What the regualtion did for all returns that were still open in September of 2009 was "clarify" that an overstatement of basis was an ommission from gross income.

Home Concrete was a fairly typical "get some basis with a one sided entry" type of deal:

On May 13, 1999, each of the taxpayers initiated short sales 1 of United States Treasury Bonds. In the aggregate, the taxpayers received $7,472,405 in short sale proceeds. Four days later, the taxpayers transferred the short sale proceeds and margin cash to Home Concrete as capital contributions. By transferring the short sale proceeds to Home Concrete as capital contributions, the taxpayers created “outside basis” equal to the amount of the proceeds contributed. 2 The next day, May 18, 1999, Home Concrete closed the short sales by purchasing and returning essentially identical Treasury Bonds on the open market at an aggregate purchase price of $7,359,043.

They weren't at all ashamed of what they did:

Home Concrete's 1999 tax return reported the basic components of the transactions. Its § 754 election form gave, for each partnership asset, an itemized accounting of the partnership's inside basis, the amount of the basis adjustment, and the post-election basis. The sum of the post-election bases is indicated at the end of the form. On its face, Home Concrete's return also showed a “Sale of U.S. Treasury Bonds” acquired on May 18, 1999 at a cost of $7,359,043, and a sale of those Bonds on May 19, 1999 for $7,472,405. The return also reported the resulting gain of $113,362. Similarly, the taxpayers' individual returns showed that “during the year the proceeds of a short sale not closed by the taxpayer in this tax year were received.”


Eventually the IRS caught on:

Notwithstanding these disclosures, the Internal Revenue Service (“IRS”) did not investigate the taxpayers' transactions until June 2003. The IRS issued a summons to Jenkins & Gilchrist, P.C., the law firm that assisted the taxpayers with the transactions, on June 19, 2003. The parties agree that substantial compliance with the IRS summons did not occur until at least May 17, 2004.


As a result of the investigation, on September 7, 2006 the IRS issued a Final Partnership Administrative Adjustment (“FPAA”), decreasing to zero the taxpayers' reported outside bases in Home Concrete and thereby substantially increasing the taxpayers' taxable income.

Absent the six year statute, they were too late.  They tried to argue that since the case hadn't been decided by September of 2009, the new regulation should apply, but the Court wasn't buying it:

In Colony, Inc. v. Commissioner of Internal Revenue, the United States Supreme Court held that an overstatement of basis in assets resulting in an understatement of reported gross income does not constitute an “omission” from gross income for purposes of extending the general three-year statute of limitations for tax assessments. 357 U.S. 28 [1 AFTR 2d 1894] (1958). Because Colony squarely applies to this case, and because we will not defer to Treasury Regulation § 301.6501(e)-1(e), which was promulgated during this litigation and, by its own terms, does not apply to the tax year at issue, we reverse and hold that the tax assessments at issue here were untimely.


The Beard decision was a similar deal.  The Court gave a nice summary of the concept:

Short selling is often a way to hedge against the market, but a Son-of-BOSS transaction relies on the delayed tax recognition of a short sale for a gamble of a different kind. In Son-of-BOSS, the taxpayer contributes the proceeds of the short and the corresponding obligation to close out the short to another legal entity in which he has ownership rights (usually a partnership). The taxpayer (or, perhaps more accurately, the tax-avoider) then sells his rights in the partnership, claiming an inflated outside basis in the partnership corresponding to the amount of the transferred proceeds without an offsetting basis reduction for the transferred liability. This is advantageous for the taxpayer because the capital gains tax on such a transaction is calculated by subtracting the outside basis from the amount recognized in the sale of the ownership rights, so a higher outside basis means lower capital gains tax and more money in the pocket of the taxpayer. Therefore, the gamble in the Son-of-BOSS transactions was that the participant could legally increase his outside basis in a partnership by not reporting the offsetting transferred contingent liability of the short position on his tax return.

The timing in Beard was similar.  It was a 1999 return that the IRS did not catch up with until 2006.  The Court in Beard (Seventh Circuit as opposed to Fourth Circuit in Home Concrete) concluded that in a non-business transaction the six year statute applies:


Using these definitions and applying standard rules of statutory construction to give equal weight to each term and avoid rendering parts of the language superfluous, we find that a plain reading of Section 6501(e)(1)(A) would include an inflation of basis as an omission of gross income in non-trade or business situations. See Regions Hospital v. Shalala, 522 U.S. 448, 467 (1997); Hawkins v. United States, 469 F.3d 993, 1000 (Fed. Cir. 2006). It seems to us that an improper inflation of basis is definitively a “leav[ing] out” from “any income from whatever source derived” of a quantitative “amount” properly includible. There is an amount—the difference between the inflated and actual basis—which has been left unmentioned on the face of the tax return as a candidate for inclusion in gross income.


They get there without even considering the IRS regulation.  Had they needed it, though, they would have used it:
Much ink has been spilled in the briefs over whether temporary Treasury Regulation Section 301.6501(e)-1T(a)(1)(iii) would be entitled to Chevron deference if Colony were found to be controlling. This temporary regulation, which was issued without notice and comment at the same time as an identical proposed regulation, purports to offer taxpayers guidance by resolving an open question and stating definitively that in the case of a disposition of property, an overstatement of basis can lead to an omission from gross income. This temporary regulation has since been replaced by a nearly identical final regulation, issued after a notice and comment period. T.D. 9511 (eff. Dec. 14, 2010), 75 Fed. Reg. 78,897. Because we find that Colony is not controlling, we need not reach this issue. However, we would have been inclined to grant the temporary regulation Chevron deference, just as we would be inclined to grant such deference to T.D. 9511.


Grapevine Imports was close to an identical fact pattern to Home Concrete even to the extent of partiotically using contracts on US Treasuries to create phony basis.  In Grapevine, the Federal Circuit reviewing a Court of Claims decisions says that the new regulations make all the difference:

The new Treasury regulations cannot, of course, change the Tax Code. But they may reflect the Treasury Department's exercise of authority granted by Congress to interpret an ambiguity in that code. Where an executive department, entrusted with interpretive authority, promulgates statutory interpretations that are reasonable within the circumstances established by Congress, then the courts must defer to that interpretation. Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843–44 (1984).


When the Court of Federal Claims entered judgment for Grapevine, the Treasury Department had not yet exercised its interpretive authority over the limitations periods at issue in this case. It now has, and we, like the Court of Federal Claims, are obliged to defer to that interpretation. We therefore reverse the entry of judgment for Grapevine and remand for further proceedings.

Frankly this stuff is all a little too lawerly for me being a simple minded CPA, who loves debits to equal credits. I would like to extract a practical lesson from it.  There are probably some people who did Son of Boss deals or similar offenses against the fundamentals of double entry in 2005 or maybe even 2004 who thought they were home free and now have to start sweating again, while they vigorously root for the Fouth Circuit.  The lesson is this.  If you are thinking about a transaction or return filing positions and find yourself getting into a discussion of whether a three year statute or a six year statute would apply, just don't do it.

P.S.

I did a follow-up on this as the Tax Court just issued another ruling on this issue.

What is Nothing ?

                            What did you get, kid ?
                             I didn't get nothing. 
                            I had to pay $50 and pick up the garbage

Estate Of Axel O. Adler v. Commissioner, TC Memo 2011-28

I thought I'd be able to make more out of this, but there is really a very simple point.  If you want valuation discounts, don't rely on fractional interest in real estate.  Form a family limited partnership.

Private Letter Ruling 201104066

I find that the hardest things to go through are private letter rulings.  They come in fairly tedious batches of late S elections and IRA rollover mishaps.  It's rare that there is anything really interesting except denials of exempt status.  Nothing yet has risen to the level of comic masterpiece equivalent to the tax court decision in Free Fertility, but some of them are pretty good.  This one was about horses.  I think the IRS has something against horses:

The general purpose of this corporation shall be to identify, conserve, safeguard, and propagate the genetic integrity of the horse originally found in the possession of the Tr. in Country, and those bred in other countries by breeders whose foundation stock was drawn entirely from those tribes of the T



Your Articles further provide, "the purpose shall be accomplished through research of historical and genetic (scientific) data to add to the X or disqualify horses from the 'X', according to the standards as set down in said 'X'. The purpose shall be additionally accomplished through education of the international horse community, the general public, and youth (by publication), regarding historic, genetic and athletic value of these endangered genetic lines, and collection and sharing of historic artifacts, letters and documents."

I don't know.  Sounds pretty good to me.  IRS didn't like it:

You have not demonstrated that you do not inure to the benefit of private individuals. You, M, maintain a website, g, that contains links to private sellers of Q horses. Those breeders earn a profit, and private benefit, by being able to sell horses and/or stud services to interested persons. As a result, under section 1.501(c)(3)-d(1)(ii) of the regulations, you do not meet the requirements of section 501(c)(3) of the Code.

The Service did suggest that they might qualify under 501(c)(5):

You are similar to the organization described in Rev. Rul. 55-230. You are organized to guard the purity of the breed of Q horses; to promote interest therein; and to help fund research on the genetics of this breed of horses. You state that you are unlike this organization because you are not a horse registry. We disagree because you do maintain a partial horse registry, as you maintain listings of horses and their genetic parents in your newsletters. You are also similar to the organization described in Rev. Rul. 55-230 because you promote and fund research on the genetics of this particular breed of horse.


Michael P. Schwab, et ux. v. Commissioner, 136 T.C. No. 6

This is probably worth a full length post, but I'm not going to get to it.  In case you've been holding your breath, it's what ties in to the quotation from Alice's Restaurant.  The Schwabs had participated in something called an 'Advantage 419' plan, which then invested in variable life insurance policies.  When I was interviewed by The Wandering Tax Pro one of his questions was what is the best tax advice I could give to anyone.  Frankly, I lied.  I save my best advice for paying clients, but the best advice, which I can give for free is pretty good- Sometimes you should just pay the taxes. It's pretty clear that paying the taxes and stuffing the after tax income in a mattress would have been a better deal than this plan worked out to be.

 Because of IRS activity in the area, the Schwabs decided that their 419 plan wasn't such an advantage anymore.  The variable life insurance policies were distributed.  The taxpayers and the IRS were arguing about whether surrender charges should be considered in valuing the policies.  There was no net surrender value after considering surrender charges, so the taxpayers argued that like Arlo they didn't get nothing. The Court after grousing about the poor record it had to work with took a different approach.  It attempted to compute the fair market value of the policies, which as it turned out was something but not much.  Because of a no lapse provision the policies provided coverage for a short time before they expired.  The Court used standard valuation tables to come up with a value of about $2,000, which was more than 0, but a lot less than the $80,000 or so the IRS was arguing for.

Songie S. Milhouse, et vir., v. Commissioner, TC Summary Opinion 2009-012



This decision was dated 2/9/2011 so I suspect the number is wrong. That's what they have in RIA anyway and who am I to argue?  It is an innocent spouse case in which the spouse is found innocent.  Mrs. Milhouse had separated her finances from her husband because of a pattern of irresponsibility on his part.  She put money into a joint account that she had access to, but he ran.  The IRS thought that since she could have looked at the account, she should have known about his unreported income. 

Respondent did not offer any corroborating evidence at trial to support a finding that petitioner had actual knowledge of the items giving rise to the deficiency, nor did respondent substantively cross-examine petitioner or Mr. Todd on the scope of petitioner's knowledge. Petitioner, on the other hand, credibly disavowed any actual knowledge of the items giving rise to the deficiency and provided a vigorous cross-examination after Mr. Todd's direct testimony. Accordingly, we hold that petitioner did not have actual knowledge of the items giving rise to the deficiency that would preclude the granting of relief under section 6015(c)

It was good that Mrs. Milhouse won the case, but I think the lesson here is that if you think your spouse is not financially responsible, think very carefully before filing a joint return.  Just because the vast right wing conspiracy thinks civilization will end if gay people are allowed to file them doesn't mean they are always a good deal.

Is IRS Ready to Attack Advance Bonus Arrangements ?

CCA 201104039

This is a short one so I will reproduce it in full :


Hi ———-, I haven't encountered the issue before. I don't know whether the arrangement is common in the industry but I suspect it is. I think the issue is whether the advances in anticipation of future bonuses were bona fide loans. The rev ruls attached are the relevant authority (not the material cited in the TAM and the write p which seem -u inapposite). It would be relevant what happens if an employee terminates before the “loan” is repaid, and how the arrangement is documented and what actually occurs in practice. We could discuss factual development with you and the agent.


Attachments: Rev Rul 68 239, Rev Rul 68-337 -

It would be nice if we knew what "the industry" is.  Unless they are cleared up in the same tax year, an arrangement where someone is getting a "loan" against a future bonus is probably fraught with peril for both the employer and the employee.  If it is a common practice in you industry, this might be a heads up.  It's interesting that the Chief Counsel is dusting off some pre-Woodstock revenue rulings.  They are also pretty short so I can give you the bulk of them:

Rev. Rul. 68-239, 1968-1 CB 414

Advance payments made to salesmen against unearned salary, commissions, or other remuneration for which they are to perform services, but which they are not legally obligated to repay are wages at the time of payment for Federal employment tax purposes.

The M company makes advance payments (actually or constructively) to its sales employees against unearned salary, commissions, or other remuneration for services to be performed. The advances are charged to each employee's account, and any advance in excess of the later earned salary, commissions, or other remuneration is carried as an account due from the employee. If an employee's services are terminated, the excess is charged to profit and loss.


Advance payments actually or constructively made by M to an employee for services to be performed are “wages” for Federal employment tax purposes at the time of payment where the salesman's obligation in return is to perform services. Under the circumstances, amounts advanced by the M company to its salesmen are subject to the taxes imposed by the Federal Insurance Contributions Act and the Federal Unemployment Tax Act, and to the Collection of Income Tax at Source on Wages.

Rev. Rul. 68-337, 1968-1 CB 417
 
Advance payments made to employees that they are legally obligated to repay are not wages for Federal employment tax purposes.
The question is whether advance payments made to employees of the M company are wages subject to the taxes imposed by the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954).


The M company engages in a general investment banking business and maintains trading departments in its principal offices in several cities. These departments are operated by employees who have profit-sharing agreements with the company. At the end of each calendar month a statement of account is made for the employees showing the net profits credited to their accounts. The net profits represent the gross earnings of such employees, less expenses incurred in the operation of the trading departments. The employees may make withdrawals at any time of amounts standing to their credit. They are also allowed, with limitations, cash advances where there is no credit balance in their accounts. At the time such cash advances are made, they are set up by the company on its books as amounts due from employees and are acknowledged by the employees either by note or letter.

In the instant case, there is an acknowledgment of the indebtedness by note or letter, the M company carries the balances as accounts due from employees, and there is a legal obligation on the part of the employees to repay the advances. This obligation must be satisfied although the employment is terminated prior to payment. The advance payments in the present case are, therefore, distinguishable from those in Revenue Ruling 68-239.

Under these circumstances, the advance payments to the employees of the M company are loans and are not wages for purposes of the taxes imposed by the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, or the Collection of Income Tax at Source on Wages.


So the revenue rulings are pretty clear.  If you want to have a deferral, there has to be a legal obligation to repay.  Since when these revenue rulings were written George Orwell's famous dystopian novel still had a future date, they did not address interest.  (Code Section 7872 was added in 1984.  Thanks to a novel called The Pale King, literary tax geekiness is going to become trendy.  I just got the novel for my Kindle.  It remains to be seen whether I'll write about it here or in my bizzaro blog.)  With the short term AFR at 0.55% charging or imputing on advances will not be that big a deal.  Nonetheless, I think this sort of thing is a very bad idea.

The reason it is a bad idea is that in order for it to work the employer must be able to legally enforce repayment from employess who don't earn the expected bonuses.  I can only think of two possible reasons that you would be advancing them their bonuses.  One is because they think they are  investment geniuses.  The other, probably more common, is that they need the money to maintain their desired lifestyle.  In the first instance, there is significant risk that they won't be able to repay.  In the latter, there is a virtual cetainity.  Not only that, they are in effect either investing or living on their gross income rather than their after tax income.  Even if they continue as employees there will be a strong inclination to put off the day of reckoning.

Does Virginia Historic Decision Impact Boardwalk Holding ?

VIRGINIA HISTORIC TAX CREDIT FUND 2001 LP v. COMM., Cite as 107 AFTR 2d 2011-1523

When I consider all the really interesting  tax things I write about besides same sex couple issues - breast pumps, soldiers of fortune, strip joints and even World of Warcraft -  it is amazing that my second ranked post is a pretty geeky one. Historic Boardwalk Hall addressed the question of whether it was valid to allocate an historic rehabilitation credit to a partner who was investing for a very limited economic return.  The Court found that the point of the historic credit was to encourage developments to be done in a way that would be less than economically optimal, but had other social utility. The fact that the development would not otherwise be feasible is the whole point of the credit. The post even got some comments, including a negative one, which I thought was really cool.

At least one commentator has speculated that the more recent decision in Virginia Historic Tax Credit Fund (VHTCF) has emboldened the IRS to appeal the Historic Boardwalk (HB) decision.  Apparently they filed the appeal in Boardwalk just after this decision.  I'm not a lawyer so the mysteries of litigation strategy are beyond me.  With that said, it seems to me that the IRS should not so much be emboldened by winning this case, rather they would have been utterly bereft if they had lost it.  The entities are partnerships and they have historic in their name.  There is an issue as to whether people were in substance partners.  That's about what they have in common.  Otherwise they are very different.

VHTCF does not concern the allocation of the federal historic credit.  It is about the federal tax effects of dealings in a state historic credit.  Many states make their historic credits and film credits freely transferable.  It is a fairly convoluted story but this was true of Virginia credits up to a certain point.  Subsequent credits though could only be used by owner of the building.  The regulations, however, allowed partners in a partnership to allocate the credit any way they saw fit.  That is not the way federal credits work.

VHTCF invested in partnerships that generated historic credits and also purchased some of the earlier transferable credits.  Investors in VHTCF would receive $1.00 of Virginia credit for every $0.74 - $0.80 that they put in (VHTCF had bought the credits for around $0.55).  In a subsequent year they would be redeemed for a nominal amount.

The promoters of VHTCF threw in a clever wrinkle.  When they paid for the credits they recorded the amount paid as an expense.  The money they received from the investors was considered a capital contribution.  So the partnership had a loss.  Frankly I get a headache when I try to think through the 704(b) issues that this transaction raises.  My guess is that the "losses" were sheltering the promoter's income.  If they were being allocated to the investors, I don't think anything very exciting would be happening, except maybe helping the investors stay out of alternative minimum tax.  There are several rulings, including PLR 200348002, that hold that when you use a purchased tax credit certificate to offset your state tax, you are entitled to deduct your cost of the certificate under Code Section 164.  I don't know what would have been happening from a federal income tax perspective to the VHTCF investors.  If you paid $0.80 on the dollar to buy a certificate to apply to your state income tax and from a federal point of view you had a capital loss, that could work out to be a crappy deal unless you were in amt (which it seems almost everybody is nowadays) and had capital gains (which people used to have back in the good old days).

At any rate, the court ruled that what was happening in substance was a sale of the credits and there weren't any losses to allocate to anybody.  Although it doesn't rise to the same level, this case has a little in common with some of the Son of Boss shenanigans that I have written about.  When you try to put it into debits and credits, it's a little challenging.  Bottom line, I don't think it was reasonable to expense the payments that were made for the credits, particularly if the loss was not being allocated to the partners who funded the deduction.

I really don't think there is any connection to the HB scenario.  If the IRS were to prevail on HB, it will send shivers not just through the historic rehabilitation business, but also low income housing.  In that industry, it is practically a given that the credit is not usable by the players actually doing the development.  VHTCF appears to have been an effort to double dip on federal deductions.

Deadline Passes For Some But Not All Same Sex Couples for 2007

Happy Patriots Day.  Patriots Day is a legal holiday in Massachusetts. "Twas the 18th of April in seventy-five, hardly a man is now alive that remembers that famous day in year."  Great poem.  He left the part about the coin toss that Bill Cosby filled in later:

Suppose way back in history if you had a referee before every war, and the guy called the toss. Let’s go to the Revolutionary War."


[Referee speaking] "British call heads. It’s tails. What do you do, settlers? . . . Settlers say that during the war they will wear any color clothes that they want to, shoot from behind the rocks and trees and everywhere. Says your team has to wear red and walk in a straight line.

If you are ever in the area be sure to visit Minuteman National Park. I couldn't find a statue of the referee when I was there, but it is a big park.  When the due date used to fall on Patriots Day that would extend the deadline for people who filed in Andover.  Apparently nobody is filing in Andover any more.  I haven't really studied the issue, but this is the end of tax season for everybody this year.

It is also the end of the line for many people being able to amend their 2007 returns.  If you have an amended 2007 return that you are planning to drop in the mail today, you might want to consider seeing if there is an IRS office that will accept it within driving range.  "Timely mailed is timely filed" rule does not apply to amended returns.  I have been talking about amended return opportunities for same sex couples since a post in August.  I went into some detail on different scenarios in a post titled Deadline Looms For Same Sex Couples Amended Returns for 2007.  There are two independent events to consider. One is the IRS decision that community property laws should be considered in computing the tax of registered domestic partners.  The other is the decision in Gill v OPM that declared Section 3 of the Defense of Marriage Act unconstitutional.  I won't rehash the whole thing here.

The important point is that the statute of limitations has not expired for people who extended their 2007 returns.  There are also other possible scenarios. If you were audited for 2007 and made a payment in the last two years, the statute might be partially open.  Here is a useful link that discusses the issue.  There are two important points I will emphasize.  If you extended your 2007 return you don't necessarily have until October of 2011 to file an amended return.  If you do not extend the three year clock does not start ticking until April 15 regardless of when you file.  If you extend, however, the clock started when you actually filed, not the extended due date.

The second point is a cautionary tale that I got from Patricia Cain.  I think her blog on same sex tax issues is great.    This caution relates to California Registered Domestic partners.  I'll use Robin and Terry.  In 2006 Robin made $200,000 and Terry made $25,000.  They each extended their returns, which they filed in September.  In October of 2010, they amended their returns to take into account the community property laws.  Robin gets a refund and Terry owes money, but the net is positive (i.e. Robin's refund is greater than Terry's deficiency).  They blew the deadline which in their case was September.  Oh well.  Only it's a lot worse.  Robin's amended return was late, but Terry is claiming an increase in gross income greater than 25%, which is a six year statute.  Ouch.

My observation on this when I first noted CCA 201021050 was that the IRS had indicated that although the ruling would be mandatory for 2010, amending was optional.  So why not just have Robin amend ?  Ms. Cain believes that only amending for the refund return is a strategy that does not pass the smell test.  I have to agree that I wouldn't plan on using it as an air freshener, but I still haven't found that it doesn't work.

I'd let things develop a little further before doing any 2008 amended returns.  The people with the most interesting issues there are the 18,000 same sex California married couples.  They can not amend or amend to conform to community property law like registered domestic partners.  They also have the additional option, less certain but pretty good, of amending to joint returns based on the decision in Gill v OPM.  On  a pure bracket analysis the community property option is probably better, but there is a lot more to joint returns.  If one of them has large capital gains and the other large capital losses, a joint return could be a huge benefit.

I've got a pretty big pile of other developments to work through now that things are quieting down a little at the day job.  If you are following same sex tax issues be sure to keep an eye on the Santa Clara blog, it is very focused.

Happy Emancipation Day

I'm writing this Sunday night April 10 to be the scheduled post for April 15, which would be the last day of tax season but for the holiday . Emancipation Day is a very worthy holiday. As I note towards the end of a lengthy post in my bizzaro blog, compensated emancipation probably would have been less expensive in money alone than the Civil War. There are a variety of reasons why it was not politically possible including racism being pervasive in the whole country not just in the slaveholding states. Nonetheless, it is an engaging counterfactual.

Emancipation Day is April 16, the day in 1862 that the slaves in the District of Columbia were emancipated 9 1/2 months before the effective date of the Emancipation Proclamation.  Owners who were loyal to the Union received monetary compensation.  Since Emancipation day falls on a Saturday it is celebrated on Friday, April 15th, the normal due date for tax returns. Falling on a holiday extends the due date to the next business day April 18th, which as it happens is a holiday in Massachusetts.  Patriots Day - "One if by land and two if by sea and I on the opposite shore shall be, ready to ride and sound the alarm to every Middlesex village and farm".  In the past Patriots Day has extended tax season for many people since there is an IRS Service Center in Andover.  I noticed, however, on one of the few paper filed returns I've handled that the instructions say to send it to Kansas City so I guess Monday the 18th is the end of the line.

I've got a pretty big backlog of material so I'm thinking I might go beyond the Monday, Wednesday, Friday schedule, but we'll see.  I'm looking forward to the return of The Wandering Tax Pro.

A Wrinkled Return

Shawn C. Blanchette, et vir. v. Commissioner, TC Summary Opinion 2011-15

Tax court decisions bring us into many dimensions of human experience - lactation, mercenaries, underwear and "gentlemen's clubs" to name but a few.  I wouldn't have thought that I'd ever get to mention tessaracts, but there you have it.  Ms. Blanchette called her science fiction memorabilia business A Wrinkle in Time, no doubt in honor of Madeleine L'Engle's novel in which the existence of extra spatial dimensions beyond the three we are familiar with plays an important role.  Just as a cube is what you get when you expand the concept of a square into the third dimension, a tessaract is what you get when you expand a cube into the fourth dimension.  You can probably get a better notion of this from reading Sphereland, the sequel to Flatland, which you should probably read first.  They are both great.  "A Wrinkle in Time" is pretty good too although it doesn't stack up to a truly great science fiction work like Acts of the Apostles by John Sundman.  (You would cause a great deal of offense if you counted the better selling work with the same title science fiction).

Because of my professional bias I usually root for the taxpayer when I am reading the case unless they are being really lame.  The clever title for her business made me really pull for Ms. Blanchette as I was reading along.  I guess I didn't root hard enough to cause a reversal in the flow of time so even after I was done reading the case, she had still lost.  It was a hobby loss case and I think it is a fairly instructive one.  Here's the story:

In 1992 Ms. Blanchette formed and operated a proprietorship under the name A Wrinkle in Time (AWIT). From 1992 through 1995 Ms. Blanchette operated AWIT as a retail store in Santa Clara, California, leasing space and obtaining a business license to do so. Ms. Blanchette was the primary business owner and was intimately involved with all aspects of the business. On average, she worked at her store 14 hours per day, 7 days a week. Ms. Blanchette aggressively promoted AWIT locally with newspaper advertisements and regionally at science fiction conventions. Although Ms. Blanchette adopted a business plan in 1993 to transform AWIT into a partnership that could further penetrate the science fiction memorabilia market, she never executed that plan. Despite Ms. Blanchette's efforts, her collectibles activity generated losses from 1992 through 1995.

In 1996 Ms. Blanchette relocated to Sunnyvale, California, where she operated AWIT as a retail store in leased space until 2001. During that time, Ms. Blanchette developed a Web site to sell her collection to online customers. Although she adopted a second business plan in 2000 to rebrand AWIT's online image, Ms. Blanchette did not bring that plan to fruition. She continued to incur losses from 1996 through 2001.

In 2001 Ms. Blanchette relocated to Las Vegas, Nevada. From 2002 through 2005 Ms. Blanchette sold science fiction memorabilia mostly online and at conventions. During that time Ms. Blanchette rented warehouse space to store her collection; and although the warehouse was generally not open to the public, she would sometimes show that collection to potential customers. Ms. Blanchette incurred losses from 2002 through 2005.

Not surprisingly the business also had losses in 2006 and 2007.  Enough being enough, the Service disallowed losses from 2005 to 2007 for a total deficiency of slightly less than 10 grand.  The Court referred to the nine factors that should be considered in a hobby loss (Section 183) case:

 (1) The manner in which the taxpayer carries on the activity;
 (2) the expertise of the taxpayer in carrying on the activity;
 (3) the time and effort expended by the taxpayer in carrying on the activity;
 (4) the expectation that assets used in the activity may appreciate in value;
 (5) the success of the taxpayer in carrying on other similar or dissimilar activities;
 (6) the taxpayer's history of income or loss with respect to the activity;
 (7) the amount of occasional profits, if any, which are earned by the taxpayer;
 (8) the financial status of the taxpayer;
 (9) elements of personal pleasure or recreation.

1.  Although Ms. Blanchette separated her personal finances from the business and kept thorough records the court noted that she did not use those records to generate business intelligence to move her toward profitability:

Petitioners contend that the online expansion of Ms. Blanchette's collectibles activity demonstrates that she sought to improve the profitability of her activity during the subject years. We disagree. The adaptation of Ms. Blanchette's collectibles activity online occurred some time between 1996 and 2000. Since she moved her collectibles activity online, we have found no significant undertakings on the part of Ms. Blanchette to improve her overall profitability. To the contrary, she continued to add to her inventory without due regard for the losses she repeatedly incurred.

Score one for the IRS.

2. The court called the "expertise" factor a push, unfairly I think:

Ms. Blanchette testified that she consulted with other science fiction memorabilia collectors about her activity. However, she never consulted with accountants, lawyers, or business advisers about her activity. The failure to procure objective business advice is a negative factor while her consultation with other collectors is a positive consideration. This factor is neutral.

I doubt that there are many accountants and lawyers who can tell you a lot about how to make money in the collectibles business.

3.  They also called the time and effort factor a push, which I thought was very unfair.

4. The court did not give Ms. Blanchette the benefit of the doubt on the expectation that her collection would appreciate.  Part of their analysis was way off:

..........even though a portion of Ms. Blanchette's collection was worthless, she did not liquidate those items and reinvest the proceeds in other collectibles with potential for real appreciation.
You do not get very much to reinvest from selling things that are worthless.  Presumably you score big in collectibles from keeping things that are presently perceived as worthless that subsequently become valuable.

Their next point though is one in which Ms. Blanchette could have really helped herself if she had had a detailed list of every item with its cost and estimated fair market value.

Also the court held it against her that she did not insure her collection.  Whether to insure or self insure is a business decision that might be reasonable either way, but it would not have been that difficult for her to get a quote on the cost of insuring her collection.

Factors 5 through 8 were not good either.  Essentially the losses from the science fiction business have been funded by her husbands salary.  It was the ninth factor that was particularly hurtful:

Ms. Blanchette is passionate about science fiction, and she derives great pleasure from her collectibles activity. This enjoyment, however, cannot overcome the complete disregard for profit objective with which she has conducted her activity. Given the small profit potential and significant satisfaction derived from the collectibles activity, we are confident that it is Ms. Blanchette's quest for personal gratification that keeps her going and not any bona fide profit objective.

The IRS really seems to hate horse breeding as a business.  Taxpayers seem to be able to win horse cases in tax court though.  Reading those cases, I always get the impression that the taxpayers somehow convince the judges that they don't particularly like horses.  Consider this from Richard A. Frimml, et ux. v. Commissioner, TC Summary Opinion 2010-176:

This factor favors respondent. Petitioners made many business decisions regarding the purchase, care and sale of a number of Paint horses for their horse activity. Petitioners paid extensive amounts to care for Special when he was injured. On the other hand, petitioners decided to put down a 2-year-old foal that hurt her leg in a fence accident because the cost to heal her exceeded the projected price in selling her.

You can check out my post on it to find out what was so special about Special (has to do with fluids).

I do have to admit that I would have a lot more fun fooling around with light sabers and phasers and reading great works of science fiction like Cheap Complex Devices by John Sundman than trying to manage animals that are considerably larger than I am that seem to defecate a lot so maybe Ms. Blanchette deserved to lose.  I don't care I was rooting for her anywhere.


Full disclosure and celebrity name dropping:

John Sundman and I were in the same high school graduating class.  The Xavier High School class of 1970 also included noted science fiction author Bradley Ferguson author of Flag Full of Stars.

RTFI - Read The Instructions

Brian J. Talaske v. Commissioner, TC Summary Opinion 2011-33

I really don't like the outcome of this case.  The basic story is one that I have seen before. A creditor writes off somebody's debt.  Time passes.  Someone who works for the creditor senses anomalies in the space time continuum.  What is the problem ?  The creditor has taken a deduction without someone picking up income.  That big balance sheet in the sky is out of balance.  Crap.  We forgot to send out the 1099-C.  Let's send it out now.  They don't know where the dead beat is or in one case even have his correct name, but they've got a social security number and they have the address of the IRS so out it goes.

That's pretty much the story with Mr. Talaske, except unlike Dennis Gaffney a/k/a Thomas Gaffney, they seem to have gotten his name correct:

In March 2002, petitioner obtained a First USA VISA (First USA) credit card. Petitioner transferred to this new account balances from credit cards issued by other financial institutions.


In September 2002, petitioner defaulted on his First USA account.


As of March 31, 2003, petitioner's outstanding balance on his First USA account was $23,119.99, consisting of principal of $20,291.22 and finance charges of $2,828.77. On that date, First USA “charged off” principal of $20,291.22 and finance charges of $2,828.77, thereby resulting in a “new balance” of zero.


In or about 2004, First USA was acquired by JPMorgan Chase (Chase). For tax year 2005, Chase issued to petitioner a Form 1099-C, Cancellation of Debt, showing cancellation of indebtedness on December 31, 2005, of $20,291.22. The account number listed on the form matches the number of petitioner's credit card account with First USA.


Petitioner does not recall receiving any Form 1099-C from Chase in 2006, and his Form 1040, U.S. Individual Income Tax Return, for tax year 2005, which was prepared and timely filed in 2006, did not report any income from cancellation of indebtedness.

My first managing partner, who was running a firm founded by his father, who also ran a finance company, had many wise sayings that had been handed down by his father.  One of them was :

You'll never get out of debt by borrowing.

I have to congratulate Mr. Talaske on finding a loophole to that principle.  If you borrow from somebody who writes it off, you will get out of debt.  I doubt that JP Morgan Chase bought First USA because First USA had such a brilliant business model.  Give somebody money to pay off his credit card bills.  Wait one year.  Write off.  Regardless, apparently JP Morgan Chase was a little more compulsive about compliance or something.

When this happened to Mr. Gaffney, he took the matter to tax court and the court determined that whenever it was that the discharge occurred, it wasn't the year of the 1099-C.  Mr.  Gaffney apparently was a little more on the ball though.  Here is what happened with Mr. Talaski:

The March 24, 2008 notice of deficiency was mailed to petitioner at his last known address and was received by him no later than March 30, 2008. Notwithstanding the language in the notice of deficiency about filing a petition with the Tax Court "[i]f you want to contest this determination in court before making any payment,” petitioner did not do so. Rather, by letter dated March 30, 2008, petitioner wrote to respondent's Holtsville, New York service center, the office that had issued the deficiency notice, stating (inter alia) that “I continue to object” and “I will petition the tax court as required if the IRS fails to recognize the errors of the IRS claims”.


He didn't read the instructions, so he didn't get a chance to contest the deficiency in tax court.  So what is he doing in tax court now ?
Petitioner having failed to file a petition for redetermination, respondent assessed the determined deficiency, together with statutory interest, on August 11, 2008, see secs. 6213(c), 6601(a), and made notice and demand for payment pursuant to section 6303(a). Petitioner did not satisfy the outstanding liability.


On December 1, 2008, respondent sent petitioner a Final Notice of Intent To Levy And Notice Of Your Right To A Hearing in respect of the outstanding liability. Petitioner responded by filing a Form 12153, Request for a Collection Due Process or Equivalent Hearing.


What many people do not realize is that there are two distinct sets of processes involved in the tax system.  One has to do with the determination of what the correct tax is.  The other is about how, when and how much of, if any, that correct amount will be paid.  It sometimes seems that there are two types of people and two types of practitioners.  One group thinks that when the first process is complete, the taxpayer just writes a check.  The other group doesn't really pay much attention to the first process, since the "correct tax" is merely of academic interest. 

Mr. Talaske, being pro se, understandably given his overall circumstances and the relatively small stakes, apparently didn't understand the system.  He blew his chance to argue about what the correct tax was.  Although you "doubt as to liability" is one of the boxes that you can check on Form 12153, those guys really don't want to hear about it.

The Tax Court noted that Mr. Talaske might have a decent argument:

Finally, petitioner argues that regardless of when his credit card debt with First USA may have been canceled, he was insolvent at the time, which, in petitioner's view, justifies his failure to report the $20,291.22 amount on any return. In this regard, the record does strongly hint of petitioner's financial frailty;

Unfortunately they don't think they can help him:

 however, petitioner's insolvency at any particular point in time was never proven. otherwise have an opportunity to dispute such tax liability. Sec. 6330(c)(2)(B). Stated otherwise, a taxpayer may not challenge the underlying liability in an administrative hearing, and therefore this Court may not review that liability in a subsequent collection review proceeding such as the instant one, if the taxpayer received a notice of deficiency or otherwise had a prior opportunity to dispute the underlying liability

It seems to me that there should almost be a presumption of insolvency, when people have cancellation of indebtedness income.  Why else is the debt being discharged ?  I'm not sure how sorry I feel for Mr. Talaske, but the decision is overall very unsatisfying.

How to Make a Small Fortune in Day Trading ?

VINES v. COMM., Cite as 107 AFTR 2d 2011-XXXX, 03/24/2011

I won't make you hold your breath for the punch line.  As with real estate and many other endeavors, the only sure way to make a small fortune in day trading is to start with a large fortune.  Of course the small fortune may be a stepping stone to no fortune.  Mr. Vines was a veteran attorney who settled a class action suit receiving fees in the vicinity of 25 million dollars.  Maybe a bit over 10 million (allowing for taxes and a few celebratory impulse purchases) isn't exactly a large fortune.  I mean if you're married they won't even bother taxing a joint estate with a lousy 10 mil any more, I'm going to stick my neck out a call it a moderately large fortune.

Having done so well as an attorney, he decided to take up day trading.  He did moderately well initially, but in relatively short order lost 23 million.  Kind of odd because by my reckoning he would have had maybe 16 million tops to start with.  Well meaning no disrespect to the profession but attorneys in general have pretty strong egos or at least that's what they project.  So Mr. Vine threw the whole 25 million into his day trading and thanks to the magic of margin loans was able to lose almost all of it before his taxes were due.

The IRS assessed a failure to pay penalty.  Talk about rubbing salt into the wound.  I mean he would have paid, probably anyway, if he had the money.  He just didn't have it.  Tough luck, says the Court:

A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless ... unable to pay the tax.... Further, a taxpayer who invests funds in speculative ... assets has not exercised ordinary business care and prudence in providing for the payment of his tax liability unless, at the time of the investment, the remainder of the taxpayer's assets and estimated income will be sufficient to pay his tax or it can be reasonably foreseen that the speculative or illiquid investment made by the taxpayer can be utilized (by sale or as security for a loan) to realize sufficient funds to satisfy the tax liability.


Somewhere in this story, there is a lesson.  When I figure it out, I will let you know.

From The Halls of Montezuma

David D. Robison, Sr., et ux. v. Commissioner, TC Memo 2011-59

Every man thinks meanly of himself for not having been a soldier, or not having been at sea.
Samuel Johnson

I promise to swear off that Samuel Johnson quotation for a while.  It seems so apt, here, though.  Perhaps it accounts for the great pride that Marines seem to have in their service and the general esteem in which they are held.  If being a soldier or going to sea suffices to not think meanly of yourself, then what must the effect be of being a sea going soldier ?  Mainly this story is about why I don't have the right attitude to be a Tax Court judge.  Never mind that I'm lacking in numerous other qualifications.

So here is the story:

Petitioner David Daniel Robison, Sr. (hereinafter petitioner), served in the U.S. Marine Corps from 1966 until 1972. From December 1966 until February 1968 he served in Vietnam, where he sustained a variety of combat-related injuries. He spent a year in the hospital and was later discharged from the Marine Corps because of his injuries.


 Petitioner worked for the U.S. Postal Service from 1980 until he was forced to retire in 1992 as a result of the injuries he had sustained while serving in Vietnam. During the years since he was forced to retire, petitioner has received a retirement annuity from OPM. During some of those years, petitioners excluded the amount of that annuity from their gross income. Respondent examined petitioners' returns for several of the years before the year in issue, and each time, respondent issued a closing letter accepting petitioners' return as filed.

There have been a couple of times where I've thought about applying to work for the IRS.  There's a lot of reasons I haven't.  It's not just because I'm too old for the really cool jobs, where you have a gun. What would I do if I was the revenue agent who was assigned to audit Mr. Robison, who quite reasonably believes that the lousy 14 grand he gets from the Post Office because he couldn't work anymore due to his war wounds acting up should be excludible ?  I don't know.  I can't knock the agents and supervisors who kind of let it slide by.  Eventually though he must have caught an agent who not only didn't remember the Vietnam War, but hadn't even been born then and felt compelled to research the basis for Mr. Robison's exclusion and found that there wasn't one as the Tax Court confirmed:

In Haar v. Commissioner, 78 T.C. 864 (1982), affd. 709 F.2d 1206 [52 AFTR 2d 83-5288] (8th Cir. 1983), this Court first addressed the question of whether an individual who retires from a civilian job because of a disability resulting from military service and receives disability payments from that civilian employer may exclude those payments from his gross income.   .................... We held that, because the disability payments the taxpayer received were not paid as compensation for personal injuries or sickness incurred in military service, the taxpayer was not entitled to exclude the disability payments under section 104(a)(4).

Mr. Robison did have another argument:

Petitioner also contends that, because respondent issued closing letters and accepted petitioners' returns as filed in previous years, respondent should be barred from determining a deficiency for petitioners' 2006 tax year.

It just doesn't work that way.  Much as they would have liked to, the previous agents who slid this buy didn't have the autority to amend the Code to put in a David Robison exception :

 However, we have held that where the Commissioner has overlooked the taxability of certain items in previous years, he is not barred from taking a different position in later years.

It's really too bad. If I'd been the Tax Court judge I would have been definitely trying to figure out a way to throw the case Mr. Robison's way.  Instead he got:


In reaching these holdings, we have considered all the parties' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit.

He can't work because he was wounded in Vietnam.  That might be moot and irrelevant to his post office pension being excludible, but don't say "without merit".

Driver - Take Me Where the Action Is

CCA 201106010

As I noted in my post From Mercenaries to Mothers Milk, tax issues enter into all aspects of life.  My blogs mission statement "providing a slightly quirky look at current tax developments"  causes me to be driven to some extent by the raw material that the system feeds me.  So here I find myself once again touching on issues that are less than edifying. 

In many major metropolitan areas and even in less than major areas there are business establishments where men go to look at women who are less than fully clothed.  With an incredible sense of irony these establishments sometimes characterize themselves as "gentlemen's clubs".  In Worcester county, to my knowledge, having heard about them from people who have spoken to people who have actually frequented them, there are at least six such establishments.  They are actually not that hard to find and some even have websites.

  I once saw a movie, I think it was on the Lifetime Channel, about a sex addict.  Checking into a hotel, he says to the desk clerk that he would like to go for a walk but he is unfamiliar with the city and asks if there are any neighborhoods nearby he should avoid.  That was clever.  Apparently in some cities, he could just hale a cab and get expert advice from the cab driver on where to go and a ride there to boot.  It turns out that cab drivers who provide this type of counsel to their passengers are not bound by standards of independence.  They frequently receive consideration from the establishments for delivering clients to them.  It turns out that this can be a fairly complex affair:

Some adult entertainment clubs (and other establishments) have a practice of making payments to taxicab drivers who bring passengers to their establishments. Generally, the club personnel will not render payment to the driver until the passengers first pay a cover charge or otherwise indicate in some manner that they are patrons of the club (such as purchasing drinks or drink tickets). Payments are usually made in cash, although some clubs issue vouchers to the drivers that can be exchanged for cash at a later time. The amount of the cash or voucher payment may or may not bear any relationship to the meter fare, may vary depending upon the number of passengers, and may be far greater than either the metered fare or the customary tip for the transportation. Typically, one or more passengers are transported from a hotel directly to a club. In some cases the driver may make agreements with certain hotel personnel so that when a guest wants to go to a club, the hotel personnel will summon the driver's taxicab from the queue at the hotel and the driver will split the payment from the club with the hotel personnel. In some cases the passenger may not request a particular destination and the driver or hotel personnel will recommend a club that will pay an amount for delivering the passenger/club patron. Several clubs and other establishments advertise in a local magazine, specifically targeted at drivers in the transportation industry, that they will pay a “referral fee” or “tip” or “incentive” for delivery of passengers/patrons.

There are three tax questions:

1. Whether the payments are income to the drivers
2.Whether the payments are tips for services the drivers perform as employees of the taxicab companies (tips in the course of employment) or are payments for separate and distinct services
3. What reporting requirements apply to the payments


The first question is kind of a "Duh", but they do take the trouble to answer it:

I.R.C. § 61(a)(1) provides that gross income means all income from whatever source derived, including (but not limited to) compensation for services, including fees, commissions, fringe benefits and similar items. Treas. Regs. § 1.61-2(a)(1) provides that tips are income to the recipients. The payments made by the clubs to the drivers are income to the drivers regardless of whether the payments are tips or remuneration for services that are separate and distinct from their employment by the taxicab companies.

The second question is a little more interesting.  It turns out that the payments are not tips:

 The fact that the payments from the clubs are contingent upon the “passenger” becoming a “patron” of the club—whether by entering the club, paying the cover charge, buying a drink, etc.— illustrates that the payment is made for the separate service of delivering a patron rather than transporting a passenger. The club is not the recipient of the transportation service; they are the recipient of the delivery of a patron. Furthermore, the fact that drivers frequently recommend the passenger's destination, sometimes in collaboration with hotel personnel, in order to secure the payment from a particular club further strengthens the conclusion that the clubs are paying the drivers for bringing them customers, a service separate and distinct from merely transporting passengers to the passenger's requested destination.

That brings us to the third question.  It turns out that the "establishments" should be sending 1099's to any of the drivers that receive more than $600 :

Because the payments at issue are for separate and distinct services of delivering patrons to the clubs, the clubs are required under I.R.C. § 6041 to file a Form 1099 with the IRS for each taxicab driver to whom they paid $600 or more during the calendar year. 6 If the clubs do not file Form 1099, whether they are subject to penalties under I.R.C. § 6721 depends on the facts and circumstances.

It seems like the Chief Counsel folks are not getting too excited about taking this project on:

While the facts you have collectively presented warrant the conclusion in this memorandum that the payments at issue are for services separate and apart from the drivers' employment, we note that an examination of a specific club or of a specific driver may produce different or varied facts, including indications that the cab companies receive part of the payments, that may or may not warrant the same conclusion or may present a differing degree of uncertainty regarding the proper characterization of the payments, thereby increasing the hazards of litigation. ——————-——————————————————————————————————————————————————————————-———————— ——————————————————————————————————————————————————-——————————————-


In addition, while published guidance and some case law provide helpful analysis in characterizing the payments at issue, we have found no prior cases or other authority which definitively defines tips in the context of the facts and circumstances described. Accordingly, the legal issue would be somewhat novel in litigation. ——————————————————————————————————————————————————————————-—————————————— ————————————————————————————————————————————-———————————————————————————— ——————————————————————————————-——————————————————————————————— ——————————————————————————————————————————————————————————-—————————————— —————————————————————————————

The blank lines are the portions of the memo that are exempt from disclosure under the Freedom of Information Act.  I can't help but wonder if they are discussing the surveillance techniques that they would have to use in order to build cases in this area

Deadline Looms for Same Sex Couples 2007 Amended Returns

There have been major developments in the tax law affecting same sex couples in the last year.  The attitude that I have as a tax advisor is "It is what it is.  Deal with it."  Whether its fair or makes sense is an interesting question, but not a practical one.  When I look at the developments my thought is "What should Robin and Terry do ?"  Robin and Terry are a couple of indeterminate gender and relationship status whose role in life is to help me avoid awkward pronoun problems.  It's been a big year for Robin and Terry.  I've decided that for this post I need to introduce some of their friends.  One couple is Alex and Marty.  The other is Blynn and Ashley.  They are going to be busy this week because despite my advice they put off looking at their 2007 returns to see if they should amend. 

Robin and Terry, at least for now, are of the same gender and were married in Massachusetts in 2007.  Alex and Marty are of the same gender and are California registered domestic partners.  Blynn and Ashley, who know how to act quickly when opportunity arises, are a California same sex married couple.  They were married in San Francisco in 2004.  Same sex marriage in California has a fairly convoluted legal history.  It's arguable that in 2007, there were no same sex married couples in California, but thanks to litigation decided in 2008, now there were. 

The development that affects Robin and Terry is the decision in Gill v OPM, which declared that Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional.  DOMA provides that for all purposes of federal law same sex marriages are not recognized.  The Obama administration has announced that it will no longer defend DOMA in court, although it will still be enforced pending appeals.  In order to benefit from the ultimate ruling, however, a claim must be filed while the statute of limitations is still open.

For 2007, Robin and Terry filed their returns as single.  It may be that they would have paid less tax if they had been able to do a married filing joint return.   I discussed the question of whether a joint return is better in a recent post, which was republished in Bay Windows.  The short answer is that there are enough potential complications that you really need to do the return in order to tell.  Now, Robin and Terry were required to file a joint Massachusetts return so it may be that somebody already prepared a pro-forma federal joint return for them.  That's how we would have done it anyway.  So one way or another Robin and Terry should compute a joint return and see if it would save them money.  It's not a sure bet that Gill v OPM will ultimately be upheld, but there is quite a good chance.  Unless there is a timely claim for refund, though, it won't do them any good for their 2007 return.

Alex and Marty have a situation that is more complicated, but not as uncertain.  CCA 201021050 holds that the IRS will recognize California community property law as it relates to registered domestic partners.  So Alex and Marty will still file as single (or head of household), but each will report half of the "community income", which includes wages.  This holding is mandatory for 2010 returns and is causing a lot of heartburn.  IRS has reissued a Publication 555 to help explain it. One of the subtleties in this is that not all income is community income and it is only community income that is split. The CCA made filing amended returns for open years optional.

There are a host of phase-outs and thresholds and offsets such that it is really impossible to say with certainty what will happen when you start moving income from one return to another.  You have to look at each return.  Let's say however that Alex and Marty don't have much other than their jobs and that Alex gets paid a ton of money by Microsoft as an independent contractor and  Marty works at Starbucks.  Most likely if they prepare amended returns for 2007 Alex will get a big refund and Marty will owe a lot of money.  They will, however, net positive, at least on tax, if not on interest.

I did come up with a nasty idea.  I've only found one other commentator that has made a similar observation:

Observation: The CCA doesn't say that if one partner amends his or her return, the other must do so as well. So, feasibly the higher income partner could amend his or her return to claim only 50% of his or her earnings while the lower income partner does nothing (i.e., doesn't file an amended return to pick up his or her 50% share). However, as withholding must also be split 50/50, it may be necessary to file both returns to get the full benefit of any savings. Also, the IRS may well require both partners to amend under these circumstances.

That comes from William Bischoff from a National Tax Advisory (NTA-743) (I can't track down a free link to it.  I got it from my RIA Checkpoint subscription).  I have not found anything to indicate that the IRS has done something to prevent being whipsawed on this issue.  So if Alex hurries out and amends for 2007, maybe kind of forgetting to mention it to Marty, it may well be that Marty will be protected by the statute of limitations.  I doubt that there is a SWAT team sitting in the service centers ready to issue timely notices of deficiency to the registered domestic partners of people filing refund claims under CCA 201021050, but I never, ever, give advice even to hypothetical clients based on the audit lottery.  This particular observation is why I titled my first post on this topic Windfall for "Unmarried" Taxpayers.  Other commentators that I have noted are good doobies on this issue.  I guess I would say that if Alex amends, maybe Marty should too, but that maybe Marty doesn't have to be in such a rush about it. Also I should note that if Marty had income low enough to not have filed a 2007 return (or didn't file one anyway), there is no statute of limitations protecting Marty.

I won't spend much time on Blynn and Ashley.  They do not represent a very large group of people.  San Francisco issued same sex couples marriage licences for a brief period in 2004.  That was shut down, but the law that declared it illegal was declared unconstitutional in 2008 opening a state wide window, which was closed in November 2008 by Proposition 8.  So of the approximately 18,000 legally married same sex couples in California only a small number would have been arguably married in 2007 (at least in retrospect).  What is interesting about them is they can either filed an amended joint 2007 return like Robin and Terry or amended 2007 community returns like Alex and Marty.  The Alex and Marty option will probably work out better, but I find their situation particularly interesting so I thought I would mention it.

There is another point, which I cannot emphasize enough.  If you might benefit from amending your 2007 return and you did not put it on extension,get the amended return done NOW.  In CCA 201052003, it was noted that the "timely mailed, timely filed" rule only applies to returns that are "required to be filed".  So an amended return to be timely must be received by the IRS before the statute expires.  I'm not going to get into whether that is April 15th or April 18th.  Don't take chances.  Get it done this week and send it return receipt.

P.S.

Patricia Cain of the Santa Clara Same Sex Tax Blog has set me straight on one issue.  The 18,000 figure that I picked up from that unimpeachable source, Wikipedia is the number of California same sex marriages in 2008.  She indicates that there were over 4,000 licenses issued to same sex couples in San Francisco in 2004, but none of those marriages were valid.  So it may well be that not only do Blynn and Ashley not exist, there may actually not be anybody like them.  The principle would apply for 2008 amended returns, but there is no rush to get those done and it is probably better to wait for more guidance.

Ms. Cain does not like the idea of the high income partners amending and the other partner letting it slide. It's not my all time favorite idea either, I just haven't figured out why it doesn't work.  You really need to go to the Santa Clara blog for a thorough treatment of same sex tax issues.  They are very focused on the issue and don't get distracted  by mercenaries and celebrity underwear.

Another point that I also picked up from Ms. Cain that I should have thought of myself is that the lower earning partner might be subject to a six year statute of limitations if his or her share of community income would be 25% greater than the income he or she reported..