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Graduate Level in Representation
Recent Trends in Tax Court Cases
August 4, 2014
Sherrill Trovato, EA, USTCP
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Sherrill Trovato, EA, USTCP, MST, MBA has a southern California firm specializing in tax prep
and controversy representation. She has authored articles in CCH’s Journal of Tax Practice and
Procedure and NAEA’s EA Journal. Trovato developed and teaches “Preparing to Practice
before the US Tax Court” to tax practitioners who report an impressive pass rate on the Tax Court
exam. She is a past NAEA president, NTPI Fellow™ and a regular instructor for the NAEA
National Conference. She is the current IRSAC chair of the SBSE subgroup. Trovato teaches
NTPI® Levels 1, 3 and the Graduate Level in Representation.
TABLE OF CONTENTS
INTRODUCTION ....................................................................................................................................... 1
TAX COURT DECISION AND OPINIONS ..................................................................................................... 1
Opinions ..................................................................................................................................................... 1
TC Opinion ............................................................................................................................................. 2
TC Memorandum .................................................................................................................................. 2
TC Summary .......................................................................................................................................... 2
Bench Opinion ....................................................................................................................................... 2
Rule 155 Computation ............................................................................................................................... 2
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TAX COURT CASES OF INTEREST ............................................................................................................... 3
ABATEMENT OF INTEREST.......................................................................................................................... 3
ABATEMENT OF PENALTY .......................................................................................................................... 4
ALIMONY .................................................................................................................................................... 5
AUTHOR...................................................................................................................................................... 5
BUSINESS EXPENSES ................................................................................................................................... 5
CHARITABLE CONTRIBUTIONS.................................................................................................................... 6
COLLECTION ISSUES ................................................................................................................................... 7
FAMILY STATUS/DEPENDENCY EXEMPTION/FILING STATUS ..................................................................... 9
FEDERAL TAX LIEN .................................................................................................................................... 11
FORM 872 ................................................................................................................................................. 11
HOBBY LOSS ............................................................................................................................................. 11
HOME OFFICE ........................................................................................................................................... 12
INCOME/EXCLUDED/UNREPORTED ......................................................................................................... 12
INNOCENT SPOUSE................................................................................................................................... 13
IRA ............................................................................................................................................................ 14
MATERIAL PARTICIPATION ....................................................................................................................... 15
MORTGAGE INTEREST .............................................................................................................................. 15
NOTICE OF DEFICIENCY ............................................................................................................................ 16
REAL ESTATE ............................................................................................................................................. 17
RECONSTRUCTION OF EXPENSES ............................................................................................................. 19
STATUTE OF LIMITATIONS ........................................................................................................................ 19
TRAVEL AND ENTERTAINMENT ................................................................................................................ 19
TRUST FUND RECOVERY PENALTY............................................................................................................ 20
VEHICLE USE ............................................................................................................................................. 20
WORKER CLASSIFICATION ........................................................................................................................ 21
WHAT WERE THEY THINKING? ................................................................................................................. 21
© 2014 Sherrill L Trovato, MBA, MST, EA, USTCP
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Recent Trends in Tax Court Cases Course Objectives
After completing this course you will be able to:
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Compare the TC Opinion, TC Memorandum and TC Summary opinions
Discuss how to use a Tax Court case when representing a taxpayer in Examination,
Collection or Appeals
Give one example of a case useful in a Collection representation
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Introduction
Case law helps develop and interpret the Internal Revenue Code (IRC) and its regulations. Since
the Tax Court only adjudicates tax issues, Tax Court cases are of interest to the practitioner who
prepares tax returns and who represents taxpayers before the Examination, Collection and
Appeals Divisions. Tax Court cases are posted daily on ustaxcourt.gov at 3:30 pm Eastern and
opinions can be searched by name or by keyword.
Tax Court Decisions and Opinions
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A decision is the court’s final determination in a proceeding. A Tax Court decision may be
stated orally, but it must be recorded in the transcript of the trial. The Tax Court can enter a
decision:
• for the taxpayer, OR
• for the IRS, OR
• by Rule 155 which indicates a split between the parties. Note the court does not itself
recompute the tax deficiency or liability, but instructs the parties to do so. See Rule 155
Computation for more information.
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In a deficiency action the decision is usually a statement of the amount of taxes owed by the
taxpayer, and which penalties apply to what extent. The date of the court’s decision is the date
the order is entered into the Tax Court records. The 90-day appeals period begins to run from
the date the order is entered. A decision becomes final upon expiration of the time for filing a
notice of appeal.
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Opinions
Each opinion is considered the decision of the entire Tax Court, rather than that of the issuing
judge. In this way the court acts in the same collegiate manner as an appellate court, although
the court-review is not truly ‘en banc’ because the judges do not sit together to hear
arguments. A draft opinion is prepared after the final reply brief is filed. Usually the judge or
trial judge who heard the case also prepares the draft opinion, but any other judge can prepare
it. Draft opinions do not become opinions of the Tax Court until the Chief Judge reviews them.
The Chief Judge may choose within 30 days to have the whole court consider the opinion,
making it a ‘reviewed’ opinion. Review by the full court is likely to happen if the draft opinion
invalidates a regular opinion or overrules Tax Court precedent. If it is a case of first impression,
the full court may review the opinion. Reviewed opinions can also occur if the issue is likely to
come up in another pending case, if the matter overrules a prior Tax Court decision, or if the
Tax Court was previously reversed by a Court of Appeals. The Chief Judge selects a judge to
write the reviewed opinion and other judges offer concurring or dissenting opinions that follow
the court opinion. The Chief Judge determines which designation an opinion will have.
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TC Opinion
Regular opinions are published in the Reports of the Tax Court; they are considered to be
binding precedent and are cited as XXX TC XX.
TC Memorandum
Memorandum opinions are published commercially; these usually apply settled law to the facts
and circumstances before the court. Memo decisions are not precedential, but the court does
not easily ignore them and they can become even more important if they were subject to an
appellate review. They are cited as TC Memo XXXX-XX.
TC Summary
Bench Opinion
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Summary opinions are those issued but not officially published (usually rendered in small tax
cases). Summary opinion is not precedential and may not be cited although they may still be
useful in Examination; they are described as TC Summary XXXX-XX.
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A presiding judge may issue a bench opinion under Tax Court Rule 152 and §7459(b); these are
not published or precedent for other cases, but can be used for res judicata, collateral estoppel,
and law of the case.
Rule 155 Computation
The entry of a decision can be withheld pending a final computation between the parties. Rule
155 computations can be on valuation issues, or can indicate a split on multiple issues. If the
parties agree on the amount of deficiency, liability or overpayment, they each submit a
computation and a statement of agreement. Agreeing with a calculation does not waive appeal
rights. Overpayments made by the taxpayer must also show the date and amount of payment.
The court renders a decision when it receives an agreed Rule 155 computation.
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If the parties do not agree either may file with the court a computation of the amount believed
to be according to the court’s findings and conclusions. If there is an overpayment the
computation must state the amount and date of each payment made by the taxpayer. If the
parties submit computations that differ they may be allowed the opportunity to be heard in
argument and the court will determine the correct amount.
No new issues can be raised at the hearing, which is held strictly on the question of correct
computation. The calculation begins with the notice of deficiency from which the parties
compute the redetermined deficiency on the basis of matters agreed to by the parties or
determined by the court.
No reconsideration can be requested, although pure issues of law may be reconsidered and
mechanical or math adjustments are permitted.
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Tax Court Cases of Interest
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ABATEMENT OF INTEREST
IS THE IRS REQUIRED TO ABATE INTEREST CHARGED ON AN ERRONEOUS REFUND UNDER §6404?
In Allcorn (139 TC 4 (8/9/12)) the taxpayer timely filed his 2008 Form 1040. He mistakenly
added a $4,000 estimated tax payment to the income tax withheld line instead of the estimated
tax payment line (because the line did not specifically reference 1040-ES). He put a note with
his W-2 and 1099 forms that an additional $4,000 was paid with Form 1040-ES. The IRS
mistakenly issued him a $4,000 refund; more than a year later the IRS informed the taxpayer
that he owed the $4,000 plus a penalty and interest. Taxpayer requested an abatement of
penalty (granted) and interest (not granted because taxpayer’s error was a ‘contributing factor
in the issuance of the refund’).
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The IRS had the authority to abate the interest on the erroneous refund, but the interest
abatement was not mandatory. The IRS may abate interest on 1) a deficiency attributable to an
unreasonable error or delay by an IRS official performing a ministerial or managerial act or 2) a
payment of tax to extend the error/delay in paying the tax is attributable to IRS official being
erroneous or dilatory in performing a managerial or ministerial act. In deciding whether to
grant relief, there cannot be any significant error or delay attributable to the taxpayer.
The standard of review is abuse of discretion: in denying the request does the IRS act
arbitrarily, capriciously or without sound basis in fact or law?
A managerial act is an administrative one that occurs during the processing of the case and can
include the temporary or permanent loss of records or the exercise of judgment or discretion
relating to management of personnel.
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A ministerial act is a procedural or mechanical one that does not involve the exercise of
judgment or discretion, and that occurs during the processing of a taxpayer’s case after all
prerequisites to the act (conferences and review by supervisors) have taken place. Evaluating
the taxpayer’s submitted materials are not ministerial acts as this involves exercise of judgment
or discretion as well as the proper application of Federal tax law.
In this case the IRS and the taxpayer both made errors, but neither side was willing to admit to
that. The IRS contended that it could not be expected to read all of the notes sent by
taxpayers, but the Internal Revenue Manual (IRM) instructs the IRS to ‘examine all attachments
to the return’ and that “all taxpayer-initiated correspondence must be responded to within 30
days.” The analysis of the relevant statutes is long, but essentially the IRS was not mandated to
refund the interest, and it did not abuse its discretion because it refused to abate the interest.
The taxpayer should have realized he received a larger than expected refund and contacted the
IRS at that time. The taxpayer received the abatement of interest.
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ABATEMENT OF PENALTY
IS IT IMPOSSIBLE TO FILE A PROPER RETURN WHEN THE S CORPORATION FAILS TO PROVIDE A TIMELY K-1?
In Sampson (TC Memo 2013-212 (9/9/13)) the taxpayer failed to report pass through items
from two S corporations on an original return, but attached statements from the return
preparer that the returns would be amended upon receipt of delinquent Schedules K-1. The
taxpayers argued there was no accuracy related penalty because of this disclosure. There is no
substantial authority to support taxpayer’s treatment of the corporate income; there was no
reasonable cause or good faith since they failed to estimate and report income from the
corporations. Taxpayer, a doctor, was the sole shareholder of two S corporations that failed to
provide source documents to the tax preparer before the return due dates. Taxpayers
amended their returns after they were notified of the examination and consistent S corporate
returns were filed later. Taxpayers were responsible for the accuracy related penalty: they had
the QuickBooks file that could have been used to estimate income, and taxpayer knew he had
reported substantial corporate income from the corporation in previous years. There was no
reasonable basis to omit income because the tax preparer told them how to file their individual
returns without Schedule K-1.
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WHAT IS REQUIRED FOR A TAXPAYER TO HAVE RELIED ON A PROFESSIONAL TO AVOID A §6662 PENALTY?
In Woodsum and Lovett (136 TC 29 (6/13/11)) the taxpayers received a $3.4 million gain from a
swap transaction that the husband was personally involved in terminating. The taxpayers gave
their preparer 160-plus information returns which resulted in a 115 page tax return. The tax
return omitted the $3.4 million from the swap transaction. Not surprisingly the IRS caught the
error and an accuracy related penalty resulted. One of the exceptions to the accuracy-related
penalty is reasonable reliance on a professional. In order for it to be reasonable reliance on a
professional advice 1) the adviser must be a competent professional with sufficient expertise to
justify the reliance, 2) the taxpayer must provide necessary and accurate information to the
adviser, and 3) the taxpayer must actually rely in good faith on the adviser’s judgment. There
was no reasonable reliance on their preparer for such a large income item when the husband
was involved in terminating the transaction.
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RELYING ON WOODSUM …
In Viola (TC Memo 2013-213 (9/9/13)) the taxpayers relied on their accountant to prepare tax
returns. Taxpayers were unaware the CPA lost his accounting license; after he suffered a stroke
the accounting firm completed the tax returns but did report nearly $800K in income and did
not give copies of the return to taxpayers until three weeks after it was filed. Taxpayer briefly
looked at the return and assumed the $800K was reported on it. Taxpayers alleged that the
accounting firm submitted their returns without signatures or permission, so the returns were
not filed and therefore §6662 penalties could not asserted, but they raised this issue only in a
brief filed after trial, which is too late. Taxpayers continued to use the accounting firm and the
Tax Court found that the relevant tax returns were filed with the taxpayers’ permission. The
Tax Court reiterated that in Woodsum they held that taxpayers could not claim they relied on
tax return preparer advice absent evidence that the return preparer made a judgment or that
the taxpayers relied on that judgment. To qualify for the reasonable cause exception taxpayers
had to show they made a reasonable review of the completed returns – at a minimum
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taxpayers should check returns prepared by others to make sure each item of income is
reported.
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ALIMONY
WHAT IS REQUIRED FOR PAYMENTS TO BE UNDER A DIVORCE OR SEPARATION INSTRUMENT?
In Faylor (TC Memo 2013-143 (6/5/13)) the attorneys for the taxpayer and his former spouse
exchanged letters with proposals for the amounts of monthly temporary support. The taxpayer
started making monthly transfers of $5,000 to a joint checking account he shared with his
former spouse. Neither of the divorcing spouses signed either of the two proposed temporary
support orders, but the taxpayer continued to make monthly transfers into the joint account,
with the belief that the former spouse would withdraw the money from the joint account. The
divorce decree the following year awarded the former spouse $2,500 a month for six months
then reduced it to $1,500. The taxpayer deducted $36,500 for alimony paid, only $16,500 of
which was court-ordered. Under §71(b)(2) the divorce or separation instrument is 1) a decree
of divorce or separate maintenance or a written instrument incident to such a decree, 2) a
written separation agreement, or 3) a decree requiring a spouse to make payments for the
support or maintenance of the other spouse. The term “written separation agreement” is not
defined in the IRC and the Tax Court held that the letters exchanged between the attorneys did
not constitute a meeting of the minds for the couple, nor was that evidence of a written
separation instrument. The IRS argued that the transfers to a joint checking account were not
payments in cash; the Tax Court’s focus was on whether it was a written separation agreement.
Taxpayer was not hit with the under-payment penalty because it was reasonable for him to
believe the money he transferred while negotiating a temporary support order was alimony.
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AUTHOR
WHAT IS REQUIRED FOR A TAXPAYER TO BE IN THE BUSINESS OF BEING A BOOK AUTHOR?
In Oros (TC Memo 2012-4 (1/5/12)) the taxpayer was a full time employee at Intel. Before 2006
he had no experience in writing or publishing books, but in 2006 he completed a business plan
to write and self-publish a book about his upcoming worldwide trip and the planning and
execution of such a trip. He is an experienced photographer and intended to use photos taken
during the trip. While on vacation or paid sabbatical from Intel taxpayer had extensive travels
where he took thousands of photos and maintained a contemporaneous journal. As of March
2011 he still hadn’t published or completed the book. In 2006 he deducted more than $17K in
travel plus meals and telephone costs. Writing need not be the sole activity of a taxpayer to
qualify as a trade or business, but the time devoted to another job must be considered. To
allow the deduction there must be more than a one-time venture.
BUSINESS EXPENSES
MUST BUSINESS EXPENSES BE PAID IN THE YEAR THEY ARE DEDUCTED?
In Iheke (TC Summary 2013-75 (9/24/13)) taxpayer-husband was a CPA who worked at the IRS
(and he was still employed there at the time of trial). He previously worked at California’s
Franchise Tax Board and his wife studied accounting in college. The expenses were not
deductible when they were not paid for in that year; §7701(a)(25) provides that the term ‘paid
or incurred’ is construed according to the taxpayer’s method of accounting. Under the cash
method items are includible in income for the taxable year in which they are received, and
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expenditures are deductible for the taxable year in which paid. Because of the taxpayers’
background, the Tax Court found that their disregard of the rules and regulations was
inexcusable. They were liable for the penalties imposed by IRS.
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CHARITABLE CONTRIBUTIONS
WHAT IF THE CHARITY IS LOCATED IN NIGERIA?
In Golit (TC Memo 2013-191, (8/21/13)) the taxpayer claimed more than $9,000 in
contributions to a Catholic church in Nigeria. §170(a)(1) permits a deduction for charitable
contributions for use of an organization “created or organized in the United States … under the
law of the United States” or its possession or any state or District of Columbia. She failed to
prove that church was created or organized within the US or that it was a qualified organization
within the meaning of §170(c). She also lost a claimed dependency exemption for her 47 year
old “son” (who is only 2 years younger than she is) and job related expenses.
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DO THE CHARITABLE CONTRIBUTION SUBSTANTIATION REQUIREMENTS FOR $250 OR MORE APPLY TO CASH
CONTRIBUTIONS?
In Durden (TC Memo 2012-140 (5/17/12)) the taxpayers routinely wrote checks to their church
for more than $250. Taxpayers had their cancelled checks, but the acknowledgments did not
contain the required statement regarding the receipt of goods or services in exchange for the
contributions. The statement is considered contemporaneous if received on the 1) earlier of
the date the taxpayer files the original return deducting the contribution or 2) the due date
(including extensions) for filing the original return for the year. Taxpayers agreed they didn’t
strictly comply but argued they “substantially” complied with the statute. Their contributions
were disallowed – strict compliance is required on this issue.
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DO THE CHARITABLE CONTRIBUTION SUBSTANTIATION REQUIREMENTS FOR $250 OR MORE APPLY TO
UNREIMBURSED VOLUNTEER EXPENDITURES?
In Van Dusen (136 TC 25 (6/2/11)) the taxpayer incurred unreimbursed volunteer expenses
while caring for foster cats in her home, including vet services, pet supplies, cleaning supplies
and household utilities. The Tax Court found that her services were directed by a charitable
organization and allowed some of the expenses; others were disallowed because they were not
sufficiently related to the foster-cat care or couldn’t be determined with precision. The Tax
Court also found that the record-keeping requirements of §1.170A-13(a) (for contributions of
money) also apply to unreimbursed volunteer expenses of less than $250. For expenses of
$250 or more she was required to have the charity’s contemporaneous written
acknowledgement to deduct them. The taxpayer was unable to show that her $100
membership dues to Costco was an exclusively charitable expense and was not deductible
because she would have paid for her Costco membership even if she didn’t foster cats. Since
she never obtained the required written acknowledgement by the time of trial, let alone the
due date of the return, the taxpayer was not permitted to deduct any foster-cat expenses of
$250 or more.
ARE THRIFT SHOP EMPLOYEES QUALIFIED APPRAISERS?
In Haskett (TC Summary 2013-76 (9/26/13)) the taxpayers deducted $9,500 as a charitable
contribution for clothing donated to a thrift shop, then claimed that they assumed the
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volunteer/employees of the thrift shop were appraisers. Nice try, but employees of the donee
are precluded from serving as a qualified appraiser.
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COLLECTION ISSUES
ARE TITHES AND CHILDREN’S COLLEGE EXPENSES DEFINED AS NECESSARY OR CONDITIONAL WHEN DETERMINING A
TAXPAYER’S ABILITY TO PAY ON A PARTIAL PAYMENT INSTALLMENT AGREEMENT?
In Thompson (140 TC 4 (3/4/13)) the taxpayer is a member of the Mormon Church and regularly
contributed 10% of his monthly income. His financial statements (433-A) submitted to obtain a
partial payment installment agreement included tithing expenses and college expenses for his
children. The IRS determined those expenses were conditional; necessary expenses must
provide for the taxpayer’s health and welfare or production of income. When a taxpayer
requests a partial payment installment agreement the taxpayer is only permitted necessary
expenses. Because he received no payment for his duties to the church, he failed the
production of income test. The 433-A does not require the IRS to classify a taxpayer’s college
expenses as a necessary expense.
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IS A SETTLEMENT OFFICER IMPARTIAL IF THEY BEGIN A REVIEW ON AN OIC AND THEN ARE ASSIGNED THE CDP FOR
REVIEW?
In Moosally (142 TC 10 (3/27/14)) the IRS rejected taxpayer’s OIC for trust fund recovery
penalties and income tax liability. She appealed the rejection, and Settlement Officer (SO) S
was assigned to review the OIC. After SO S began the review, IRS assigned another SO to
handle the CDP, but the case was then assigned to SO S. An ‘impartial officer or employee’ is
one who has had no prior involvement with respect to the unpaid tax specified in
§6320(a)(3)(A) before the first hearing under §6320 or §6330. The court found that SO S was
not impartial because of her prior involvement with the OIC for the same taxes and periods in
issue.
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WHAT IS REQUIRED IN AN OFFER IN COMPROMISE FILED FOR EFFECTIVE TAX ADMINISTRATION?
In Bogart (TC Memo 20146-46 (3/18/14)) the taxpayers’ Federal tax troubles stemmed from the
criminal conduct of their former bookkeeper. They submitted an OIC of $10K to resolve
deficiencies of nearly $69K on the basis that it promoted effective tax administration. IRS
rejected the ETA OIC – taxpayer argued that IRS failed to adequately consider it on public policy
and equity grounds. Their bookkeeper embezzled at least $116K from taxpayers but she did
not report the stolen funds as gross income when she prepared the taxpayers’ jointly filed
Federal income tax returns. Taxpayers discovered the fraud when IRS examined those returns,
and deficiencies were determined for two years. The bookkeeper pleaded guilty to 10 counts
of theft in the first degree and was sentenced to prison – she did not pay court-ordered
restitution and the taxpayers did not satisfy their tax liability. The IRS may determine that an
OIC would promote effective tax administration when collection in full would create economic
hardship, but the IRS may also compromise the liability when the taxpayer identifies compelling
public policy or equity considerations. Public policy or equity requires “exceptional
circumstances” and 1) taxpayers must remain in compliance since incurring the liability and not
have a noncompliant history, 2) taxpayer must show s/he acted reasonably and responsibly in
incurring the liability, and 3) IRS must determine that other taxpayers would view the
compromise as fair and equitable. IRS determined there was no economic hardship but failed
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to consider whether there was a public policy/equity ground. The IRS must review issues raised
by taxpayers during the CDP hearing; since that did not happen here, the Tax Court remanded
the case for consideration of the ETA OIC.
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HOW DOES THE TAX COURT EVALUATE A CASE FOR ABUSE OF DISCRETION STANDARD?
In Szekely (TC Memo 2013-227 (9/24/13)) the taxpayer contacted Taxpayer Advocate Service
when he was unable to stay current on tax obligations while paying off prior year debts. He
timely filed for a Collection Due Process (CDP) hearing but it took IRS 4 months to acknowledge
that request. He was given 14 days to provide an OIC or other collection alternative, which he
did. At the CDP hearing he reiterated a desire to enter into a compromise agreement; the
Settlement Officer sent him Forms 656 and 433-A and gave him 14 days to comply. One day
after the missed deadline the Settlement Officer sustained the Federal tax lien, and a week
later the IRS issued a Notice of Determination. Before receiving the notice of determination the
taxpayer submitted his OIC request and the related financial information plus the $150
application fee and the $1,600 for his initial offer payment. It took nearly 6 months for the IRS
to indicate it could not process the OIC. The Tax Court used an abuse of discretion standard to
evaluate the CDP hearing, and found there was a double standard applied when it took IRS 4
months to acknowledge his request and only one day for IRS to close the case. Essentially the
Settlement Officer gave the taxpayer only 3 or 4 days to complete the 656/433A since she
expected the information on her desk by the deadline. The Tax Court remanded the case for a
supplemental CDP hearing to consider the OIC.
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CAN THE IRS BE REQUIRED TO REOPEN A RETURNED OFFER IN COMPROMISE (OIC) BASED UPON DOUBT AS TO
COLLECTABILITY THAT WAS RETURNED TO THE TAXPAYER AS UNPROCESSABLE YEARS BEFORE THE CDP HEARING?
In Reed (141 TC 7 (9/23/13)) taxpayer failed to timely file tax returns for 1987-2001. The
returns were subsequently filed, but taxpayer did not pay the outstanding liabilities. Taxpayer
submitted two OICs to satisfy the liability – the IRS rejected the first one and returned the
second OIC years before the CDP hearing. The 2004 offer was rejected because taxpayer
received $258K from the sale of property in 2001, most of which was lost in high-risk day
trading in the stock market (making it a dissipated asset). The 2008 offer proposed to settle
nearly $500K in liability for just over $35K. That offer was returned because the taxpayer was
not compliant when the offer was submitted. Taxpayer made payments during the pendency
of the offer. In the CDP hearing he argued that the IRS should reopen the 2008 offer then
consider his debt was paid in full because his payments exceeded the offered amount.
Taxpayers are required to submit current financial data (no more than 6 months old) when
proposing an OIC, doubt as to collectability. Taxpayers have the right to seek administrative
review of a rejected OIC, but not of a returned OIC.
ARE DISSIPATED ASSETS INCLUDIBLE IN REASONABLE COLLECTION POTENTIAL?
In Taggart (TC Memo 2013-113 (4/18/13)) the taxpayer filed for a review of the IRS’s sustaining
a notice of Federal tax lien for 2006 and 2007. During those years taxpayer worked as a real
estate appraiser and a real estate broker, and he owned 4 rental properties. He originally filed
his 2006 return reporting zero taxable income, but amended that a year later without making a
payment. The 2007 return was timely filed, but no payment was made. The taxpayer
refinanced two loans on rental properties and used the nearly $70K to pay other non-IRS debt.
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He attempted to compromise more than $54K in IRS debt for $2,500, payable $100 a month.
The first Settlement Officer rejected that offer because the taxpayer could pay the amount in
full according to her calculation of reasonable collection potential (RCP). The dissipated assets,
not used to pay his living expenses, are includible in the RCP and taxpayer had sufficient assets
to pay the debt in full. It does not matter that the refinancing occurred “before lien was placed
on taxpayer” because the tax return amounts were due on the dates the returns were required
to be filed.
IS IT AN ABUSE OF DISCRETION FOR THE IRS TO USE PROPERTY TAX ROLLS TO DETERMINE IF TAXPAYER OWNS
PROPERTY AND/OR THE APPROPRIATE VALUE?
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In McCarthy (TC Memo 2013-214 (9/10/13)) taxpayer listed assets owned, but did not include a
property that the Settlement Officer discovered by a search of county tax assessor and a
recorder of deeds office. Taxpayer flipped houses and owned real property in Louisiana and
Arkansas plus other personal property. There is no requirement that IRS use a licensed real
estate appraiser to determine a property’s fair market value, so the IRS did not abuse discretion
by relying on county tax assessor valuations.
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IS A FACE TO FACE CDP HEARING A TAXPAYER RIGHT?
In LaForge (TC Memo 2013-183 (8/12/13)) taxpayer filed for a CDP hearing related to 2005 and
2006 tax debt. Taxpayer’s past compliance history is poor. The Settlement Officer’s initial
letter indicating that a face to face hearing could be requested within 14 days from the notice,
and requested a completed Form 433-A plus proof of estimated payments for 2011 and signed
tax returns for unfiled years 2007, 2008, 2009 and 2010. Taxpayer’s representative requested a
face to face conference, but taxpayer failed to provide the requested information by the
deadline, so the in person conference was denied. There is no face to face hearing requirement
under §6330 and the Court noted there is no statutory or regulatory provision that requires
“taxpayers be afforded an unlimited opportunity to supplement the administrative record.”
There was no abuse of discretion when the Settlement Officer did not follow-up with
documents received after the CDP was held.
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WHAT IF TAXPAYER FAILS TO PROVIDE ALL REQUESTED INFORMATION FOR AN OIC?
In Glossop (TC Memo 2013-208 (9/3/13)) the taxpayer asked the Tax Court to review whether
the IRS abused discretion in sustaining a proposed levy to collect unpaid trust fund recovery
penalties. Taxpayer failed to provide requested documents, or filed incomplete documents.
The taxpayer lost, but it has a good discussion of the Collection Due Process procedures (for
individuals and their businesses) in the IRS and what the Tax Court can review.
FAMILY STATUS/DEPENDENCY EXEMPTION/FILING STATUS
WHAT IF A FORMER SPOUSE FAILS TO EXECUTE FORM 8332 EVEN WHEN REQUIRED TO BY A STATE COURT ORDER?
In Armstrong (139 TC 18 (12/19/12)) the taxpayer’s former spouse was required to execute
Form 8332 in his favor by an arbitration award and two state court orders, on the condition
that he pay child support. Taxpayer complied with child support payments in 2007, but his
former spouse failed to provide the executed Form 8332. Taxpayer attached a copy of the
arbitration award to the tax return, and provided the child support orders, signed by the former
spouse, during examination. The Tax Court found that a substitute Form 8332, the state court
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order signed by the ex-wife, does not comply with §152(e)(2)(A) because it failed to
unconditionally declare that the ex-wife “will not claim such child as a dependent.” The IRC
requires specific information when a non-custodial parent is going to claim a dependent,
including the child’s name, name and social security number of the noncustodial parent
claiming the dependency exemption deduction, the social security number of the custodial
parent, the signature of the custodial parent, the date of the custodial parent’s signature, and
the year(s) for which the claims were release. A basic element of satisfying the statute is the
custodial parent’s declaration that they “will not claim” the child as a dependent for a taxable
year. That statement is an unconditional agreement.
AE
A
IS FORM 8332 REQUIRED WHEN THE DIVORCE DECREE ESTABLISHES WHICH PARENT IS ENTITLED TO THE
DEPENDENCY DEDUCTION FOR EACH CHILD?
In Shenk (140 TC 10 (5/6/13)) the divorce decree established that taxpayer’s ex-wife had
primary residential custody of their three minor children, and that the dependency exemption
deductions would be divided between the two ex-spouses without specifying that the ex-wife
had to execute Form 8332, Release of Claim to Exemption for Child of Divorced or Separated
Parents. The children resided with the ex-wife but taxpayer claimed head of household status
and one child was claimed by both parents; at trial taxpayer contended he was entitled to the
dependency exemption for all three children and the related child tax credits.
Form 8332 or its equivalent is required for a deduction under §152(e)(2)(A), and it doesn’t
matter that the divorce decree specified an every other year dependency exemption routine.
The divorce decree did not require a release, and none was obtained. Once the three year
period of limitations to assess tax is expired, Form 8332 cannot be filed, and taxpayer’s attempt
to obtain it now was not successful.
N
WHAT IF THE FORMER SPOUSE IS BEHIND IN CHILD SUPPORT?
In George (139 TC 19 (12/19/12)) the taxpayer executed Form 8332 as required by a state court
order. She believed that was improperly required so on her tax returns for 2007 and 2008 she
claimed a dependency exemption and child tax credit for her daughter. Her former spouse also
claimed the daughter and attached Form 8332 to his tax returns. The 8332 was not invalid by
any error in the state court order or that she signed it because of the state court order. The
court order indicated that he could claim the daughter “provided that all support payments are
current.” A court in 2007 ordered that she execute Form 8332 for tax years 1996-2010; she did
so under threat of contempt. The Tax Court declined to examine whether the state court order
was proper. The statute does not require that the noncustodial parent pay support, only that
the custodial parent execute Form 8332.
MAY MARRIED TAXPAYERS ALWAYS FILE A JOINT RETURN AFTER ONE FILED AS HEAD OF HOUSEHOLD?
In Ibrahim (TC Memo 2014-8 (1/13/14)) the taxpayer is married to his half-brother’s widow and
is raising his 4 children. Taxpayer and his wife are immigrants from Somalia and cannot speak,
read, or write English. He timely filed his 2011 Form 1040A tax return claiming head of
household status and claimed two of the kids. His wife filed single and did not claim any of the
kids. Before receiving the notice of deficiency taxpayer did not elect to file an amended joint
return with his wife for 2011. IRS found the correct filing status was married filing status and
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not HoH – since taxpayer and his wife filed separate returns for 2011 he cannot file MFJ.
Taxpayer argued that he was incorrectly advised by his tax preparer and so should be allowed
to file an amended return. Under §6013(b)(1) an individual who has filed a “separate return”
for a taxable year where they could have filed a joint return with a spouse can amend a return
to elect joint filing status. Under 6013(b)(2) there are 4 limitations on filing the joint return;
including specifically under 6013(b)(2)(B) after “a notice of deficiency under section 6212” has
been mailed to either spouse, if the spouse files a petition with the Tax Court. Since taxpayer
sought review in the Tax Court he is specifically barred from filing a joint return with his wife.
A
FEDERAL TAX LIEN
WHAT IF THE FEDERAL TAX LIEN WILL AFFECT THE TAXPAYER’S EMPLOYMENT?
In Blackman (TC Memo 2013-194 (8/26/13)) the taxpayer argued the lien should be withdrawn
because he has no current assets and public disclosure of the NFTL could cause him to “be fired
and become permanently unemployable” within his industry. He provided a copy of the
employer’s handbook but did not request a hearing relating to the NFTL. Even though the IRS
entered into an installment agreement, it had discretion to maintain the NFTL and is not
required to authorize a withdrawal.
AE
FORM 872
ARE FORMS 872 (CONSENTS TO EXTEND THE SOL) VALID IF EXECUTED AFTER THE 3 YEAR PERIOD OF LIMITATIONS
EXPIRES?
In Carpenter Family Investments, LLC (136 TC 17 (12/19/11)) the taxpayers executed Form 872
after the 3 year period of limitations, which invalidated them according to the taxpayers. The
IRS wanted to apply a 6 year statute of limitations on the basis of temporary regulations the Tax
Court previously found were invalid. Consents executed outside the statute of limitations are
not valid.
N
HOBBY LOSS
WHAT ELEMENTS ARE CONSIDERED TO DETERMINE IF A TAXPAYER’S HORSE ACTIVITY IS A HOBBY OR A BUSINESS?
In Rodriguez (TC Memo 2013-221 (9/18/13)) the taxpayer’s mother began a horse-breeding
activity when married to her husband – the activity never turned a profit and incurred more
than $1.8 million in losses since inception. The taxpayer claimed half the deductions for the
annual losses between 2002 and 2008, which offset all taxable income and tax liability until the
taxpayer left the partnership. The activity income was termed both “dismal and sporadic” with
approximately $15,000 between 1993 and 2009. The mother researched the appropriate breed
for dressage, met with breed experts to learn more, joined professional associations and
attended events to learn more about how to evaluate and grade the horses. She sought advice
from SCORE but did not meet with a counselor knowledgeable in horse breeding. Taxpayer
took riding lessons when she was a child and took college classes in agricultural sciences and
animal husbandry. She focused research on breeding the specific type of horse recommended
for dressage. The Court looked at the various factors under §1.183-2(b) and determined they
were not in a for profit enterprise.
© 2014 Sherrill L Trovato, MBA, MST, EA, USTCP
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HOME OFFICE
CAN A TAXPAYER DEDUCT A HOME OFFICE WHEN SHE WORKS THERE AT HER REQUEST AND FOR HER CONVENIENCE?
In Fontayne (TC Summary 2013-54 (7/3/13)) the taxpayer was allowed to deduct a home office
for the time period she was an independent contractor, but not when she was an employee.
She was allowed to work from home up to 3 days a week at her request. The taxpayer made
substantial improvements to the office, including moving walls to increase its size. The return
at issue reported a tentative profit of nearly $25K and expenses of the same amount for the
home office. The Tax Court rejected their inclusion of the square footage of a hallway,
bathroom, entryway and closet since those areas were not used exclusively as a home office.
The capital expenditures were not permitted as currently deductible.
AE
A
INCOME/EXCLUDED/UNREPORTED
HOW DOES THE IRS DETERMINE IF A TAXPAYER HAS UNRECORDED INCOME?
In Hall (TC Memo 2014-16 (1/27/14)) the taxpayer (an attorney who is admitted to the Tax
Court) failed to provide complete documentation (books and records) for all his business
activities, and the IRS summoned his bank deposit records. Using a bank deposit analysis to
reconstruct income, the IRS later reduced that by known nontaxable deposits for a total of
$61K. First the IRS must produce sufficient evidence connecting the taxpayer to the unreported
income, and then the taxpayer must prove, by a preponderance of the evidence, that the
unexplained deposits do not constitute taxable income. If the taxpayer doesn’t maintain
business records, or those records are inadequate, the Commissioner is authorized to
reconstruct the taxpayer’s income by any method that clearly reflects income. That
reconstruction need not be exact, but it must be reasonable in light of all the surrounding facts
and circumstances. The use of the bank deposits method has long been sanctioned by the
court and bank deposits are prima facie evidence of income. Taxpayer did not maintain books
or records and failed to introduce receipts, invoices, cancelled checks etc to prove he paid
relevant business expenses – the court may not use the Cohan doctrine to estimate expenses
covered by §274(d). The court also noted that they will not sift through taxpayer’s bank
statements to try to match the evidence to IRS’s adjustments as that is the taxpayer’s job. His
travel and other business expenses were disallowed.
N
IS DISABILITY FOR A PRIOR YEAR EXCLUDED FROM INCOME IN THE YEAR RECEIVED?
In Rayhill (TC Memo 2013-181 (8/8/13)) the taxpayer failed to file a tax return for 2007. She
received nearly $65K in disability payments under an employer provided and funded group
long-term disability policy. She argued that the disability payment represented amounts that
should have been received in prior years, so only the portion allocable to 2007 is includible in
that year’s income. She also argued that since she was sick during 2008 she should not have to
pay §6651(a)(1) and (2) additions for delinquent filing and failure to pay timely. She is a cash
basis taxpayer, and so must include all amounts received in 2007 on that year’s return. She was
not relieved of the failure to file and failure to pay penalties because she was able to carry on
her real estate brokerage business and other business affairs. Note that a properly made
substitute for return is required before the failure to pay penalty can be imposed on a nonfiler.
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A
INNOCENT SPOUSE
IS A TAXPAYER ENTITLED TO A REFUND OF HER SHARE OF LEVIED FUNDS?
In Minihan (138 TC 1 (1/11/12)) the taxpayer requested §6015(f) relief. IRS created a separate
account for each spouse in order to pursue collection from the intervenor (her former husband
– the nonrequesting spouse is called the intervenor). While collection was suspended against
taxpayer, the IRS collected the entire tax liability at issue by levying on a bank account owned
jointly by the taxpayer and her former spouse. Taxpayer sought a refund of 50% of the funds
levied from the joint account. Under state law taxpayer was a 50% owner of the funds in the
joint bank account, so she could receive a refund. The IRS tried to argue that she was not
entitled to a refund because it came from intervenor’s assets or joint assets, but not taxpayer’s
separate assets. The Court determined that taxpayer had 50% ownership in the bank account
and 50% of the money seized was hers, if she was entitled to §6015(f) relief – stayed tuned
because that remains for trial.
AE
WHAT IF THE INNOCENT SPOUSE HAS NO REASON TO BELIEVE THE TAX WOULD BE PAID?
In Wallace (TC Memo 2013-218 (9/16/13)) the taxpayer’s request for 6015(f) relief was denied.
She knew her husband’s business was failing and that her husband was in poor health; there
was no reasonable expectation that the nearly $8,000 in 2007 tax could be paid because there
was no income when the return was filed. When Form 8557 was submitted there was no
balance due for 2006 and no tax return was filed for 2008, so the Appeals Office could not
consider those claims. The case discusses 6015(f) factors and mentions new streamlined
procedures proposed by Notice 2012-8 (see page 6). Economic hardship and knowledge are
still factors that must be considered and taxpayer failed to provide appropriate information.
N
WHAT IS REQUIRED FOR A TAXPAYER TO PARTICIPATE MEANINGFULLY IN A §6015 CASE?
In Harbin (137 TC 7 (9/26/11)) the taxpayer filed for relief from liability of the portions
attributable to his former wife’s gambling activities. Taxpayer kept the gambling logs and
prepared the joint return for each year. All the gambling income and losses were reported to
the best of what taxpayer knew – as it turns out they were inaccurate. During examination the
intervenor stopped cooperating with the examiner and gave documents that didn’t match what
was given to the taxpayer. The taxpayer and intervenor were represented by the same counsel
during the prior deficiency case. The parties executed a stipulated decision that they owed
deficiencies and neither of them requested relief under §6015. While that deficiency case was
going on the attorney represented them during the contentious divorce proceeding until the
divorce was final. The financial interests and allocation of liability interests were adverse and
the joint representation created a conflict of interest. Counsel did not explain the advantages
and risks of joint representation to taxpayer and he failed to disclose the conflict of interest and
never requested a waiver. Counsel even filed the petition contesting denial of relief under
§6015(b) – IRS informed counsel of the conflict and he withdrew.
Meaningful participation has not been defined so the Court looks at the totality of the facts and
circumstances to determine if the participation was meaningful. The Court looks to whether
the taxpayer signed court documents and participates in settlement negotiations and the
opportunity to raise a claim for relief from joint and several liability as probative of meaningful
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participation. The court found that intervenor had the meaningful participation, not the
taxpayer.
A
WHAT IF THE INTERVENOR IS PRESENT WHEN THE TAX RETURN IS PREPARED?
In Kellam (TC Memo 2013-186 (8/15/13)) the taxpayer’s wife prepared their 2007 return
including noncash charitable contributions of more than $19K for two cars given to her
children, plus more than $19K in unreimbursed employee expenses and other erroneous
deductions. Taxpayer was given the opportunity to review the 2007 return, but did not do so
before it was electronically filed. In 2008 the couple separated; taxpayer was not present for
the preparation or given an opportunity to review the return prepared by the wife. Taxpayer’s
wife efiled that return without consulting with the taxpayer and did not give him copies of the
return until two weeks later. The taxpayer was involved with the family’s finances and
knowledge of the 2007 transactions, so he was not granted relief for that year. The case also
has a nice look at all factors involved in evaluating an innocent spouse request.
N
AE
IRA
HOW MANY IRA DISTRIBUTIONS CAN BE ROLLED OVER IN ONE TAXABLE YEAR?
In Bobrow (TC Memo 2014-21 (1/28/14)) the taxpayer-husband (a tax attorney) maintained
various accounts at Fidelity during 2008, specifically a traditional IRA and a rollover IRA.
Taxpayer-wife also maintained a traditional IRA at Fidelity. On 4/14/08 husband requested and
received 2 distributions from his traditional IRA for $65,064. On 6/6/08 he received a $65,064
distribution from his rollover IRA. On 6/10/08 he transferred this amount from a bank account
to his traditional IRA. On 7/31/08 his wife received a $65,064 distribution from her traditional
IRA. On 8/4/08 taxpayers transferred $65,064 from a bank account to husband’s rollover IRA.
On 9/30/08 taxpayer wife transferred $40K from their joint account to her traditional IRA.
Taxpayers and IRS differ in how these are treated. Under §408(d)(3)(A) a payee of an IRA
distribution can exclude from gross income any amount paid or distributed from an IRA if the
entire amount is put into an IRA within 60 days. The code specifically limits the taxpayer from
performing more than one nontaxable rollover in a one year period with regards to IRAs and
individual retirement annuities. The taxpayers argued that the rule applied to each IRA
maintained by a taxpayer, citing a Tax Court case and Technical Advice Memorandum (which of
course cannot be used or cited as precedent in the Tax Court even though it supported
taxpayers’ argument). Taxpayer wife’s repayment was not within 60 days so that $65K was
includible in gross income and one of taxpayer husband’s $65K distribution was also includible
in gross income. Since she was under 59.5 years old her distribution was also subject to the
10% excise tax. His training as a tax attorney worked against him and they were also assessed a
6662(a) accuracy related penalty.
NOTE: of interest, a CFP I work with touted this in a recent newsletter and indicated that IRS will not
apply “this new interpretation” to any rollover that occurs before January 1, 2015 (Announcement
2014-15). Publication 590 provided an example that is consistent with what the taxpayers did in
Bobrow, but we all know that publications are not authoritative
IS A PERSONAL GUARANTEE A PROHIBITED TRANSACTION IN A SELF-DIRECTED IRA?
In Peek (140 TC 12 (5/9/13)) the taxpayer established traditional IRAs in 2001 then directed
their new IRA to use rolled-over cash to purchase 100% of their new corporation’s stock.
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Taxpayers personally guaranteed the corporate loans. In 2003 and 2004 taxpayers rolled over
the corporate stock from their traditional IRA to Roth IRAs, paying tax on the FMV values. In
2006 after the corporate stock significantly appreciated in value taxpayers directed their Roth
IRAs to sell all of the corporate stock. The Tax Court held that each personal guarantee was an
indirect extension of credit to the IRAs, which is a prohibited transaction. Under §408(e) the
accounts that held the stock ceased to be IRAs, and gain on the sale of the corporate stock are
included in taxpayers’ income. §4975(c)(1)(B) prohibits any “direct or indirect” “lending of
money or other extension of credit between a plan and a disqualified person. The loan
guaranties were not a ‘once-and-done’ transaction but remained in place and constituted a
continuing prohibited transaction.
AE
A
MATERIAL PARTICIPATION
WHAT IS REQUIRED TO ESTABLISH MATERIAL PARTICIPATION?
In Bartlett (TC Memo 2013-182 (8/8/13) taxpayer claimed his bull breeding activity had active
participation, resulting a deduction in excess of $100,000 for the two relevant years. Taxpayer
employed others to stay on the ranch during the winter months. §469 disallows passive activity
loss of an individual taxpayer; a passive activity is a trade or business in which the taxpayer
does not material participate. Taxpayers are permitted to prove participation by any
reasonable means, but the Tax Court is not required to accept ‘post event “ballpark
guesstimates”’ nor are they bound to accept the “unverified, undocumented testimony of
taxpayers.” Although the taxpayer testified he spent more than 1,000 hours during the tax
years at issue, including 7-10 hours a week in research, they provided no contemporaneous
records or documentation of his participation. The Tax Court was also troubled by a claim that
the taxpayer worked 28 hours during a 24 hour period. The Tax Court was not persuaded that
the taxpayer either worked 500 hours on this activity in each year, or that he worked more than
others who worked on the ranch 40 hours a week.
N
MORTGAGE INTEREST
CAN A TAXPAYER DEDUCT MORTGAGE INTEREST AMOUNTS CAPITALIZED INTO THE PRINCIPAL OF THE MORTGAGE
BUT NOT ACTUALLY PAID?
In Smoker (TC Memo 2013-56 (2/21/13)) the taxpayer had an adjustable rate mortgage that
secured one of his properties. The monthly payment was less than the interest portion, and
that excess interest was added to the note principal. Cash basis taxpayers cannot deduct
accrued but unpaid interest. The Tax Court found that the borrower simply postponed
payment, which does not allow an interest deduction, despite the plain language of §163(h)(3)
which refers to deductions for interest that is “paid or accrued.” Taxpayer was liable for the
accuracy-related penalty.
IF THE TAXPAYER PAYS THE MORTGAGE SOLELY FROM HER SEPARATE FUNDS, CAN SHE DEDUCT INTEREST BASED ON
THE $1 MILLION AND $100K LIMITATIONS IF SHE IS MARRIED FILING SEPARATE?
In Bronstein (138 TC 21 (5/17/12)) the answer is no and Taxpayer was also subject to an
accuracy related penalty. No one else deducted any of the mortgage interest, but a MFS return
is limited to $500K and $50K for acquisition and equity debts, as expressly stated in §163.
© 2014 Sherrill L Trovato, MBA, MST, EA, USTCP
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A
CAN THE TAXPAYER CHANGE FROM MFS TO MFJ TO DEDUCT MORE MORTGAGE INTEREST?
In Zdunek (TC Summary 2013-15 (2/20/13)) taxpayer deducted more than $47K on her married
filing separate return. The taxpayer, a CPA, has a BS in accounting and was employed by the IRS
for 15 years, including time as a revenue agent and in the Training Division where she assisted
in developing training programs for revenue agents and tax auditors. She continues to take CPE
classes each year, including one on the mortgage interest deduction. Those using MFS status
are only allowed to deduct interest on acquisition indebtedness not to exceed $500K, and they
are generally limited to claiming one residence unless they obtain written consent from their
spouse to claim another residence. Taxpayers are precluded from filing a joint return after a
taxpayer files a separate return if the taxpayer files a timely petition with the Tax Court with
respect to a notice of deficiency. Taxpayer claimed she shouldn’t be precluded from changing
her filing status since she was not informed of the MFS limitations by the IRS until after she filed
her petition with the Tax Court. The taxpayer was liable for an accuracy-related penalty.
AE
DO THE $1 MILLION ACQUISITION INDEBTEDNESS AND $100K OF HOME EQUITY INDEBTEDNESS UNDER §163(H)
APPLY SEPARATELY OR IN AGGREGATE WHEN CO-OWNERS ARE NOT MARRIED TO EACH OTHER AND EACH CO-OWNS
UP TO 2 RESIDENCES?
In Sophy (138 TC 8 (3/5/12)) the taxpayers co-owned two California residences as joint tenants.
The first loan was $500K and the second for $2 million plus they obtained a HELOC of $300K on
the second residence. The court ruled that the acquisition/home equity limitations are
properly applied on a per residence, not per taxpayer, basis. This is the calculation made for
one taxpayer’s limitation:
N
Total qualified loan limit
Total average balance of all
mortgages on all qualified loans
Limitation ratio
Total amount of interest paid
by TP
Deductible mortgage interest
2006
$1,100,000
2007
$1,100,000
$2,703,568
0.4068697
$2,669,136
0.41211838
$85,962
$34,975
$76,635
$31,583
NOTICE OF DEFICIENCY
IS THE IRS REQUIRED TO LAY OUT THE FACTUAL BASIS FOR HIS DETERMINATION IN THE NOTICE OF DEFICIENCY?
In Caldwell (136 TC 2 (1/3/11)) the taxpayer contended the IRS failed to send him a 30 day
letter before issuing the notice of deficiency. The Tax Court will generally not look behind the
NOD to examine whether it is appropriate and it refused to look into the IRS’s failure to issue
the 30 day letter. Even an inadequate description of the Commissioner’s basis in the NOD does
not invalidate the notice.
WHEN WILL THE TAX COURT ‘LOOK BEHIND’ THE NOTICE OF DEFICIENCY?
In Obedin (TC Memo 2013-223 (9/23/13)) the taxpayers claimed an NOL for their 2004 tax
return without attaching any statement describing or computing the NOL deduction. In 2003
they started a real estate development; when the contractor failed to perform they hired a law
© 2014 Sherrill L Trovato, MBA, MST, EA, USTCP
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firm for litigation and paid subcontractors to finish the project in 2004. The revenue agent
found mistakes in the 2004 return (employment taxes were deducted twice, and the taxpayers
were unable to substantiate deductions), and the agent adjusted the 2004 and 2005 returns,
and reduced the amount of the NOL from previous years because it was “probable” that similar
results would apply to those years. Normally the Tax Court will not discuss details of the audit,
but because substantiation of items by adequate records and the propriety of the examiner’s
determination were in dispute, the Tax Court described the process leading to the notice of
deficiency. Taxpayers who claim an NOL deduction must establish both the existence and the
amount of the NOL. A tax return is not sufficient – it is merely a statement of the taxpayers’
claim to the NOL and does not establish the facts within the return.
N
AE
A
REAL ESTATE
HOW DOES THE TAX COURT EVALUATE THE 750 HOUR REQUIREMENT FOR A REAL ESTATE PROFESSIONAL?
In Almquist (TC Memo 2014-40 (3/10/14)) the taxpayer-husband was an executive (VP
Operations) at a realty group for more than 15 years where he managed 15 rental properties
and 300 employees. Since 2001 he and his wife owned and managed from one to three rental
properties of their own. He estimated that he worked no more than 20 hours a week as an
executive (making $180K annually) but did not provide any paperwork or documents
supporting his claim that he worked no more than 980 hours in 2008. Taxpayer’s wife worked
as an operations manager where she oversaw properties, buildings and apartments. They
owned two rental properties, one in California (approximately 130 miles from their home) and
one in Florida (they hired a management company for the FL property and did not visit it during
the year at issue). Taxpayer-husband created a log about a year after the fact, which showed
notes about the days he worked on the rental properties. The log was created on the advice of
their CPA, but was not given to the CPA as part of the tax return preparation. The first log
indicated that taxpayer husband worked 486 hours on the CA property and 188 hours on the FL
property (674) plus 101 hours looking for investment properties and attending open houses.
After meeting with the revenue agent the taxpayers created a second log allocating additional
time, including additional activities (craigslist ads and emails) plus additional hours for his drive
in CA (6 to 7 hours to go 130 miles “because of Los Angeles traffic and gas stops”) – now 759
hours on CA and 84 hours on FL. The time spent as an employee performing real estate
activities is ignored, unless the employee is also a 5% owner; since taxpayer husband was not
an owner, those hours did not count. Taxpayer did not qualify as a real estate professional
because he did not spend more than 50% of his time engaged in real property trades or
businesses, even if he did satisfy the 750 hour requirement. Taxpayers did not provide the
court with any supporting documentation, and the court is not obligation to accept self-serving
testimony.
NOTE: §469 disallows passive losses, with an exception for real estate professionals who are engaged
in a real property trade or business. To do that more than half the personal services must be performed
in real property trades or businesses in which the taxpayer materially participates, and the taxpayer
must perform more than 750 hours of services in the taxable year in the real property trades or
businesses. Unless a timely election is made, taxpayer must meet this test for each rental real estate
interest.
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A
JUST BECAUSE IT’S COMPLICATED DOESN’T MEAN IT’S NOT THE LAW …
In Hassanipour (TC Memo 2013-88 (4/2/13)) the taxpayer was a full time research associate
who worked 1,936 hours for 2008. In that year he owned 28 rental units in 7 fourplexes plus a
50% interest in a single family residence. On their joint return for 2008 he and his wife claimed
$120K net rent losses, and did not aggregate all interests as a single rental income. Taxpayer
self-prepared the return; he tried to claim that his hours on the rental activities exceeded the
time working for his employer, using a non-dated generic calendar he claimed was
contemporaneously kept in 2008 even though the calendar was copyrighted in 2009 (oops). His
testimony contradicted the monthly timesheets he signed and submitted to his employer. Just
because §469 rules are complicated does not excuse the taxpayer from the accuracy-related
penalty. He never consulted a competent tax professional and should have understood the
requirement to keep adequate records if he indeed spent ‘many hours’ studying the law and
preparing returns.
AE
CAN A TRUST QUALIFY A REAL ESTATE PROFESSIONAL?
In Frank Aragona Trust (142 TC 9 (3/27/14)) the taxpayer (a trust) owned rental real estate
properties that would be considered per se passive activities under §469(c)(2) unless the trust
qualified for the exception found in §469(c)(7), which applies if more than one-half of the
personal services performed by the taxpayer are performed in real property trades or
businesses in which the taxpayer materially participates, and the taxpayer performs more than
750 hours of services during the year in real property trades or businesses in which the
taxpayer materially participates. The IRS argued that a trust could not perform personal
services. The court disagreed – since a trust is an arrangement whereby trustees manage
assets for the trust’s beneficiaries, a trust is capable of performing personal services; services
by individual trustees on behalf of the trust may be considered personal services performed by
the trust.
N
DOES A SPOUSE’S EFFORTS AS A REAL ESTATE PROFESSIONAL COUNT EVEN WHEN A MFS RETURN IS FILED?
In Oderio (TC Memo 2014-39 (3/10/14)) the taxpayer filed separately from her spouse, but
wanted to claim that he allowed her to meet the real estate pro test so she could claim a
$29,583 rental loss. She was a full time employee for a real estate investment company. When
a return is jointly filed the requirements of the more than one half of personal services and the
750 hour test are met if either spouse separately satisfies the requirements. When married
taxpayers file separate returns they must separately meet the tests to avoid the per se passive
activity loss treatment. While taxpayer claimed reasonable reliance on a tax professional who
prepared her return, she didn’t call him as a witness or introduce evidence that established he
possessed the requisite expertise.
CAN YOU DEDUCT RENTAL EXPENSES WITHOUT RENTAL INCOME?
In Meinhardt (TC Memo 2013-85 (3/27/13)) the taxpayers attempted to rent a farmhouse for
30 years without ever finding a rent-paying tenant, although they were able to rent the
farmland separately. Various individuals, including family members, lived at the farmhouse
between 1976 and 2007 on a seasonal or full time basis; they exchanged services for use of the
house. Taxpayers failed to prove deductibility of the rental expenses because they did not
establish they were tied to a real estate property rental business.
© 2014 Sherrill L Trovato, MBA, MST, EA, USTCP
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A
RECONSTRUCTION OF EXPENSES
WHAT IF THE TAXPAYER PAID CASH AND HAS INCOMPLETE RECORDS?
In Bauer (TC Memo 2012-156 (6/4/12)) the taxpayer wanted to deduct contract labor expenses
paid in cash for his relocation business. Taxpayer used a logbook to record the amount of his
expenses per relocation project, but he did not record names or Social Security numbers and or
issue Forms 1099. The IRS used a ratio for sole proprietors in the long distance freight trucking
industry as reported by BizStats; taxpayer disagreed with the BizStats reports and provided a
BizMiner report on a household goods transport business as an alternative way to estimate his
labor expenses. The Tax Court declined to use the BizStats report because it didn’t really define
the taxpayer’s business (which included packing and moving furniture, not just hauling goods),
but allowed the BizMiner report. The Court, citing the Cohan rule, allowed the taxpayer to
deduct an estimated amount of labor using an average ratio found in the BizMiner report.
N
AE
STATUTE OF LIMITATIONS
IS FORM 5329 A SEPARATE TAX RETURN WITH A SEPARATE STATUTE OF LIMITATIONS THAN THE 1040 RETURN?
In Paschall (137 TC 2 (7/5/11)) the taxpayer made excess contributions to his Roth IRA without
reporting them on Form 5329. Taxpayer followed a “perfectly legal” plan proposed by a
financial adviser that would permit the taxpayer to convert a traditional IRA to a Roth IRA by
converting taxable IRA distribution to nontaxable Roth distributions. The taxpayer engaged a
large CPA firm for the Roth restructure (at a fee of $120K). Several years after the Roth
restructure was started the CPA firm divulged names of people engaging in that transaction to
the IRS, and taxpayers began disclosing the transaction using Form 8886, Reportable
Transaction Disclosure Statement. Failure to file Form 5329 was deemed to be failure to file a
return that permitted the §4973 excise tax to be assessed even on years with closed statute for
Form 1040; since the appropriate line indicating a need to file Form 5329 was left blank on the
1040, the IRS had no way of determining one was required. Without Form 5329 the IRS was
unable to reasonably discern that the excise tax applied, so filing Form 1040 did not start the
running of the statute for the excise tax. For reasonable cause abatement based on the
reliance of a professional, the professional cannot be “actively involved in planning the
transaction.” The CPA firm prepared some returns, but was involved in the transaction and
thus tainted by an inherent conflict of interest. Taxpayer should have realized the deal was too
good to be true – he repeatedly asked whether the Roth restructure was legal, but never
sought the advice of an independent adviser or for an opinion letter.
DOES AN IMPROPERLY SIGNED FORM 990 EXTEND THE STATUTE OF LIMITATIONS FOR THE RETURN?
In Chapman Glen (140 TC 15 (5/28/13)) the taxpayer’s Form 990 was not signed by an officer as
required. The 3 year period of limitations remained open because the 990 was not considered
a valid return. It was a costly error; when they lost their tax exempt status they were
considered to have sold all assets in a taxable transaction.
TRAVEL AND ENTERTAINMENT
WHEN IS A TAXPAYER “AWAY FROM HOME” FOR PURPOSES OF DEDUCTING TRAVEL EXPENSES?
In Bogue (TC Memo 2011-164 (7/11/11)) the taxpayer was an independent contractor who
worked on property renovations at various locations in Pennsylvania and NY; most of these
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locations were within 25 miles of his home. During the relevant years he lived with his fiancé.
He deducted more than $9,000 in car and truck expenses for the two years, plus tolls and auto
insurance. He also deducted $4,600 in depreciation for a 1991 Ford, based upon the Kelley Blue
Book value in the year it became inoperable. There were many other dubious deductions
claimed in the two years at issue.
A
The decision of where to live and work is a personal one, so taxpayers are not permitted to
deduct commuting expenses. There are 3 exceptions: 1) when the taxpayer travels from a
home office to a business location, 2) when the taxpayer travels between their residence and
temporary work locations out the metropolitan area where the taxpayer lives and normally
works, and 3) when the taxpayer has one or more regular work locations and travels between
the residence and temporary work locations. The home office exception is independent of
whether the home office is claimed on the tax return and requires that the space be used
regularly and exclusively for business. The Tax Court found that the work did not occur outside
the area where the taxpayer normally worked and lived. All of the taxpayer’s worksites were
temporary; he only worked at one location at a time, and he had no regular work location. Just
carrying tools in a work truck does not make the travel deductible
AE
IS DEDUCTIBLE TRAVEL ALLOWED WHEN A HOME OFFICE IS STRESSFUL?
In Linzy (TC Memo 2013-219 (9/16/13)) the taxpayer is an unenrolled tax preparer who
operated her tax business out of her home. She found it stressful to deal with clients who
phoned her at all hours so she deducted $5,200 in travel “just to get rest” that allowed her to
function. She provided invoices from a hotel, car rental service and a casino. A taxpayer’s
choice about where to live is personal, and she was not allowed to deduct the travel. She lost
the meals deduction because she failed to establish the business nature. She also was
unsuccessful in her bid to deduct half of her mortgage payment as “rent” for her home office.
N
TRUST FUND RECOVERY PENALTY
IF YOU ARE LOOKING FOR A COURT CASE ON TFRP…
… see Lengua (TC Memo 2013-197 (8/27/13). Taxpayer failed to file all Form 941 tax returns or
payover amounts deducted from her employees (Hey Baby Enterprises). The IRS filed an SFR
for the missing quarter with an estimated liability. Taxpayer did not request a hearing in
response to the IRS’s determination that the TFRP applied but requested a CDP upon receipt of
the Final Notice. Taxpayer was given time to refinance her home (which had more than $300K
in equity) to pay the debt. Taxpayer had an opportunity to discuss the underlying liability but
she failed to respond to the IRS’s letter of the intention to assess the TFRP so she was not given
another opportunity in the Tax Court. The IRS is not required to attempt to collect underlying
trust taxes from the employer before attempting to collect §6672 penalties against a
responsible person.
VEHICLE USE
WHAT IS REQUIRED FOR AN RV TO BE TREATED AS A BUSINESS VEHICLE?
In Dunford (TC Memo 2013-189 (8/20/13)) taxpayers operated a consulting business at warmer
locations while living in their motor home away from their residence. The motor home had a
second countertop that taxpayer used as a desk for his computer and supplies. During the
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relevant years they traveled across the United States and spent significant time with their
children; in fact, their dominant motive for the travel was personal. They claimed deductions
for actual vehicle costs, depreciation for their vehicles, interest expenses for the motor home,
and mileage deductions. Although they were entitled to deduct the motor home interest as
mortgage interest, they failed to maintain required records or to substantiate they were
entitled to business deductions beyond what was already permitted by the IRS.
A
IS THE TAX COURT REQUIRED TO ACCEPT RECONSTRUCTION OF AUTO MILEAGE?
In Daniel-Berhe (TC Memo 2013-33 (4/29/13)) the taxpayer was a part time engineering
instructor at 5 different colleges and universities. He often drove to more than one school per
day to teach class. He drove approximately 85,000-95,000 miles per year and deducted nearly
$47K in vehicle expenses. During testimony he submitted a mileage log created after the tax
year and claimed he drove 88,820 miles in 2008. The Tax Court found the mileage summary
was insufficient because the mileage amounts were not entered at the time the vehicle was
used. The IRS allowed just under 5,000 miles. Taxpayer was not allowed to deduct nearly $13K
in overnight travel, office supplies, and miscellaneous legal and other expenses.
AE
WORKER CLASSIFICATION
WHAT IS EVALUATED FOR A WORKER CLASSIFICATION CASE?
In Glass Blocks Unlimited (TC Memo 2013-180 (8/7/13) taxpayer, an S corporation, was notified
that an officer was classified as an employee for Federal employment tax purposes, and that it
was not entitled to relief under Section 530 of the Revenue Act of 1978. Taxpayer only
disputed the amount of the tax, not the worker classification who was the sole shareholder and
only worker; cash distributions were provided the worker’s upon request and taxpayer issued
no Forms 941, W2 or 1099-Miscellaneous. The distributions were deemed as wages and
subject to employment tax. Transfers of funds into the corporation were deemed capital
contributions rather than loans because the taxpayer could not establish that a loan existed.
N
WHAT WERE THEY THINKING?
IS IT WISE TO SHOW CI INVESTIGATORS THE ‘REAL BOOKS’?
In Potter (TC Memo 2014-18 (1/27/14)) the taxpayer owned and operated a gentlemen’s club, a
cash based business that appears to either lose money or break even based upon corporate and
individual tax returns filed. IRS special agents engaged in an undercover investigation of
taxpayer’s business, posing as buyers interested in acquiring the business. Surprisingly the
business was much more profitable that it appeared – taxpayer explained that he deposited
only enough into the corporate account to cover its expenses and he wired the balance of the
revenues to his personal bank account in Florida. The wire transfers were less than $10K to
avoid reporting obligations back to the IRS. The business actually grossed more than $1 million
and taxpayer took home between $400K and $500K per year, taxpayer told CI. He showed
them the real books which showed wide discrepancies between what taxpayer reported and
what he received. When taxpayer knew he was under criminal investigation he provided
additional information to his accountant so amended corporate and amended personal returns
could be filed. In his plea agreement taxpayer admitted he willfully submitted false tax returns
– he was sentenced to prison and supervised release and ordered to pay restitution. After
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applying the various badges of fraud (below) to this case the court found taxpayer was liable for
§6663 civil fraud penalties.
A
NOTE: remember there is no period of limitations on fraud. Taxpayer tried to argue that some of his
assessments were barred by the three year period of limitations. Fraud is a question of fact to be
resolved after considering the entire record, and it cannot be presumed or based on mere suspicion.
Fraudulent intent may be established by circumstantial evidence. Badges of fraud include 1)
understating income, 2) maintaining inadequate records, 3) giving implausible or inconsistent
explanations of behavior, 4) concealing income or assets, 5) failing to cooperate with tax authorities, 6)
engaging in illegal activities, 7) providing incomplete or misleading information to one’s tax preparer, 8)
lack of credibility of the taxpayer’s testimony, 9) filing false documents, including false income tax
returns, 10) failing to file tax returns, and 11) dealing in cash. No single factor controls, but the
existence of several factors “is persuasive circumstantial evidence of fraud.”
AE
IS THE NOTICE OF DEFICIENCY INVALID BECAUSE IT GIVES A WEB PAGE LINK FOR THE NATIONAL TAXPAYER
ADVOCATE RATHER THAN THE ADDRESS AND TELEPHONE NUMBER OF THE LOCAL OFFICE?
In Hom & Associates (140 TC 11 (5/7/13)) the taxpayer’s corporate status was suspended when
the petition was filed. Taxpayer also claimed the notice of deficiency was invalid because it
didn’t meet requirements of §6212(a), which indicates a notice of deficiency “shall include a
notice to the taxpayer of the taxpayer’s right to contact a local office of the taxpayer advocate
and the location and phone number of the appropriate office.” A petition cannot be filed by a
corporation that isn’t a corporation for state purposes at the time of the petition.
A notice of deficiency is valid if it notifies the taxpayer that a deficiency has been determined
and it gives the taxpayer the opportunity to petition the Tax Court for redetermination of the
proposed deficiency. Mistakes in a notice do not invalidate it if there is no prejudice to the
taxpayer. Taxpayer was able to file, and did file, a timely petition.
N
IS THIS ANY WAY TO PRACTICE AS AN EA/CPA?
In Osband (TC Memo 2013-188 (8/19/13)) the taxpayer filed original tax returns for 2005, 2006
and 2007 claiming little income. After she moved she met a CPA/EA based upon a friend’s
recommendations. The EA/CPA prepared amended tax returns reporting fictitious interest and
withholdings (of exactly the same amounts); the IRS requested information about the change in
withholding that was claimed, but erroneously issued her a refund of more than $20,000. The
EA/CPA falsified Forms 1099-OID. The IRS sent a frivolous submission letter that warned
taxpayer of a possible §6702 penalty of $5,000 and she was given the opportunity to send
corrected returns. Taxpayer mailed the IRS a “Registered Bonded Promissory Note” for $10
million along with other frivolous letters and notices. She also demanded $24 million in
damages plus interest, penalties and fees. She ultimately suggested an installment agreement
of $25 per month, which the IRS refused. Taxpayer should have known the amended returns
were “too good to be true” despite her claims that she reasonably relied on her tax
professional.
ARE PENALTIES PROPERLY ASSESSED NOW THAT THE IRS NO LONGER HAS DISTRICT DIRECTORS?
In Grunsted (136 TC 21 (5/11/11)) the taxpayer filed tax returns showing zero income (on the
basis that private sector payments for labor are not taxable) and sought refunds of taxes paid.
The IRS indicated two of those returns would not be accepted and that they were based on
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frivolous positions. IRS assessed five frivolous return penalties, which taxpayer failed to pay.
Taxpayer was warned he would be subject to §6673 penalty if he continued to advance
frivolous arguments. I don’t even have to tell you how this one comes out, do I?
AE
A
MUST YOU FILE 2005 RETURN BEFORE 2006 AND SUBSEQUENT TAX RETURNS CAN BE PREPARED?
In Dickes (TC Memo 2013-210 (9/9/13)) the taxpayer’s compliance pattern was poor; he
generally did not make estimated payments and always requested an extension of time to file
and made an estimated payment then. He lost most of his net worth in his divorce plus paid
alimony of $1,000 per week to his former wife. That was ultimately reduced to $400 per week,
but he was in arrears when he traveled to his former home to deal with a contempt complaint.
He was jailed for 90 days. After he was incarcerated his attorney retrieved his computer and
business records from taxpayer’s hotel room, but these 2004-2006 items were stolen from the
attorney’s vehicle. When taxpayer was released from jail he discovered that all of his business
clients were gone and he had no financial resources left. During the incarceration he forgot
about filing his 2005 return and his records had been stolen. He attempted to use off the shelf
software to prepare 2006 but was told he had to complete his 2005 return before that year
could be done. In a phone call an IRS assister advised the taxpayer to pay whatever he thought
he owed for 2005 and 2006 and to reconstruct his missing information to file those returns. In
2010 the IRS sent a letter regarding the delinquent returns and in late 2010 taxpayer filed 20052008 returns. He requested that IRS abate all penalties and interest, and indicated he exercised
ordinary business care and prudence but was unable to timely file 2007-2009 returns because
of his problems filing 2005 and 2006. Of note, the Tax Court ruled that unavailability of records
does not necessarily establish reasonable cause for penalty abatement – he had information to
file 2007-2009 on a timely basis. The case was remanded to Appeals because the Settlement
Officer effectively denied the taxpayer an opportunity to submit an OIC during the CDP hearing.
IS IT WISE FOR AN IRS AGENT TO FALSIFY CHARITABLE CONTRIBUTION SUBSTANTIATION?
N
In Payne (TC Summary 2013-64 (8/13/13)) the taxpayer had been employed by the IRS for 28
years, 20 of them as a revenue agent. She graduated from college with two majors and a minor
in accounting, finance and economics, and was trying to pass the remaining parts of the CPA
exam at the time of trial. She claimed she made cash contributions from her gambling winnings
to a small NY church. The pastor personally greeted all guests each week; the church provided
a letter about the contributions, but required each person to pick up his or her letter and to
sign to acknowledge it was received. Taxpayer provided a letter for the two years at issue
which was apparently forged. The Tax Court found that the record in this matter is “full of
inconsistencies, contradicting testimony, fabricated documents, and simple untruths.” The
Court found that it was ‘highly probable’ that the taxpayer cut and pasted stationery from the
church to give to the IRS agent examining the returns. Taxpayer was liable for the accuracyrelated penalty for both years.
SHOULD IT BE A CLUE WHEN THE TAX-RETURN PREPARER REFUSES TO SIGN A TAX RETURN FOR FEAR OF AN AUDIT?
In Phillips (TC Memo 2013-215 (9/10/13)) the taxpayer claimed deductions on Schedule C as a
professional bowler who incurred approximately $30,000 in expenses annually, which far
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N
AE
A
exceeded gross winnings for any year since 2000. After the petition was filed the taxpayer
refused to send documentation to the IRS indicating he would only send it to a Tax Court judge.
Taxpayer lost the deductions.
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