Posts Tagged ‘Judge Gustafson’

Tax Roundup, 9/18/14: The $14.8 million suitcase squeeze. And: Koskinen visits the Hill.

Thursday, September 18th, 2014 by Joe Kristan
Flickr image courtesy Sascha Kohlmann under Creative Commons license

Flickr image courtesy Sascha Kohlmann under Creative Commons license

Accounting Today visitors: click here for the item from the September 17 “In the Blogs.”

When tax-free merger isn’t. Working with family-owned businesses, a common misunderstanding arises: if a deal is tax-free, like an “A” merger or a partnership contribution, there can’t be gift tax, right?  Very wrong, as a New Hampshire couple’s experience in Tax Court shows.

The parents, Mr. and Mrs Cavallero, had a successful S corporation known as Knight Tool Co. Their son Ken set up another business to make liquid dispensing machines, Camelot.  As part of their estate planning, the two companies merged in an income tax-free deal.  From the Tax Court summary:

Ps and their sons merged Knight and Camelot in 1995, and Camelot was the surviving entity. Valuing the two companies in accordance with the advice their professionals had given, Ps accepted a disproportionately low number of shares in the new company and their sons received a disproportionately high number of shares.

It turns out that the estate planners “postulated” a technology transfer earlier in the lives of the companies that would have resulted in most of the value already being in the second generation. One planner explained to a skeptical attorney that “History does not formulate itself, the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force.”

The trouble with doing that is that when the latches break, the suitcase spills all over the place. But the planners persisted.  From the Tax Court decision:

As a result of Mr. Hamel’s correspondence campaign, however, the previously separate tracks of advice — one from the accountants at E&Y and Mr. McGillivray, and the other from the attorneys at Hale & Dorr — now came together for the first time. The contradiction was evident to all the professionals: The accountants had assumed no 1987 transfer (and thus believed there was a need for a means to transmit value to the next generation), but the attorneys postulated a 1987 transfer (and subsequent transfers) pursuant to which that value had already been placed in the hands of the next generation. The attorneys eventually prevailed, however, and the accountants acquiesced. Eventually all of the advisers lined up behind Mr. Hamel’s suggestion that a 1987 transfer be memorialized in the affidavits and the confirmatory bill of sale. They provided a draft of the documents, which Mrs. Cavallaro read aloud to Mr. Cavallaro. After they reported a few typographical errors, the attorneys prepared final versions, which Mr. Cavallaro and Ken Cavallaro executed on May 23, 1995.

So in 1995 they executed documents for a 1987 transaction.  What could go wrong? Well, perhaps the IRS could come in and assess $27.7 million in gift taxes, plus fraud penalties.  And they did. The dispute ended up in Tax Court.  The IRS won the main issue — its argument that the valuable technology was not in fact transferred in 1987 — and with that win, predictably also won the battle of appraisers.  The IRS appraiser at trail asserted a $29.6 million gift, which would result in a gift tax of about $14.8 million at 1995 rates. Because of the involvement of the outside experts, the Tax Court declined to uphold penalties.

This shows how important valuation can be even in a “tax-free” deal.  When doing business among family members at different generations in estate planning, you don’t have the conflicting interests that unrelated buyers and sellers have, so you have the possibility of creating a taxable gift if you are careless. It’s natural for family members to believe numbers that help their estate planning, so it’s wise to get an independent appraiser in to provide a reality check.  And if the facts, or values, don’t fit into the suitcase, don’t squeeze; get a bigger suitcase.

Cite: Cavallero, T.C. Memo 2014-189


This Koskinen isn't the IRS commissioner

This Koskinen isn’t the IRS commissioner

Instapundit, IRS COMMISSIONER: Our Story On The IRS Scandal Isn’t Changing. It’s Just, You Know, Evolving Now And Then.  “I’ve taken a dislike to this Koskinen fellow. He seems sleazy even by DC standards.”

TaxProf, The IRS Scandal, Day 497. Mostly coverage of another slippery appearance by Commissioner Koskinen before House investigators.


TaxGrrrl, Back To School 2014: American Opportunity Credit

Kay Bell, Private and often untaxed home rentals under fire

Peter Reilly, Need To Show Rental Effort To Deduct Expenses. “I think the way I would put it is ‘If at first and second and third you don’t succeed, try something different.  Otherwise forget about deducting losses.'”


David Brunori, Fairness and the Reality of State Tax Systems (Tax Analysts Blog) “etc. This week WalletHub released a rating of the fairest state and local tax systems… I am not doubting the accuracy of WalletHub’s survey. But the results don’t align with political reality.”

Cara Griffith, Single Sales Factor May Be Inevitable, but Is It Fair? (Tax Analysts):

In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining (or returning to) the three factor apportionment method and focus on a less burdensome corporate tax system overall. In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining (or returning to) the three factor apportionment method and focus on a less burdensome corporate tax system overall.

No, they are concerned with ribbon cuttings, press releases, and campaign contributions from those seeing tax credits and carveouts.



20140805-2Renu Zaretsky, A Hail Mary or Two on the Hill.  The TaxVox tax headline roundup covers inflation adjustments and beating up on the NFL with the tax code, among other things.

Alan Cole, Why do I have Four Different Retirement Accounts? (Tax Policy Blog) “Give us one unlimited saving account, tax it properly, like an IRA, and let us use it how we will.”

Russ Fox, Zuckermans Sentenced; No Word on Fido & Lulu “Unfortunately, members of a board of directors must be human: Fido and Lulu don’t qualify.”

Adrienne Gonzalez, Mad Scientist Gets Prison Time for Using His Dog and Cat in a Tax Avoidance Scheme (Going Concern). PETA couldn’t be reached for comment.



Charity may begin at home, but not with the down payment.

Tuesday, August 27th, 2013 by Joe Kristan


One curiosity of the Great Housing Bubble was the emergence of the “down payment assistance” enterprise.  These outfits, typically established as “non-profit” entities, purportedly helped home buyers come up with a down payment.  Some of these didn’t look quite right.

Back in 2005 we noted an Illinois organization called “Partners in Charity”:

An Illinois organization known as “Partners in Charity” (PIC) has been helping home sellers close deals when the buyer is unable to come up with a down payment. PIC “gives” the down payment to the buyer, and the seller “reimburses” the downpayment to PIC, plus an “administration fee.” If the seller were to pay the down payment directly, that could make the lender walk away; running it through PIC gives everyone a fig leaf that there is a “down payment” and gets the deal closed.

Here’s the fun part, from a tax viewpoint: Partners in Charity claims to be a 501(c)(3) charity, and the Government says they tell house sellers that the “reimbursed” down payment and administrative fee qualify for a charitable contribution.

In other words, a charitable deduction for what amounts to a reduction in the sales price.  Sweet.  Too sweet.  We looked at the documents that they helpfully posted on their website and found the whole thing a stretch:

Note that the seller is “obligated” to make the “contribution,” or PIC doesn’t play. This is an obvious quid pro quo, and the Eddie Haskell-like language “Seller understands that the contribution will not be used to provide down payment assistance to the Buyer of the Participating Home, and that the gift funds provided to the Buyer toward the purchase of the Seller’s home are derived from pre-existing PIC funds” isn’t going to fool anybody. If that worked, the only way you could ever stop somebody from running almost any expense through a purported charity would be if the charity used the exact same dollar bills that you gave them to pay the expense.

The Tax Court yesterday pondered Partners in Charity’s tax-exempt status and arrived at a similar conclusion (my emphasis, citations omitted):

PIC argues that it did not give seller funds to a buyer — an important requirement under the HUD guidelines. PIC contends that it received fees from sellers only after closing and that the fees were necessary for PIC to recoup the costs of its grants, and, therefore, the seller-paid fees furthered the grant-making purpose. This argument misses its mark. Before PIC gave funds to a buyer, PIC required a promise from the seller that, immediately after closing, the seller would pay PIC the buyer’s grant amount plus a fee-and the evidence shows that in fact the seller’s payment was made to PIC from the escrow, i.e., without risk that the seller would renege. In essence, a DPA grant went from PIC to the buyer, to the seller, and right back to PIC.

The Tax Court upheld the revocation of Partners In Charity’s exempt status retroactively to inception.  As the company had accumulated over $3.5 million in assets, according to the decision, that will result in an ugly corporate tax bill.

The Moral? If you find yourself sounding like Eddie Haskell when explaining a transaction, maybe it’s not such a great idea.

Cite: Partners in Charity, Inc.,  141 T.C. No. 2


Tax Roundup, 6/25/2013: IRS says it was evil to lefties, too. And: RRTP > CPA?

Tuesday, June 25th, 2013 by Joe Kristan

20130419-1The IRS yesterday issued a new internal report showing that the hold-ups on Tea Party exemption applications continued until just now.  Tax Analysts reports ($link):

IRS Principal Deputy Commissioner Daniel Werfel told reporters that when he began his 30-day review of the agency’s mishandling of conservative groups’ exemption applications, he discovered that the exempt organizations unit was still using BOLO lists that included inappropriate or questionable criteria.

“BOLO” is “be on the lookout” lists looking for suspicious signs of political activity via the names of the organization.  These lists included “progressive” as a suspicious word, along with some right-side words, but it it appears that the left-side groups were not singled out for the “special” treatment accorded the Tea Party.

There is still a lot we don’t know about how the IRS treated the 501(c)(4) applications.  Unless we find out about left-side applications left to languish for years, like the Tea Party applications, it still doesn’t appear that IRS was evenhandedly evil.  And “they screwed some of us, too” isn’t exactly a ringing defense of the organization.

IRS, Charting a Path Forward at the IRS: Initial Assessment and Plan of Action

Kay Bell, IRS also was on the lookout for progressive tax-exempt groups

Linda Beale, To All Those Right-Wingers Complaining about IRS Targeting–guess what, they used “progressive” to help screen, too!

TaxProf, The IRS Scandal, Day 47


You can’t condition your conservation easement on it being deductible, says the Tax Court. (Graev, 140 T.C. No. 17).  $990,000 deduction fails.

Tony Nitti, Tax Court: Leasehold Interest Exchanged For Fee Interest In Real Estate Does Not Qualify For Section 1031 Treatment,  If your leasehold is less than 30 years, don’t expect it qualify in a swap for a fee interest in real estate.

Jana Luttenegger, Emergency Preparedness includes Safeguarding Records (Davis Brown Tax Law Blog).  “Have you thought about what records could be destroyed if a severe storm damaged your home or business?”


Tuesday Buzz from Robert D. FlachIt links to a new post on Robert’s “The Tax Professional” blog, where Robert asserts:

If a CPA were able to earn the designation of RTRP it would clearly identify that individual CPA as being competent and current in 1040 preparation.

False.  The now-dormant RTRP exam was a literacy test that proves tax competency in neither CPAs nor anyone else.  Robert is correct, though, when he says “A CPA is not automatically a 1040 expert, but a specific CPA may be a 1040 expert.”

I do think that CPAs who do tax work tend to be very capable, but so are many non-CPA preparers.  I think the competency curve would look something like this:


You should choose your tax preparer not just because of initials; you should find out what kind of work the preparer does.  And check references.


Russ Fox, FBAR Deadline Is Now.  If you haven’t sent in your FBAR, Russ shows how to e-file.

Austin John, Maryland Soon to Roll Out the Rain Tax (Tax Policy Blog)

Tax Justice Blog, Governor Cuomo, Meet Governor Brown.  “California Shows that Geographically Targeted Tax Incentives Don’t Work.”   Leave out “geographically” and it’s even better.


David Henderson, Atkinson and Krugman on Tax Rates (Econlog).

Jeremy Scott, Can the OECD Be Trusted on Base Erosion? (Tax Analysts)

TaxGrrrl, If It Ain’t About Money (Turns Out It Is): Rapper Fat Joe Headed To Prison For Failure To Pay Taxes


Breaking News from 2010:  Tax Return Fraud Spiraling Out of Control (Citizens Against Government Waste).  It’s ID theft fraud, of course.  Too bad Commissioner Shulman was busy regulating preparers and holding up 501(c)(4) applications.

Athletic ability has a weak correlation with financial ability.  Bankruptcy Rates Among Professional Athletes Need to Be Addressed (Jen Carrigan at Missouri Tax Guy)




Tax Court makes IRA ownership of your business even more dangerous

Friday, May 10th, 2013 by Joe Kristan

20120511-2Owning a closely-held business through your Individual Retirement Account has always been a high-wire act of tax compliance.  The Tax Court snipped one end of the wire for many IRA-owned corporations yesterday.

The biggest danger of owning your business in an IRA has been the risk of having a “prohibited transaction.”  The tax law has hair-trigger rules for pension funds and other exempt organizations to prevent abuse of the funds by related parties or trustees.

Prohibited transactions are foot-faults.   If you have one, the 15% tax applies to the “amount involved” for each year of the transaction, even if you didn’t mean to do any harm — even if you in fact did no harm.  There is no “good-faith” out.   Worse, prohibited transactions terminate your IRA, triggering any untaxed income within the account.

In yesterday’s case, a taxpayer acquired a C corporation through an IRA.  The taxpayer then guaranteed loans to the corporation.  The Tax Court said this constituted an “indirect extension of credit” to the IRA (my emphasis):

 As the Commissioner points out, if the statute prohibited only a loan or  loan guaranty between a disqualified person and the IRA itself, then the prohibition could be easily and abusively avoided simply by having the IRA create a shell subsidiary to whom the disqualified person could then make a loan. That, however, is an obvious evasion that Congress intended to prevent by using the word “indirect”. The language of section 4975(c)(1)(B), when given its obvious and intended meaning, prohibited Mr. Fleck and Mr. Peek from making loans or loan guaranties either directly to their IRAs or indirectly to their IRAs by way of the entity owned by the IRAs.

That triggered both a prohibited transaction and the termination of the IRA.  The corporation was sold in 2006.  The termination of the IRA status meant the gain was taxable on the IRA-owner 1040s, rather than sheltered in an IRA.  Worse, the court upheld “accuracy-related” penalties.

Have you ever tried to get a loan for a closely-held corporation without personal guarantees?  It can be difficult, especially when you have a new business.  Unfortunately, owners of startups are often sorely-tempted to use their IRAs as owners, as it may be their best source of equity capital.  This case shows how dangerous IRA ownership of your business can be.

I suspect there are a lot of similar taxpayers out there, with much riding on any appeal of this case.  The consequences to these folks will be catastrophic, in the same league as the ruin caused by Incentive Stock Options (ISOs) exercised just prior to the dot-com collapse.   The ISO disaster was bad enough to get Congress to enact legislative relief.  This could also get Congressional attention.

Cite: Peek, 140 T.C. No. 12.



F. Lee Bailey, tax litigator

Tuesday, April 3rd, 2012 by Joe Kristan

F. Lee Bailey once had fame as an attorney like a rock star.  His name is no longer a popular synonym for “awesome lawyer,” so maybe that’s why he decided to see whether he should try his hand at tax litigation. 

He certainly chose a difficult case — his own.  The IRS was after him on several issues, the biggest of which was an attempt to tax him on client funds that he was holding (long story involving a foreign fugitive).  The IRS wanted to tax him on about $5.9 millions of funds on the grounds that it was available for his personal use.  The Tax Court assessed him on about $450,000 of the funds that he “wrongly appropriated” and later repaid.

Mr. Bailey did less well on the hobby loss portion of his case.  He failed to convince the judge that his custom-built yacht was a “for-profit” activity.  One of the elements of the “hobby loss” tests is whether the taxpayer derives personal pleasure from the activity.  Mr. Bailey said the yacht was just no fun.  From the Tax Court opinion:

The Commissioner contends that Mr. Bailey took a great deal of personal pleasure from sailing on the Spellbound with his family and friends, but Mr. Bailey claims that “[i]t’s no fun to drive a boat”. Mr. Bailey testified that the steering wheel and navigational instruments of the Spellbound are isolated from the rest of the deck, and the pilot is therefore isolated from the party-goers on the deck.

While it may be true that Mr. Bailey did not enjoy piloting the yacht, the record belies the claim that he derived no personal pleasure from it. First, the Spellbound was built to Mr. Bailey’s specifications, and he testified that it was beautiful. Second, the record does not show that Mr. Bailey always took on the job of piloting the Spellbound. PBR hired a captain and crew to sail and maintain the Spellbound, and Mr. Bailey could have used their services to pilot the yacht any number of times. Even assuming arguendo that Mr. Bailey piloted the Spellbound on every personal trip–and that he disliked the task–we find that he derived pleasure from sharing the yacht with his family and friends and that he anticipated doing so when he purchased the yacht in 1989.

This factor–elements of personal pleasure–is in the Commissioner’s favor.

The 143-page opinion covers over a dozen different tax disputes the famous litigator had with the IRS, with the IRS prevailing on most of them, to the point that the court upheld an accuracy-related penalty

Peter J. Reilly has much more

Update: The TaxProf also has more.

Cite: Bailey, T.C. Memo 2012-96


You’re tax-exempt? That doesn’t always mean you’re tax-exempt

Thursday, September 29th, 2011 by Joe Kristan

While the tax law provides many entities the opportunity to be tax-exempt, there are limits. The government doesn’t want tax exempt entities to use their exemption to compete with taxable businesses. It wouldn’t be fair to the taxable entities, and it would cut into the government’s action.
That’s why we have the “Unrelated Business Income Tax.” This tax can be understood as the corporation income tax applied to business activity of otherwise tax-exempt entities. It’s something exempt entities, including IRAs and pension funds, should be careful of any time they have income from things other than interest, dividends and capital gains. And it can crop up in surprising ways, as the National Education Association learned yesterday in Tax Court.
The NEA publishes two magazines for its members, and it generates unrelated business income from selling ads. The NEA deducted its circulation costs against this income. The IRS said that because the magazines are available to all NEA members, it was required to allocate a portion of its dues income to its income from the magazines. The Tax Court sided with the IRS, saying the tax law

…requires an allocation of membership dues to circulation income if the exempt organization’s members have a legal right to receive the publications. For the years at issue, NEA members had such a legal right to receive the periodicals. The fact that NEA also made most of the content of the periodicals available on the Internet does not change this conclusion. Consequently, the IRS was correct in requiring NEA to allocate a portion of its membership dues to circulation income.

The decision, unless reversed on appeal, will cost NEA $1.1 million. It reminds us that tax exempt status has its limits, and that exempt organizations need to be careful with investments that aren’t plain-vanilla.
Cite: National Education Association of the United States, 137 T.C. No. 8
Related: Got UBIT? Why IRAs need to be careful where they invest


Tax Court: No casualty loss deduction for casualties you inflict

Thursday, March 10th, 2011 by Joe Kristan

The tax law allows an itemized deduction for “casualty losses” not covered by insurance, to the extent they exceed 10% of your adjusted gross income. A taxpayer yesterday learned that it doesn’t apply to casualties that you inflict.
A taxpayer ran over a pedestrian while driving, and the victim later died of the injuries. The taxpayer had to pay a $250,000 wrongful death settlement that apparently wasn’t covered by insurance. They deducted the payment as a casualty loss. The taxpayer, whose last name is Pang, said the payment was the result of a casualty, after all — the casualty suffered by the poor pedestrian. The Tax Court said that the tax law doesn’t mean that kind of casualty:

The Pangs maintain, however, that their $250,000 settlement payment is deductible under section 165(c)(3) as a casualty loss because Webster’s Dictionary defines “casualty” as “[l]osses caused by death, wounds” and the accident victim’s death in December 2002 was certainly a casualty.
This issue is resolved not by Webster’s definition of “casualty” but by the Code’s provisions for “casualty loss” quoted above. Moreover, the Pangs’ position conflates two distinct things — the victim’s casualty (which occurred when he died in 2002) and the Pangs’ financial loss (which occurred when they made their payment in 2004)4 — and does not explain how the “casualty” of the victim results in a deductible “casualty loss” for the Pangs under section 165.
This Court has held that “physical damage or destruction of property is an inherent prerequisite in showing a casualty loss.” Citizens Bank of Weston v. Commissioner, 28 T.C. 717, 720 (1957), affd. 252 F.2d 425 (4th Cir. 1958). The Court of Appeals for the Ninth Circuit, to which an appeal in the present case would lie, likewise requires physical damage to the taxpayer’s property as a prerequisite to a casualty loss deduction… As a result, although the death of the pedestrian was certainly a “casualty” in the general sense of the word, and although one could say that the Pangs suffered a subsequent economic “loss” when they paid the wrongful death settlement, we cannot hold that Congress intended such a payment to be a “casualty loss” within the meaning of section 165(c)(3).

Decision for IRS.
The Moral? Make sure your auto or umbrella policy covers this sort of thing; The tax law won’t help you with the cost of racking up a body count.
Cite: Pang, T.C. Memo. 2011-55
UPDATE, 3/11/2011: The TaxProf has more.