Posts Tagged ‘Judge Holmes’

Tax Roundup, 10/22/13: Birthday edition! And an unappealing appeal.

Tuesday, October 22nd, 2013 by Joe Kristan

The Internal Revenue Code of 1986 celebrates its 27th birthday today.

President Reagan signs PL 99-514, the Tax Reform Act of 1986.

The authors of the Tax Reform Act of 1986 felt so good about their work amending the Internal Revenue Code of 1954 that they gave it a new name.  And it had some wonderful features compared to what we have now:

– Top marginal rate of 28%, with no stupid phase-outs of itemized deductions or exemptions.

– No capital gain-ordinary income rate differential – tolerable with low marginal rates, and a great simplifier of tax planning.

– It eliminated a whole bunch of complexity, including investment tax credits, and it simplified the life of preparers everywhere by making miscellaneous itemized deductions subject to a 2% of AGI floor, saving us the pain of telling clients they can’t deduct the Swimsuit Issue as an investment expense.

Sure, it had more complexity than I’d care for.  The complicated passive loss rules came in then, on top of existing complicated at-risk rules.  Phase-outs of the passive loss rules imposed hidden marginal tax brackets that helped inspire many awful imitations, like the phase-outs reenacted this year of itemized deductions and personal exemptions.   The 1986 Act brought us inventory capitalization rules, and it left in place the alternative minimum tax.  But at the time, it looked like a good start at much better tax policy.  Now it looks like a high-water mark.

 

Martin SullivanTax Policy In a Knowledge Based Economy (Tax Analysts Blog):

The skeptical accounting profession rarely allows worker training, brand-building, software, and business restructuring to be capitalized, but in so doing it is unwittingly keeping the most important sources of value out of view of managers and stockholders.

Actually, smart managers and investors know about these things, but financial statements aren’t very good at measuring them.

 

20120801-2Tax Court leaps back to work, releasing seven new cases on its first day back after the shutdown.  They include a Judge Holmes case illustrating how good news on the estate tax return can mean bad news on a later income tax return; that case will get its own post this week.

 

TaxGrrrl, Losing Your Identity In Five Easy Steps. Step One: Go To The Doctor.  “And it can all start out with something as simple as handing out your Social Security number at the doctor’s office”

Jason Dinesen, Incorporate Your Life? Not So Fast  “…simply having a business entity DOES NOT make everything in your life tax deductible.”

William Perez, Payment Plan Options. “The IRS will automatically grant a payment plan if your balance owed is under $50,000 and the monthly payments will fully pay the outstanding balance in 72 months or less.”

TaxProf, The IRS Scandal, Day 166

Jack Townsend,  Ex Top UBS Banker Arrested; Likely to be Extradited

Kay Bell, Amazon tax now out in Illinois, coming Nov. 1 to Wisconsin

 

Not only is it the birthday of The Code, it’s Buzz Day at Robert D. Flach’s place!

The Critical Question (Really): Is Obamacare in a Death Spiral? (Megan McArdle): “Another week has passed, which apparently means that it’s time for another terrifying article from Sharon LaFraniere, Ian Austen and Robert Pear on the federal health-care exchanges.”

 

SuccessDetermined Iowa City man may be first in state to buy insurance via glitch-plagued public exchange (Des Moines Register):

Voss said Monday that he tried more than 100 times before finally being able to sign onto healthcare.gov, type in his personal information, compare insurance plans, and purchase a policy. 

I wonder if Amazon.com ever tried that?

 

20121226-1Speaking of train wrecks,  McCoy gives up on train funds (Des Moines Register).  An Iowa legislator gives up on spending $310 million to build a money-losing, slower and more expensive competitor to the Megabus.  Now he can concentrate on getting that downtown zeppelin port that is so critical to the economic future of Des Moines.

 

The Cougars of Madison County. No, Francesca Johnson isn’t back on the prowl.

 

Hey, I said I’m sorry!  That you want to put me in jail.  A New Mexico man convicted of tax crimes and of collecting fraudulent farm payments maybe should have left well enough alone, if you can think a five-year prison sentence is well-enough.  But Billy Melot appealed, with potentially dire consequences.  DailyJournal.net reports:

A southern New Mexico farmer and businessman could face more time in prison because a federal appeals court on Monday tossed out his five-year sentence for failing to pay more than $25 million in federal taxes and fraudulently collecting farm subsidies.

However, the court said a federal district court judge erred in calculating Melot’s sentence by concluding that he had accepted responsibility for his crimes. Judges have the discretion of imposing a less severe sentence when they make that determination.

Under federal sentencing guidelines, the court said, Melot had potentially faced more than 20 years in prison.

The appeals court opinion noted that if Mr. Melot accepted responsibility, he had a funny way of showing it:

Since his conviction, Melot has tenaciously opposed the Government’s efforts to collect the restitution he was ordered to pay by the district court, attempting to thwart the collection of more than $18 million in outstanding income tax assessments and more than $6.5 million in outstanding excise tax assessments. In 2012, a federal magistrate judge issued a certification of criminal contempt against him in the ancillary collection proceedings, finding he “actively and intentionally participated in a scheme to fraudulently create a third party interest in his properties with the intention of defrauding the Court, sabotaging the orderly administration of justice and delaying the United States’ lawful efforts to recover the judgment as ordered by the Court.”

Mr. Melot is 61 years old.  If his sentence is stretched to 20 years, he won’t have much time to enjoy any money he keeps away from the feds.

 

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Tax Roundup, 7/25/2013: Mo’ refundable credits, mo’ fraud. Plus cigarettes and preschoolers!

Thursday, July 25th, 2013 by Joe Kristan

momoneyRefundable tax credits are a magnet fo’ mo’ fraud.  Five from Mo’ Money tax prep office in St. Louis arrested in scheme (St. Louis Post-Dispatch):

Mo’ Money franchise owner Jimi Clark, 57, of Memphis, Tenn., abused the American Opportunity Credit to attract and keep clients, prosecutors said. They filed for the credit on at least 47 returns where the taxpayer had not incurred any educational expenses, and unwisely, claimed the same amount of educational expenses, $3,765, on the “vast majority” of the returns, their indictment says.

In all, the 47 returns claimed more than $50,000 in educational credits.

Maybe 25% of the rundable Earned Income Tax Credit is paid improperly.  Yet legislators ignore how the credits actually work because they like them in theory.

 

Bankrupt state pays people to be friends. Illlinois governor to sign deal to lure fertilizer plant (Sioux City Journal)

Speaking of Bankrupt… Detroit Taxes and the Laffer Curve (Alex Tabarrok):

  • [The] per capita tax burden on City residents is the highest in Michigan. This tax burden is particularly severe because it is imposed on a population that has relatively low levels of per capita income.
  • The City’s income tax… is the highest in Michigan.
  • Detroit residents pay the highest total property tax rates (inclusive of property taxes paid to all overlapping jurisdictions; e.g., the City, the State, Wayne County) of those paid by residents of Michigan cities having a population over 50,000.
  • Detroit is the only city in Michigan that levies an excise tax on utility users (at a rate of 5%).

Sometimes you can’t solve the problem with more taxes.

 

Robert D. Flach, DEDUCTING CAPITAL LOSSES

Tony Nitti, Q&A: How Can An Accrual Basis Business Defer Revenue When It Receives Cash In Advance?

Phil Hodgen, Nonfilers–voluntary disclosure is not your only choice:

But my opinion is that the official program is fabulous for someone who is in deep trouble and might otherwise face a spot of prison time.  For that person, the “Your money or your life!” demand from the IRS is easy to answer.  Give ‘em your money. 

For almost everyone else, the voluntary disclosure program is stupidly expensive–in tax cost, penalties, interest, and professional fees to give the government all of the paperwork they want.

You gotta shoot the jaywalkers so you can slap the real crooks on the wrist.

Peter Reilly, Not Good For Real Estate Loss When Tax Court Judge Says Purports

Fiduciary Income Tax Blog, Trials and Tribulations of Nongrantor Trusts

 

 

Cara Griffith, Improving Transparency in Pennsylvania (Tax Analysts Blog)

TaxProf, The IRS Scandal, Day 77

Howard Gleckman, The OECD’s International Tax Plan: The First Step on a Long Road (TaxVox)

Tax Justice Blog, CTJ Presents the Nuts & Bolts of Corporate Tax Reform

Linda Beale, Senators promised 50 years of secrecy on their tax reform proposals

Daniel Shaviro, What is a “tax expenditure” and when does this matter?

 

TaxGrrrl,  Louisiana To Offer ‘Fresh Start’ Tax Amnesty Program.  I’m sure this time they really mean this is the last one.

Missouri Tax Guy, The Enrolled Agent, EA

Jack Townsend, Fourth Circuit Holds Defendant to His Tax Loss Stipulated in the Plea Agreement

Kay Bell, Summer 2013 sales tax holidays begin this weekend

William Perez, Sales Tax Holidays in 2013

                                                              

Quotable: (my emphasis)

The manufacturing innovation institute, meanwhile, is just another iteration of an idea that’s been around for longer than Barack Obama has. Go to any Rust Belt city and you’ll find research campuses, innovation institutes and similar institutions named after hopeful politicians who promised that a new manufacturing base would coalesce around this exciting agglomeration of creative minds. Unfortunately, in most instances it has turned out that manufacturing bases would rather coalesce around cheap land, low taxes and acres of uncongested freeway.

-Megan McArdle, “Obama’s Speech Is a Confession of Impotence

 

I think one judge will think otherwise. Three South Dakota men say income taxes don’t apply to them (Argus-Leader.com)

Tax Court Judge Holmes has a new opinion out.  Always entertaining and enlightening.

News you can use:  No Such Thing as Free Swag (Austin John, Elizabeth Malm, Tax Policy Blog).  Sorry, ESPY winners.

More harebrained than what they do anyway? U.S. Senators with Harebrained Tax Reform Ideas Offered an Opportunity (Going Concern)

Maybe not where you grew up. Cigarettes and Preschoolers Don’t Go Together (Scott Drenkard, Noah Glyn, Tax Policy Blog)

 

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Donating property? Get an appraisal. And it helps to get it on the property you donate.

Tuesday, February 5th, 2013 by Joe Kristan

20120801-2There are big tax advantages to donating appreciated capital gain property.  You get a charitable deduction for the full value of the property without ever paying tax on the appreciation.

There is lots of potential for abuse in valuing property, so the tax law lays out strict standards requiring “qualified appraisals” for most property donations over $5,000.  A taxpayer found out how strict yesterday in Tax Court.  Judge Holmes sets the stage:

Harvey Evenchik owned shares in a corporation known as the Chateau Apartments, Inc. Chateau’s sole assets were two apartment buildings — a 42-unit building known as the Chateau Apartments at 3666 East 2nd Street in Tucson, Arizona (Second Street), and a 10-unit complex at 3815 through 3821 East Lee Street, also in Tucson (Lee Street).

     Sometime in 2004 Harvey donated the approximately 72% of Chateau’s capital stock that he owned — 15,534.67 shares — to Family Housing Resources, Inc. (FHR), a nonprofit housing corporation.

Mr. Evenchik claimed a charitable deduction of $1,045,289 on his 2004 return — more than they could deduct.  The IRS challenged the carryover used on his 2006 return, saying the appraisal requirements hadn’t been met.  The Tax Court agreed that the taxpayer disclosures fell short, but then considered whether the taxpayers came close enough.  Unfortunately, the taxpayers valued the wrong asset.  Their appraisals covered the apartment units, but the taxpayer donated stock of the corporation owning the units — not the apartments themselves:

Commissioner is unable to determine whether the contributed property interest was overvalued. And the problem of misvalued property is so great that Congress was quite specific about what the charitably inclined have to do to defend their deductions.

So while close might have been good enough, this wasn’t close.

The Moral:  When you make a property donation — whether its real estate, art, or anything besides publicly-traded securities — you need an appraisal when the donation exceeds $5,000.  Make sure you get the appraisal done right.  If you wait until the IRS audits you, it’s too late.  And make sure the appraisal covers what you actually donate.

Cite: Estate of Evenchik, T.C. Memo 2013-344.

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Cobbler’s children go barefoot, tax lawyer’s income goes unreported.

Friday, January 18th, 2013 by Joe Kristan
Flickr image courtesy Lara604 under Creative Commons license.

Flickr image courtesy Lara604 under Creative Commons license.

Judges are often hard on tax pros who get in trouble.  They seem to think practitioners should know better than to underreport income or fudge deductions.  That led to a bad result for California attorney Owen Fiore in Tax Court yesterday.

Mr. Fiore apparently was the model of a rainmaking partner.  Unfortunately, he failed to delegate other duties, according to Judge Holmes:

His sophistication did not extend to his management of the firm’s finances. Fiore came to rely on a three-checkbook method of accounting — one for the general account, one for the client trust fund, and one for minor expenses such as filing fees. The preponderant flow of dollars was thus through the general account. Client billings went into the general account; payroll, office rent, and the firm’s other expenses came out of that account. Fiore even handled payroll in a way that would have been familiar to lawyers of a hundred years before — writing out checks to each associate and employee by hand on paydays. At the end of each year, he would write out a W-2 for each employee by hand.

The attorney came under financial pressure, and things at the firm got out of hand until he turned over management of the firm to a partner in mid 1999.  Unfortunately, the IRS came poking around in time to look at the pre-transition returns.  After Mr. Fiore ignored one too many requests for a meeting, the examiner turned the case over to the Criminal Division.

Special Agent Lisa Sasso took over the investigation. She started by requesting copies of Fiore’s 1996 and 1997 tax returns from IRS Service Center — but they were missing the Schedules C. Unlike the civil agents, Sasso didn’t ask for meetings — she just showed up unannounced at Fiore’s office in March 2002. She read Fiore his rights and asked him questions about his billing procedures, books and records,  and business expenses. After her initial visit, she requested documents  for the 1996 and 1997 tax years. Fiore sent her some documentation, but  didn’t cough up any work papers to tie his information to his return.  So Sasso sent a summons to Fiore’s bank and then she did a bank-deposits analysis for 1996 and 1997.

Things went badly from there.  The agent detected unreported income, and Mr. Fiore was eventually pleaded guilty  and was sentenced to 18 months in federal prison for underreporting 1999 income.  He contested the IRS imposition of civil fraud penalties for 1996 and 1997.  Judge Holmes said that the cobbler should have minded his own shoes (my emphasis)

Notwithstanding his busy schedule and administrative shortcomings, he must have known that there was a very high probability that he wasn’t reporting all of his income. His educational background and work experience would alert him to the likely outcome of his haphazard income-estimation method — that he was likely failing to report substantial amounts of income. Fiore knew he was neglecting firm administration and running a high risk of not reporting taxable income.

We also find that Fiore deliberately avoided steps to confirm the possibility of unreported income. He could have easily confirmed whether his estimates of gross income were correct by checking his business-account bank statements. He also had a three-ring binder for each taxable year that included a copy of all the bills and deposit slips.

     Fiore in fact admitted to willful blindness “not for the purpose of defrauding the government, but rather, sadly, for the purpose of getting and keeping clients.” At the very least, this is an admission that he believed his time was better spent on getting clients than confirming whether he reported all his income — even when he suspected that at least some taxable income wasn’t being properly reported. We therefore find that Fiore was willfully blind, weighing in favor of finding fraud.

     And with particular weight given to this willful blindness we find that the Commissioner has met his burden of proving by clear and convincing evidence that Fiore filed fraudulent returns.

The court upheld the 75% civil fraud penalty for 1996 and 1997.

The Moral?  Sure, you’re busy.   Don’t be too busy to deal with an IRS agent; they won’t just go away if you ignore them.  And if you are too busy to take care of your tax filing requirements, you may wish you had taken the time to tend to your cobbling.

Cite: Fiore, T.C. Memo. 2013-21

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Tax Roundup, 12/5/2012: Happy Repeal Day! Too bad it’s not the tax code.

Wednesday, December 5th, 2012 by Joe Kristan

Happy National Repeal Day!

 

Either we cut spending or everyone will pay more taxes.  This post by Veronique de Rugy puts together in one handy package some points I have been trying to drive home about budget and tax policy.  It’s all worth reading, but some key items include:

 In my opinion, the problem with the fiscal-cliff debate has been that no one is acknowledging the fact that there is no way out of raising taxes on everyone eventually unless Congress gets serious about addressing our long-term fiscal problem, by restraining spending.

“The Rich” simply don’t have enough income to foot the bill.  But borrowing temporarily hides the problem:

This, by the way, is why I thought the Bush years were so toxic. Cutting taxes while increasing spending dramatically — Bush increased real spending by 60 percent, as opposed to Clinton’s increase of 12.5 percent — is a recipe for large deficits leading more taxes later or certainly intense pressure to raise taxes.

What will taxes look like when the bill comes due?

This weekend, Mark Steyn gave us an idea of what that tax bill would look like. He writes:

A couple of years back, Andrew Biggs of the American Enterprise Institute calculated that, if Washington were to increase every single tax by 30 percent, it would be enough to balance the books — in 25 years. If you were to raise taxes by 50 percent, it would be enough to fund our entitlement liabilities — just our current ones, not our future liabilities, which would require further increases.

Finland shows how high taxes have to be to adequately fund a lavish welfare state, as I have noted:

Finland has an extensive welfare state and most years pays for it without budget deficits.  It does so with income taxes that reach a 2012 top rate of 29.75% at €70,301, which is about $57,021 at current exchange rates.  For a US taxpayer filing single, the 28% rate doesn’t start until taxable income reaches $85,651, and not up to $142,701 on joint returns.  On top of that, Finns pay a 23% Value-added tax on most purchases — a tax that is not tied to income.  But there’s more!  There is a mandatory 4.7% payroll tax on employee gross wages, plus another 18.3% “paid” by the employer — but that necessarily reduces what they can pay the employee after-tax.

I’m not sure all that would go over well here, but that’s what we’re headed for.  Anybody who says rich people can pay for all of the free government stuff is either clueless or lying.  The rich guy isn’t buying.

 

Megan McArdle,  Who Gets More Damaged If We Go Over the Fiscal Cliff?  At least there’s a drink at the bottom.

At least the weather’s nice.  Oh, maybe not…  Top Federal Marginal Tax Rate Will Exceed 50% in California, New York, and Hawaii in 2013 (TaxProf)

Amy Feldman,  Getting ready for the Medicare tax on investment income   (Reuters)

Don’t think he actually plans to pay the higher taxes he supports.  Warren Buffett Makes Money On Tax Breaks He Discredits (Steve Stanek, IBD)

Joseph Thorndike, Moral Abdication Dressed Up Like Hard-Nosed Realism (Tax.com)

 

But think of the intangible benefits of the Iowa film tax credit program! Film financier sues state over unpaid film credits (AP)  The producer of one of the films involved in the suit pleaded guilty to felony chargesarising from tax credits for the film.

Joseph Henchman,New York Times Tells the Tale of Michigan’s Bankrupt State-Backed Film Studio (Tax Policy Blog Oh, and Happy 75th Birthday to the Tax Foundation! 

 

Kay Bell, Tax Carnival #109: Tax Stocking Stuffers

TaxGrrrl,  12 Days of Charitable Giving 2012: Be An Elf

Russ Fox,Nominations Due for 2012 Tax Offender of the Year.  ‘Tis the Season!

Must be a Cubs fan. Hapless Mr. Williams Loses Again (Jack Townsend)

Nor do I.  No, I Don’t Plan to Take the RTRP Exam (Jason Dinesen). 

Jim Maule, The Hidden Government Spending Game.  Spending doesn’t become something else just because you run it through a tax return.

Trish McIntire, Do You Have a Spare $2,350?  You do?  Good, you may need to send it to the IRS in April if Congress doesn’t “patch” the Alternative Minimum Tax for this year.

Peter Reilly, Hobby Losses – Need To Convince Tax Court You Love Money More Than The Game

Robert D. Flach has his Wednesday Buzz roundup of tax posts up!

 

 

Holistic auto healing?  Cadillac chiropractor sent to prison for tax fraud  (Mlive.com)

The Critical Question:  Bartlett: The Fiscal Cliff and the Debt Limit — What Would Lincoln Do? (TaxProf)

Judge Holmes Quote of the day. 

Allison T. O’Neil, the ex-wife of Michael J. O’Neil, does not want to pay a penny of their joint 2005 federal tax liability because, she says, it [*2] would be inequitable to make her do so.

2 Michael recalls providing Allison with $6,000 to $10,000 per month. Allison recalls getting only $6,000 per month.

Cite: O’Neil, T.C. Memo 2012-339

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It was a dark and stormy night in Cicero

Tuesday, July 31st, 2012 by Joe Kristan

Of the many bad consequences to tax fraud, the way it keeps the statute of limitations for assessment of tax open forever is definitely one of them.  A convicted former Mayor of Cicero, Illinois, Betty Loren-Maltese, learned about that the hard way yesterday in Tax Court.  

Her pain probably wasn’t eased by the delighful opinion written by Judge Mark Holmes.  You should read the whole thing, starting with its great explanation of how the tax law determines when there is fraud when a taxpayer invokes the Fifth Amendment (all emphasis mine):

We can also draw inferences from her silence if, under the circumstances, it would’ve been natural for her to object. See United States v. Hale, 422 U.S. 171, 176 (1975). This later principle is not constitutional, just an acknowledgment of human nature. The original Cicero made the point 2,000 years ago in his oration exposing the plot of Lucius Catilina and his friends to plunder their government’s treasury. He observed that people have a natural tendency to defend their reputation, and that silence in the face of accusations suggests that there might be some merit to the charges. The Latin is more succinct: Cum tacent, clamant.

The background is also full of fun:

The silence that shouts out here arose from Cicero, Illinois, a suburb of Chicago that sits on its western hip like a well-holstered gun, and that has a colorful history that reaches back into the 1920s when Al Capone took refuge there. (Capone, though best known for his failure to file accurate tax returns, was also apparently well known for superintending a large number of saloons and other illegal enterprises in Cicero during Prohibition.) Some of this past is not dead, and is not even past — as Ms. Loren-Maltese remarked at trial: “There’s always investigations in Cicero.”

And:

Her tenure in office was not tranquil. In October 1996 the Chicago Sun-Times ran an article that named her as a target of a government investigation. In June 2001 a federal grand jury indicted her and several coconspirators for conspiracy to defraud the Town through a pattern of racketeering via multiple acts of bribery, money laundering, mail and wire fraud, official misconduct, and interstate transportation of stolen property. Her criminal trial lasted about three months, culminating in a conviction on August 23, 2002, on all but one count of the indictment (the criminal tax charge later tried separately). This put an end to her political career, and she was sentenced to eight years in prison.

A not-unusual Illinois political career trajectory.

Ms. Loren-Maltese, whose coiffure is legendary in Chicagoland, broke her Fifth Amendment silence on this subject only once — to tell us that though the car was a convertible, she didn’t go “cruising around” Town with the top down because she “wouldn’t want to mess up [her] hair.” On this narrow issue, we find her entirely credible, but the evidence that her use of the Cadillac was personal rather than political is overwhelming.

What is it with corrupt Illinois politicians and hair?

Cite: Loren-Maltese, T.C. Memo. 2012-214

 

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It’s not an apartment building, it’s a machine!

Wednesday, March 14th, 2012 by Joe Kristan

Most business fixed assets are depreciated over five or seven year lives. The cost of buildings, in contrast, has to be recovered over much longer lives — 27.5 for residential property and 39 years for other business buildings. An entire “cost segregation study” industry thrives by identifying items to carve out of buildings as shorter-lived assets.
20120314-2.jpg
An apartment building, or a finely-crafted machine?
Cost segregation studies are most effective in a factory building, where special wiring, concrete pads built to accommodate heavy machinery, lighting and so on can qualify for shorter lives. There is less opportunity for savings in apartment buildings, but that didn’t keep one partnership that showed up in Tax Court this week from giving it the old college try. Amerisouth XXXII, Ltd. threw in everything — including the kitchen sink — as shorter-lived property to maximize depreciation deductions. Judge Holmes sets the stage in his distinct style:

The Commissioner argues that with minor exceptions the apartment complex is one asset that AmeriSouth must depreciate over 27.5 years. AmeriSouth argues that, whatever the apartment complex may look like to an untrained observer, to a tax adept it is not a single asset but a collection of more than 1,000 components depreciable over much shorter periods. It is usually the case that a shorter depreciation period benefits taxpayers. It would certainly benefit AmeriSouth by generating hundreds of thousands of dollars’ worth of accelerated depreciation deductions. We are tempted to say this is why AmeriSouth throws in everything but the kitchen sink to support its argument — except it actually throws in a few hundred kitchen sinks, urging us to classify them as “special plumbing,” depreciable over a much shorter period than apartment buildings.

Judge Holmes considers the sinks:

AmeriSouth concentrates most of its persuasive efforts on the permanence of the sinks. AmeriSouth argues that the sinks are easy to remove — disconnect the sink from the water lines and remove approximately four screws or clamps — and uses the 2003 apartment renovations as an example.
But section 1.48-1(e)(2), Income Tax Regs., specifically lists sinks as structural components (“‘structural components’ includes * * * plumbing fixtures, such as sinks and bathtubs”). And while AmeriSouth tags this type of plumbing with the epithet “special”, providing water for the kitchen is hardly unusual in the sense of Scott and later cases, and AmeriSouth fails to give any other evidence that it periodically replaced or even planned to replace sinks after the 2003 renovation. So we find the sinks are also structural components of the buildings and not depreciable apart from them.

This reminds me of the “sledgehammer theory” used back in the old investment tax credit days — in fact, cost segregation studies are pretty much the old ITC studies under a different name. The theory was that if it could be moved with the help of a sledgehammer, it was “movable,” rather than part of the building, and could qualify for the credit. It wasn’t a particularly successful theory.
In this case, many other items – pipes, drain lines, wiring, and electric panels, for example, were claimed to be five-year property, unsuccessfully. A few items — garbage disposals, special plugs for refrigerators, and cable, phone and data outlets — did qualify for shorter lives.
The Moral: You should ponder what you are buying if you buy real property; there may be more depreciation available than meets the eye. But don’t throw in the kitchen sink.
Anthony Nitti has more.
Cite: AmeriSouth XXXII Ltd, T.C. Memo 2012-67

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It’s a long way from Milan, Minnesota to Nuremberg

Tuesday, December 20th, 2011 by Joe Kristan

A Minnesota banker-attorney has explored an unorthodox approach to tax : invoking the Nuremberg laws. Tax Court judge Holmes explains:

Erik Thompson didn’t file returns for tax years 2004 and 2006 because he disapproved of the wars in Iraq and Afghanistan and didn’t want to fuel “the government’s killing machine.” The Commissioner sent him a notice of deficiency, and Thompson filed a petition. He didn’t approach pretrial preparation in the spirit of cooperation that our Rules hope to inspire, because he saw “little distinction between the activities of the IRS and Tax Court and the activities of those good law-abiding Germans who drove the trains to the death camps.”

The IRS wasn’t persuaded by the analogy, and perhaps the taxpayer wasn’t either, as he began to change his approach:

He began to back off from such sentiments at trial and brought with him numerous documents that he’d never shared with the Commissioner. We reserved decision on the Commissioner’s motion to exclude this evidence, and Thompson eventually collaborated with the Commissioner to settle many issues. Two remain for both years in issue: (1) investment-interest expense and (2) rental-real-estate loss. The Commissioner says Thompson didn’t substantiate the former and didn’t participate actively enough in the rental real-estate activity to get the latter.

The IRS didn’t raise the issue of whether the losses were passive until trial, which led the banker-attorney taxpayer to protest that the IRS failed to raise the issue on a timely basis. The judge found that the IRS had some good reasons:

The Commissioner argues that “petitioner was not able to establish that the rental activity was non-passive or that the activity was engaged in for a profit.” Showing unusual chutzpah, Thompson blames the Commissioner for waiting too long to raise the issue of character of the losses. (At trial Thompson focused on the amount of the loss.)
It’s true that if an issue is untimely raised — unfairly surprising the opposing party by not giving him a chance to adequately address it at trial — we’ll refuse to consider it. Rolfs v. Commissioner, 135 T.C. 471, 484 (2010) (citing prior caselaw). But we disagree with Thompson’s premise. The Commissioner didn’t raise this issue for the first time on brief; he raised it at trial. (And considering Thompson hadn’t bothered giving the Commissioner anything relating to his deductions and losses until one week before trial, this was no small feat.)

The only way for the losses to be non-passive would be either:
– if the taxpayer met the “active participation” rule that allows up to $25,000 of rental losses to be deducted, a provision that phases out as AGI exceeds $100,000; or
– If the taxpayer met the “rental real estate professional tests (750 real estate hours and more than any non-real estate activities) AND materially participated in the real estate activity under the usual material participation tests.
Judge Holmes found he failed to meet the tests. Apparently the taxpayer brought his banking into the argument:

Thompson also makes “fairness” arguments concerning the Prairie losses. First he argues that because he believes Milan Agency, Inc., and Prairie [the rental business] are grouped together under banking law, they should be grouped together for tax law (and thus, we suppose, gains and losses of the two should be netted). But grouping for tax law — at least for the purpose of applying the passive-activity loss rules — is defined under section 1.469-4, Income Tax Regs., which doesn’t cross-reference banking law.

Fairness, of course, has nothing to do with the passive loss rules.
Cite: Thompson, T.C. Memo. 2011-291

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Tax Court softens landing for Des Moines club owner displaced by airport

Monday, November 28th, 2011 by Joe Kristan

A Tax Court case out of Des Moines last week tells a tale of mayhem, music, and strip clubs. Oh, and basis, gain and loss. Judge Holmes sets the stage:

Robert Willson opened a bar in 1986, and it gave him nothing but trouble. He’s seen lawsuits, endless repairs, and even a catastrophic fire. One might say the City of Des Moines did him a favor when it finally condemned the land in 2000 to expand its airport — right around the time Willson began serving a federal prison term. But the Commissioner wouldn’t let things be and says that the condemnation triggered a large capital gain that Willson didn’t correctly report. This meant the bar would give him one more headache — because, though Willson represented himself at trial, the facts as he described them would be worthy of an advanced exam problem in tax accounting

After being shot in the arm by a burgler, the taxpayer had do give up car repair work, so he turned to tavern ownership, buying a bar near the Des Moiens Airport that he renamed “City LImits.” He fixed it up and catered to Des Moines’ insatiable desire for rock acts whose popularity had waned elsewhere:

With these new stages, the bar became a local mecca for a type of “rock and roll” called “glam metal.” While the Court took no expert testimony on the nature of such groups, it did allow into the record Willson’s own explanation of this genre of musical entertainment. We also took judicial notice that “hair bands” had lost much of their popularity with the coming of something called “grunge rock” (another type of “rock and roll” music) in the early nineties. This was important to Willson’s business because “hair bands,” with such unlikely names as Head East, Great White, and Saturn Cats could still draw large crowds to a bar on the outskirts of Des Moines but had become affordable providers of live entertainment.

Can’t say I ever made it to that incarnation of the bar, or to a successor business launched after a fire wrecked the place:

One night in 1994, a few band members did something to a smoke machine that sparked an enormous fire. This fire engulfed everything except the parking lots, the shed, and the property’s original house. It also forced Willson to make a choice — sell to the City as part of its airport expansion, or rebuild. Willson was unable to sell, so he had to rebuild. He rented out the old house to a tenant who installed minor improvements (e.g., poles) and opened an establishment felicitously — and paronomastically — called the “Landing Strip,” in which young lady ecdysiasts engaged in the deciduous calisthenics of perhaps unwitting First Amendment expression.

Do you suppose Judge Holmes tells his wife he’s going to visit a deciduous ecdysiast when he heads to the strip club? If I used all of those big words in one sentence, my wife might get a restraining order on me, just to be safe.
Eventually he got to sell out to the airport when it expanded, and the IRS was there with its hand out for some of the gain. The judge sorted through the messy facts and made three points worth noting:
– The seller has to take depreciation into account in determining gain on the sale. The more depreciation you take, the less basis you have, and the higher the gain (or lower the loss).
– The gain is on the depreciaton allowed or “allowable.” Since the records available didn’t show how much depreciation was taken, the judge backed into it.
– The IRS has to let you allocate some basis to land. This helped the taxpayer because land isn’t depreciable, so its basis wasn’t reduced by any depreciation allowable. The Tax Court used the relative assessed values of the land and buildings at the time to determine how much of the purchase price was allocable to the land.
The Moral? Des Moines’ love of hair bands outlasted that of the outside world, and it lingers still. Keep good records, because the IRS gets the benefit of the doubt if you don’t. And just because the IRS assesses you, that doesn’t mean that’s what you owe. The allocation to the land will save the taxpayer some real cash.
Cite: Willson, T.C. Summ. Op. 2011-132
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Tax Court: the salesman’s pitch isn’t going to get you out of tax shelter penalties

Tuesday, January 11th, 2011 by Joe Kristan

The Tax Court yesterday ruled that a taxpayer who invested in a bad tax shelter couldn’t rely on the opinion of his lawyer — who got a fee for selling the deal — to avoid penalties. Judge Holmes explains how the advice of attorney Garza and accountants Turner and Stone fell short (my emphasis):

We find that both these advisers not only participated in structuring the transaction, but arranged the entire deal. Garza set up the LLCs, provided a copy of the opinion letter, and coordinated the deal from start to finish. And both Garza and Turner & Stone profited from selling the transaction to numerous clients. Garza charged a flat fee for implementing it and wouldn’t have been compensated at all if Palmlund decided not to go through with it. He wasn’t being paid to evaluate the deal or tweak a real business deal to increase its tax advantages; he was being paid to make it happen. And Turner & Stone charged $8,000 for preparing Palmlund’s tax returns — $6,500 more than usual. The extra fees were not attributable to an extraordinarily complex return — Palmlund’s returns were always complex due to his various business interests — but, we find, were the firm’s cut for helping to make the deal happen. Because Palmlund’s advisers structured the transaction and profited from its implementation, they are promoters. Palmlund therefore could not rely on their advice in good faith.

The moral? If the drug dealer tells you it’s legal, you’ll still get in trouble for smoking dope, and if the promoter tells you the tax shelter is legit, that doesn’t help if the judge finds otherwise.
Cite: 106 Ltd., 136 T.C. No. 3

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IRS lays siege to Knight of Malta

Tuesday, December 14th, 2010 by Joe Kristan

20101214-1.jpgAn attorney took his tax greivances to Tax Court Judge Holmes, and the result is a history lesson on the Knights of Malta — and disallowance of thousands of dollars of expenses.
The taxpayer in this case was an attorney, a Mr. Pace, who specializes in “qui tam” work — compensated whistleblowing is the way I understand it. He attracted IRS attention with a rookie mistake — he earned a million dollars but didn’t file a return. Somehow his status as a member of the Knights of Malta had something to do with it, leading the court to explain a little history:

The Sovereign Military Hospitaller Order of St. John of Jerusalem, of Rhodes, and of Malta was established in the mid-eleventh century, when merchants from Amalfi founded the Benedictine Abbey of St. Mary of the Latins in Jerusalem. By 1080 the abbey built St. John’s hospital — located on the traditional site of the angel’s announcement of John the Baptist’s conception — which provided a place of refuge for poor and sick pilgrims visiting the Holy Land. Under the leadership of Brother Gerard, the Hospital of St. John grew to include several ancillary hospices in Palestine along the pilgrimage route. Pope Paschal II officially recognized the hospital in 1113, establishing the Order of St. John.
As the twelfth century wore on, the Hospitallers of St. John expanded their medical mission to preventive care by providing armed escort to pilgrims traveling the hostile route to Jerusalem. Crusading knights who stayed in Jerusalem began to join the Order, and by 1148 — the time of the Second Crusade — the Hospitallers of St. John were recognized as an essential part of the Holy Land’s defense…
The next several centuries did not go as well.

Sort of like the taxpayer’s case. You know the taxpayer has a problem when the discussion starts (my emphasis):

We begin by reviewing some of the basics of substantiation. The most important rule is that taxpayers have to keep records. Section 60014 and its accompanying regulations tell taxpayers to hold onto records that would enable the IRS to verify their income and expenses. See sec. 1.6001-1(a), Income Tax Regs. Unsophisticated taxpayers unfamiliar with the substantiation requirements often get extra leeway in their good-faith attempts to comply. See, e.g., Larson v. Commissioner, T.C. Memo. 2008-187. But sophisticated attorneys like Pace should know better.

The court disallowed many of the deductions, often on account of lack of substantiation:

Pace attempts to substantiate $1,711 in office expenses with a list of expenses containing check numbers, dates, and descriptions. He did not, however, introduce into evidence the underlying canceled checks, and the only testimony supporting the deduction was conclusory statements by Pace and his secretary that the office expenses were “incurred in the ordinary course of business.” Therefore, we disallow in full these office expenses.
Evaluating the remaining $6,698 in contested office expenses led to some engaging reading — nearly 150 pages of credit-card statements. Pace provided annotated statements to back up these deductions. But the majority of these expenses aren’t business related.

I like this:

Pace deducted custom-made shirts and a tie as office expenses. He explained that he found it difficult to buy some of his clothes off the rack because of his unusual physique. Our own observation makes us suspect that Pace was being modest, but no inspection could affect our necessary conclusion: expenses in this category are not deductible because Pace failed to establish that the clothing was not suitable for everyday wear. See, e.g., Hamilton v. Commissioner, T.C. Memo. 1979-186; Rev. Rul. 70-474, 1970-2 C.B. 35. And he wore one of his bespoke shirts to trial-showing without any doubt its suitability for everyday use.

Our taxpayer gave it his best:

The Commissioner has moved to impose a penalty under section 6673(a)(1), which authorizes us to impose a penalty not in excess of $25,000 whenever it appears that proceedings have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer’s position in such proceedings is frivolous or groundless. Pace vigorously contested the Commissioner’s determination, resulting in a weeklong trial, 760 pages of trial transcript, and thousands of pages of credit-card statements, canceled checks, and other documents. But Pace’s aggressive advocacy doesn’t rise to the level of sanctionable behavior. He may be long winded – as many lawyers and even some judges are — but delay and frivolous positions were not the crux of his case.

But it wasn’t good enough; the court upheld a 20% “accuracy-related penalty” for a substantial understatement of tax without reasonable casue:

Pace offers a novel defense to the accuracy-related penalty in his opening brief — that it’s the IRS’s fault because it didn’t settle. Review of the caselaw fails to find any support for this penalties-don’t-apply-when-the-IRS-won’t-settle argument. And Pace never argued any of the valid defenses to the penalty. See secs. 6662(d)(2)(B), 6664(c)(1). We therefore find that he is subject to this penalty.

We’ll let Judge Holmes explain what it all means:

In the best of all possible worlds, perhaps, Pace’s pursuit of the unified life would be recognized and rewarded. See, e.g., Pope Paul VI, Pastoral Constitution on the Church in the Modern World — Gaudium et Spes sec. 43 (December 7, 1965). But the Code imposes a more exact and less merciful accounting: business expenses, charitable contributions, and the costs of everyday life must be identified, segregated, and substantiated by reliable documents and credible testimony.

Cite: Pace: T.C. Memo. 2010-272
Flickr image courtesy bazylek100 under Creative Commons license
UPDATE: The TaxProf has more.

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Your wife commits insurance fraud. You repay. Can you deduct?

Wednesday, January 6th, 2010 by Joe Kristan

Peter Dentist hires his wife, Karen, to handle insurance company billing for the dental office. Mrs. Dentist went a bit overboard and billed insurance companies for work that was never done. This displeased the insurance companies, and the dentist ended up paying it back. He had picked up the fraudulent payments in his Schedule C income, so he reasonably deducted the repayments there. This generated a net operating loss, so he carried them back to claim refunds from earlier years.
The IRS was OK with a deduction, but they wanted to call it a non-business deduction. Non-business deductions only generate NOLs to the extent of non-business income, so the deduction would be worth a lot less to the dentist. The Tax Court sorted things out yesterday.
The tax law says that you can’t be in the business of fraud and embezzlement, so Karen Dentist wouldn’t be entitled to a Schedule C deduction. But it’s different for Peter:

This strikes a nerve with the Commissioner, who bristles at seeming to give Karen a tax benefit. And we agree with him that Karen could probably not get carryback-generating deductions if she were filing by herself. But the Supreme Court has said, “The deductions to which either spouse would be entitled would be taken, in the case of a joint return, from the aggregate gross income.” Helvering v. Janney, 311 U.S. 189, 191 (1940). We have interpreted this to mean that one spouse may take a deduction on the joint return even if the other spouse would be prohibited from taking the same deduction. DeBoer v. Commissioner, 16 T.C. 662 (1951) (loss on sale to wife’s grandson deductible by husband, despite prohibition on recognition of losses to family members, because husband not himself related to grandson),6 affd. 194 F.2d 289 (2d Cir. 1952). So even though Karen could not deduct the payments as business expenses on the Cavarettas’ joint return, we hold that Peter is not similarly barred.

The Moral? If your husband-wife business defrauds insuarance companies, make sure only one spouse knows about it.
UPDATE: More at Federal Tax Crimes blog.
Cite: Cavaretta, T.C. Memo. 2010-4
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