Posts Tagged ‘tax court’

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Tax-efficient grocery shopping?

Wednesday, May 29th, 2013 by Joe Kristan

20120801-2Can a whiff of business buying make a trip to the store a “business trip?  Apparently not.

The Tax Court yesterday considered the travel deductions of a DJ.  He did a good job documenting much of his travel — but not quite all of it (my emphasis)

The spreadsheets for shopping, office-meetings-storage, and business meetings were not nearly as detailed as the spreadsheet for DJ events, and they uniformly lacked a description of the particular business purpose for individual trips. That lack of detail, combined with errors in some of the mileage calculations and [the taxpayer's] testimony suggesting that he converted some personal trips to the grocery store into business trips merely by purchasing batteries or other incidental items, leads us to conclude that the spreadsheets are not a reliable indication of the miles that [the taxpayer] drove for the purposes indicated therein. In sum, the remaining spreadsheets do not satisfy the strict substantiation requirements of section 274(d).

If you want to deduct business travel, the tax law requires you to document the amount, date and business purpose of each expenditure.  The best way to do this is with a travel calendar, log, or smartphone app as you go.  Even when your travel is legitimately for business, no substantiation means no deduction.

Cite: Reiff, T.C. Summ. Op. 2013-40.

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Tax Roundup, 3/12/2013: What tax protester “victory” really means.

Tuesday, March 12th, 2013 by Joe Kristan

20130312-2It just doesn’t work.  The “Tax Honesty Movement” got excited a few years back when Louisiana attorney Tom Cryer was acquitted on criminal tax charges.  For example:

The Internal Revenue Service has lost a lawyer’s challenge in front of a jury to prove a constitutional foundation for the nation’s income tax, and the victorious attorney now is setting his sights higher.              

“I think now people are beginning to realize that this has got to be the largest fraud, backed up by intimidation and extortion and by the sheer force of taking peoples property and hard-earned money without any lawful authorization whatsoever,” lawyer Tom Cryer told WND just days after a jury in Louisiana acquitted him of two criminal tax counts.

There’s just one problem with the idea that this struck a death blow to the income tax:  he still owes the taxes.  Even though he’s dead.  Being aquitted in a criminal tax case doesn’t make it legal to not pay taxes any more than the O.J. Simpson acquittal legalized multiple homicides in Brentwood.

The Tax Court yesterday ruled that Mr. Cryer owes taxes, interest and civil fraud penalties for tax years for which he didn’t file income tax returns.  From the Tax Court:

In essence, Mr. Cryer claimed that the income he received during the tax years at issue from certain “sources” was taxable under Louisiana law, but not under Federal law. In United States v. Clayton, 506 F.3d 405, 412 (5th Cir. 2007), the Court to which an appeal would lie in this case, cited and followed its prior unpublished opinion holding that “the argument that income derived from sources within the United States” is not taxable under Federal law is “patently frivolous” and “absurd”.

The moral: No matter how convincing they are on the Internet, “Tax Honesty” arguments don’t work.  They will not keep the IRS from taxing you.  When “winning” means staying out of jail but paying 75% civil fraud penalties, you set the bar for victory too low.

Cite: Cryer, T.C. Memo. 2013-69

Related: Daniel B. Evans, The Tax Protester FAQ

Prior Coverage:  ‘NOT GUILTY’ DOESN’T MEAN ‘NOT TAXABLE’

 

Nick Kasprak, Weekly Map: State and Local Sales Tax Rates, 2013 (Tax Policy Blog)

 20130312-1

 

Peter Reilly,  Carried Interest Debate Heats Up Without Much Light .  A reasonable outline of the issues involved in the so-called “loophole” for private equity:

If “carried interest” were really just a loophole it would not need such an elaborate fix.  In fact, it is based on fundamental principles of partnership taxation.

I don’t think it’s a problem, so I don’t think it needs fixing.  Related:  New York Times Dealbook, Why Carried Interest Is a Capital Gain.

 

Tony Nitti, Contrarian Tax Planning: Increasing Income To Take Advantage Of The AMT

Missouri Tax Guy, Is that Gift Taxable?

Martin Sullivan, Showdown in Kansas: Realtors vs. Governor (Tax.com).  Will Kansas eliminate the home mortgage deduction on its state returns?

Jeffrey M. Kadet,  Tax And Territoriality: The Corporate 99% Versus The Law School 1%

William Perez,  IRS Plans Spending Cuts Due to Sequestration.  They can’t answer their phones, but they still want to regulate preparers.

Kay Bell,  NYC soda ban overturned. Would a soda tax have been better?  Maybe better, but still unwise.

TaxGrrrl, Former Detroit Mayor Found Guilty On Multiple Counts, Including Tax Charges.  Poor Detroit.

 

Tax News from the Animal Kingdom.

Beavers’ tax-evasion trial to begin (WGNTV.com)

Former Bear Chris Zorich charged in tax case  (WGNTV.com)

Fmr. Eagle Freddie Mitchell pleads guilty in tax scheme (6ABC.com)

 

Remember, Calendar 2012 1120 and 1120-S returns are due Friday!

 

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Teaching by bad example, Nebraska-style.

Friday, February 22nd, 2013 by Joe Kristan
Hall County Courthouse, Grand Island, Nebraska (Wikipedia image)

Hall County Courthouse, Grand Island, Nebraska (Wikipedia image)

Sometimes the best role models are those who show us what happens when we do everything wrong.  A lawyer in Grand Island, Nebraska featured yesterday in Tax Court takes up this underappreciated but essential chore for us.  We’ll let the Tax Court take up the story for us (my emphasis):

Petitioner, a self-employed attorney, failed to pay his Federal income tax for 1996 to 2002 after notice and demand for payment. Consequently, liens in favor of the United States arose and attached to all his property, including his personal residence. The Internal Revenue Service (IRS) filed notices of Federal tax lien on March 4, 2003, March 5, 2004, and June 19, 2007, in Hall County, Nebraska, and on December 19, 2006, and June 19, 2007, in Hitchcock County, Nebraska. On June 26, 2008, petitioner made a payment of $132,580 to the IRS, which included interest of $46,308 and penalties of $16,683 with respect to the unpaid tax liabilities.



During 2007 and 2008 petitioner operated a law practice in Nebraska as a sole proprietorship. He drove a BMW in 2007 and the first six months of 2008. On July 1, 2008, he traded in the BMW for a Lexus, which he drove for the second half of the year. He used the automobiles in his law practice and for his personal needs, but he did not keep any records separating the uses.


So in 2008 he finally gets around to paying seven years worth of taxes, and he gets a Lexus.  After paying $16,000 in penalties, he still fails to track his business use.  That plays poorly in Tax Court, where they enforce the strict substantiation rules for business mileage of Sec. 274:


Petitioner claimed deductions of $15,200 and $11,700 for car and truck expenses on Schedule C for 2007 and 2008, respectively. He testified that he incurred expenses each year of approximately $9,000 for depreciation, $3,500 for fuel, $1,200 for insurance, and $1,000 for maintenance. He further testified that he drove approximately 20,000 miles per year and “figured just slightly more than half of * * * [the] miles are driven for * * * work”. The only documents that he introduced into evidence to substantiate the expenses are copies of the sales invoices for the BMW and the Lexus and a sales tax receipt for the Lexus. Except for some vague testimony, he did not introduce any evidence to establish the elements of time and place or business purpose. Furthermore, his testimony as to the mileage is just an approximation and is not corroborated by any other evidence. We do not doubt that petitioner incurred car and truck expenses for the years in issue; however, we find that he has not met the strict substantiation requirements of section 274(d). Accordingly, petitioner is not entitled to deduct the car and truck expenses for 2007 and 2008.


So what should he have done?  He should have kept a log recording his business miles with information showing time, date, and business purpose for the trip, including the persons and places visited.


The attorney also took a creative position with respect to the IRS interest.  Because the IRS had liens against his house, he deducted interest on his late-paid taxes as home mortgage interest.  That didn’t work either.  The judge sums it up:


Petitioner failed to keep adequate records and to properly substantiate the car and truck expenses and the expenses that he conceded. He failed to report income on Schedule F, and he disregarded rules or regulations in claiming a deduction for the interest and penalties with respect to his Federal income tax liabilities for 1996 to 2002. Therefore, we find that respondent has met his burden of production. Petitioner offered no evidence that he acted with reasonable cause and in good faith. Accordingly, we find that petitioner is liable for the 20% accuracy-related penalty for 2007 and 2008.


You can learn a lot from this example, starting with the value of paying your taxes on time.  Skipping payment on the 1996-2002 returns made it a lot more likely that the IRS would look at his later returns, and it cost a bundle in interest and penalties.  Even though he had to have been in regular contact with the IRS by 2007 and 2008, he still didn’t keep track of his business miles or report all of his farm income.  He apparently didn’t hire out his tax work to somebody who actually knows taxes, or he wouldn’t have tried to deduct interest on unpaid taxes as home mortgage interest.


The moral: You might be driving the nicest car in town, but you still have to document your business miles.  File timely, report all of your income, track your mileage, and hire the tax help appropriate to your needs.  The long arm of the tax law reaches even to Grand Island.


Cite: Wagoner, T.C. Summary Opinion 2013-14.


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Ex-linebacker Romanowski calls an audible.  Bad call.

				Thursday, February 21st, 2013 by Joe Kristan

				

					
20130221-1
Wikipedia image


Bill Romanowski couldn’t have played 16 years in the NFL by defying his coaches.  When he retired from the NFL, he appears to have become more difficult to coach.  That led to a $13 million investment loss, plus loss of deductions, according to a Tax Court decision yesterday.  Yet the Tax Court didn’t tack on personal foul accuracy-related penalties.


NFL players are notoriously bad at managing their money.  One source says “By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.”  Mr. Romanowski took a wise step to avoid this trap.  From the Tax Court:


From the late 1990s until early 2004 petitioners employed a financial adviser, Kathy Lintz. According to Mrs. Romanowski, Ms. Lintz “Basically * * * took care of everything” regarding petitioners’ finances, including managing their portfolio and allocating them a monthly stipend. Ms. Lintz also collected relevant information from petitioners in order to have their tax returns prepared by a certified public accountant (C.P.A.) and reviewed the completed tax returns before sending them on to petitioners. Ms. Lintz is a certified financial planner, but she is not an accountant or an attorney.


As a result, the Romanowskis faced retirement with the ability to finance a $13 million investment.  Then they decided to defy their coach.


According to the Tax Court, Ms. Lintz referred the Romanowskis to an attorney, a Rodney Atherton with Greenberg Traurig, LP, to deal with tax issues arising from a real estate investment in Colorado.  That’s where things started to go wrong.


During October 2003 Mr. Romanowski met with Mr. Atherton at the Greenberg Traurig office in Denver. At the meeting they discussed petitioners’ real estate investment issues as well as certain other issues. Mr. Atherton told Mr. Romanowski about a horse-breeding business, ClassicStar, which had retained Greenberg Traurig in July 2003 in connection with certain transaction and tax issues, including review of a tax opinion ClassicStar had received from another law firm. ClassicStar was working with Mr. Atherton, among others at Greenberg Traurig, to review the tax opinion.


Unfortunately, according to the Tax Court, the attorney wasn’t just looking out for the Romanowskis:


Although he testified multiple times to the contrary, the evidence is clear that Mr. Atherton received improper payments from ClassicStar as a result of petitioners’ choosing to enter the program. Mr. Atherton claimed that multiple documents regarding payments he received from ClassicStar were sent to him (from ClassicStar) in error. Many of those documents were chain emails which contained conversations between Mr. Atherton and ClassicStar employees in which Mr. Atherton used terms such as “fee splits” and “percentage” when discussing the amount of money ClassicStar would pay to him or Greenberg Traurig for bringing people into the program.


The Romanowskis fell in love with the horse program, which appears to have been intended as a tax shelter from the outset, what with “NOL illustrations” for net operating loss refunds being provided in the process.


The financial planner saw it that way:


On February 4, 2004, Ms. Lintz resigned as petitioners’ financial adviser, partially because of petitioners’ investment in the program. Ms. Lintz’s resignation letter states that petitioners choose to “enter into an aggressive tax shelter”, presumably the [ClassicStar] program.


In other words, the Romanowskis stopped listening to Ms. Lintz’s coaching and called their own play, investing $13 million into ClassicStar (much of it borrowed).  The rest is just predictable details.  The program never had the thoroughbred horses that it claimed, using most of the funds to breed less-desirable quarterhorses — and the Romanowskis went along.  Over time the program went bust and the Romanowskis lost their investment.  And now, they have lost their tax deduction on hobby-loss grounds, with the Tax Court upholding a $4.4 million deficiency.


The judge cut the Romanowskis slack on the penalties, though, apparently based on his belief that their attorney had a conflict of interest in advising the Romanowskis about the horse investment:


While a taxpayer familiar with the field of tax would have done several things differently from petitioners, petitioners were not sophisticated or knowledgeable in the field of tax. Petitioners had good reasons for the trust they placed in Mr. Atherton.


Decision for IRS, except for penalties.  And a “notify the carrier” moment for Greenberg Traurig.


The Moral?  Professional football may not be the best training for investments.  And when the coach tells you to run the play as called, there’s probably a good reason.


Cite: Romanowski, T.C. Memo 2013-55


Tony Nitti has more, as do the TaxProf and Russ Fox.


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Tax Roundup, February 20, 2013: Fire fail and tax reform frenzy!

				Wednesday, February 20th, 2013 by Joe Kristan

				

					
Flickr Image courtisy Llima under Creative Commons license
Flickr Image courtisy Llima under Creative Commons license


If you are going to say the dog ate your tax records, make sure you have a dog.  A New Jersey man was having a hard time coming up with records supporting his deductions in Tax Court.  He blamed a fire.  The success of the argument can be guessed from the Tax Court’s discussion of “Petitioner’s Alleged Fire”:


The circumstances surrounding petitioner’s purported fire are vague, and he has offered no evidence, apart from his testimony, that a fire occurred and that his 2006 tax records were destroyed in such a fire. Significantly, he failed to introduce insurance documentation or third-party testimony describing the alleged events or the extent of any fire.


The Tax Court said the man couldn’t support his deductions.


The Moral?  Back up your work.  And if you are going to have a fire, something needs to actually burn.  (Cite: Mears, T.C. Memo 2013-54)


 


It looks like the dreaded automatic “sequestration” spending cuts are going to happen, so there is a flurry of proposals to stop this sliver of random spending discipline:


Martin Sullivan, A Proposal to Get Tax Reform Back on Track:


Before earmarking what we will do with the money from limits on chimerical loopholes, our leaders need to clear the path for the painful process of broadening the tax base. President Obama has now poisoned the well by turning Republicans’ tax reform instincts against them. If they were to put any revenue increases on the table, the President would claim the proposals have the Republican seal of approval and incorporate them into his tax hike plans.


At the same time Republicans tax reform strategy is wearing thin. Their extravagant claims about cutting the top individual rates below 30 percent are just hollow speechifying as long as they refuse to put specific revenue-raisers on the table.


Inspiring leadership.


 


Jeremy Scott, Simpson-Bowles Try Again (Tax.com):


Simpson-Bowles is just another deficit reduction plan — and a politically infeasible one at that.  Its authors want to make it seem grander by attaching tax reform to it, just like Obama wanted his own proposals (which simply include ways to raise revenue that Democrats have proposed ad infinitum over the years) to sound better when he mentioned tax reform at least three times during the State of the Union.  But what they are offering isn’t comprehensive enough to qualify as true tax reform.  Deficit reduction has its place, but conflating it with tax reform will stall whatever momentum people like Camp are trying to create for a true tax system overhaul.  


They just aren’t serious yet.


Also:


Howard Gleckman, Bowles-Simpson II: A New Plan to Avoid the Sequester (TaxVox)


Patrick Temple-West, Simpson, Bowles revive deficit plan, and more


Jacob Sullum on Obama’s Misguided Vision of Tax Reform (Reason.com)


 


High taxes are good for us, so infinite taxes will make us perfect.  The high-tax advocacy group Citizens for Budget and Policy Priorities has generated a paper that says that state tax cuts do no good:


This paper argues that state personal income tax cuts won’t help small businesses create jobs, and in fact could harm the ability of the small-business sector to contribute to economic growth.  For all the reasons  stated in this paper, the converse is also true:  personal income tax increases, including those on the highest earners, won’t harm small-business job creation. 


Really?  There is no level of taxation that would discourage economic activity?  There is no level of tax increase that would cause economic activity to be located in a neighboring state with lower taxes?


The paper makes the same mistake as the guy who drowned trying to wade across the river that was only two feet deep, on average.  You can see it on the headings of the paper: “The vast majority of those who would get a personal income tax cut are in no position to create small-business jobs.”  “Most small businesses make too little money for tax cuts to produce enough income to pay new employees.”  “Most small business owners are not significant ‘job creators’ and have no plans to be.”


This is the same logic we heard when we were told that individual tax increases wouldn’t hurt business because most small businesses wouldn’t be affected.  When you define “small business” to include your office Avon Lady and a manufacturer with dozens or hundreds of employees, of course “most” businesses won’t hire more if taxes are lower.  Just the ones that matter.


When you measure by amount of income, the amount of business affected by individual rates is huge:20130220-1


 


Sure, relatively few businesses achieve enough success to hire a lot of employees.  Yet some do, and they do a lot of hiring.  And, contrary to the CBPP paper, their ability to expand does shrink if they have to pay more taxes.  As a tax accountant, it’s part of the world I live in.  Prices matter in making decisions — including the price of living, doing business and paying taxes in a state.  Any argument to the contrary has to overcome the basic rule of economics that incentives matter.


 


Paul Neiffer, 1031 Tax-Deferred Exchange Does Not Always Defer All Taxes!


Jack Townsend, Another Plea Agreement and Sentencing for HSBC and Bank Woori Depositor


Tax Trials,  Petition for Writ of Certiorari Filed in Historic Boardwalk Hall Tax Credit Case


Trish McIntire, FASFA?


 


Kay Bell, Tax Carnival #113: Presidents Day 2013 or maybe you, too, can one day be Acting President of the United States


Breaking news from 1147: Tax Havens: The Second Crusade (Robert Goulder, Tax.com)


Going Concern, The IRS Is Wasting Millions on Unused Blackberrys and Aircards Because Of Course It Is.  Meanwhile they prepare to lay off their useful employees when sequestration hits.


 


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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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Bad records help stick struggling S corporation owner with extra salary

				Thursday, December 27th, 2012 by Joe Kristan

				

					
S corporation K-1 income isn’t subject to self-employment or payroll taxes.  This tempts S corporation owners to take minimal salary and take earnings out as S corporation distributions instead.   Former vice-presidential nominee and model husband John Edwards famously used an S corporation to minimize his payroll taxes.


20121227-1The IRS has had success in imposing additional payroll taxes when owners of profitable S corporations take little or no salary.  Yesterday the Tax Court also imposed payroll taxes on the owner of a struggling S corporation.


The owner of a small Twin Cities courier business reported wages of $24,452 to $28,452 in 2004-2006.  He took only $2,400 in salary in 2007.  The IRS found that $55,000 was transferred from the S corporation to the owner’s bank accounts in 2007 and imposed payroll taxes on that amount of salary.


How do we know the business struggled?  The Tax Court explains:


During petitioners’ operation of H&H up to some point in 2009, H&H either lost money every year or earned little income. In 2009 petitioners finally closed the business down, after losing their home on  account of losses incurred in the business and their inability to make payments on a home equity loan obtained in 2004 to finance their purchase of the business.


This wasn’t like the CPA who earned around $200,000 from his busienss and reported salary of only $24,000.  Yet the IRS didn’t let the taxpayer’s financial ruin stand in the way of an assessment of additonal payroll taxes.  The Tax Court upheld part of the assesment:


     We believe and accept petitioner’s testimony that he in fact paid significant H&H expenses with cash using funds received from H&H. For example, petitioner credibly testified that after finishing deliveries, truck drivers often would assist with repairs on the trucks and that he would pay the drivers cash for their assistance. No evidence indicates any unusual personal use by petitioners of the funds in question received from H&H.


     In spite of the limited evidence before us, we believe it improper and excessive to charge petitioner with receipt from H&H in 2007 of $52,600 in additional wages. However, we also believe petitioner’s reported H&H wages of $2,400 are unreasonably low.


Unfortunately, as you might have guessed from this, the taxpayer’s records were a mess.  The Tax Court used a very rough estimate:


To estimate what portion of the funds petitioner received from H&H in 2007 is to be treated as wages, we believe it appropriate to average petitioner’s wages for 2002 through 2006 and to use the average wage amount as the total for petitioner’s 2007 H&H wages subject to employment taxes — namely, $30,445.


I think the result would have been better if the taxpayer had kept better records.  If the taxpayer had kept personal and company spending separate and could account for all expenses, the Tax Court might have left him alone.


Still, I think the IRS and the Tax Court did the taxpayer a disservice.  Lee Iacocca famously took a $1 salary when he was in charge of struggling Chrysler.  If Warren Buffett can hold his salary to $100,000 in a fabulously profitable company, it’s plain mean to stick a struggling owner with additional salary just to collect more payroll taxes.


Fortunately this is a “summary opinion,” which isn’t supposed to serve as precedent.  A better-represented and better-organized taxpayer might well do better.


Cite:  Herbert, T.C. Summary Opinion 2012-124


 


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Tax Court keeps taxpayer mistake from triggering the “self-rental” passive income rule.

				Wednesday, November 14th, 2012 by Joe Kristan

				

					
Cell tower image courtesy Wikpedia Commons


The tax law “passive activity” rules were written to shut down real estate shelters by making rental losses “passive,” deductible only to the extent of “passive” income.  About 3 seconds after the rules were enacted, taxpayers began thinking of ways to generate passive income so they could deduct their passive losses by renting land or by renting property to a controlled business activity.  Rules treating “land rent” or “self-rental” net income as non-passive were issued quickly to stop that.


The new Obamacare 3.8% tax on “investment income” will apply to “passive income” as determined under the passive loss rules, so a  Tax Court decision issued yesterday exploring these issues takes on added importance.


The taxpayer leased land with cell-phone towers to his wholly-owned S corporation.  The S corporation in turn leased the towers to phone companies.  The taxpayer also leased land to his S corporation.


The S corporation mistakenly reported the income from its leases to the phone companies as ordinary income, rather than rental income, lumping the tower rental with the S corporation’s other business income.  The taxpayer treated the income as non-passive.


The towers leased to the S corporation were reported as passive leases on the taxpayer’s 1040, as were the land rents.  Some tower leases were profitable while others generated losses, but because they were all reported as “passive,” the losses and income offset.


The IRS had other ideas. The IRS left the K-1 income as non-passive, saying that the leases to the phone company wasn’t really “rental,” and in any case the taxpayer was stuck with the way the income was reported.  The IRS split the income from ”self-rental” of the towers to the controlled corporation,  with the losses treated as passive and the income reclassified as non-passive under the self-rental rules.   The bottom line: a lot of non-passive income that couldn’t be offset by the now non-deductible passive losses.


The Tax Court said the IRS was being too cute.  The IRS said that the taxpayer was bound by his treatment of the S corporation tower income as non-passive because he had already grouped it with his other activities.   Judge Halpern said the IRS regulations didn’t have to cause such a harsh result.  While the taxpayer might be stuck with its return reporting for determining whether to report income from the K-1 as passive, that didn’t extend to the self-rental rules. so the taxpayer didn’t have to split up the cell-tower rental to the S corporation between profitable (non-passive) and loss-generating (passive):


We recognize that, because ICE erroneously reported all of its income as ordinary business (non-passive-activity) income, nonapplication of the self-rental rule of section 1.469-2(f)(6), Income Tax Regs., to ICE’s rental payments to petitioner, in effect, results in the reduction of what was reported as “active business income” and the offsetting creation of “passive income” in seeming contravention of the congressional conferees’ directive to issue regulations preventing that result. See H.R. Conf. Rept. No. 99-841 (Vol. II), at II-147 (1986), 1986-3 C.B. (Vol. 4) 1, 147. We do not believe, however, that ICE’s tax return mischaracterization of its tower access rental income from third parties should control the application of the self-rental rule where, as here, it is, by its terms, inapplicable, i.e., where petitioner’s towers were not, in fact, used in a trade or business. Moreover, we are not persuaded that the result we reach herein violates the conferees’ directive as it does not, in fact, permit “passive income” to offset “active business income”.


The Tax Court upheld the IRS in treating the land-rental as non-passive.


The Moral?  The Tax Court reached a fair result, even though it had to stretch around the regulations to do so.  Had the towers been rented to the S corporation for use in its non-passive business, the judge would probably have given the IRS its “heads I win, tails you lose” treatment — the income would have been non-passive, and the losses would have been passive and non-deductible.  The result was different because the S corporation in turn leased the properties to third parties, instead of using them in its non-passive business.


The result is fair because the taxpayer isn’t really generating improper passive income that wouldn’t be there if it had reported the income on the K-1 properly in the first place.


This case reminds us how important it is to identify your passive activities and group them properly.   With the 3.8% tax on passive income taking effect in January, this is even more important.


Cite: Dirico, 139 T.C. No. 16.


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What really happened to the dinosaurs.

				Thursday, October 4th, 2012 by Joe Kristan

				

					
They got audited.


A Florida couple set up a ministry and a theme park devoted to the “young earth” theory that dinosaurs and humans walked the earth together.   Things didn’t go so well, and the husband ended up going to prison on federal tax charges.   Meanwhile the IRS went after his wife for civil tax fraud penalties.  The IRS won in Tax Court yesterday.




The wife at first asserted she hadn’t filed tax returns for a number of years because she had no taxable income.  The IRS then went through the tedious process of analyzing bank deposits, finding over $14 million in income and just short of $7 million in deductible expenses over nine years.  You can assume that the IRS wasn’t as aggressive in looking for deductions.


The Tax Court looks at a number of factors to determine whether there is fraud.  One is the absence of records:


    In a letter attached to her untimely filed returns, petitioner wrote: “I have not kept financial records, as I did not know that I needed to do so.” Petitioner introduced no records of her income and did not substantiate the amounts she claimed as income on her tax returns.


     Although petitioner claimed that she was unaware of the obligation to keep financial records, we reject this explanation as not credible. Accordingly, petitioner’s failure to keep and/or provide records of income and expenses is indicative of fraud.


The day went badly for the taxpayer, with the court saying the evidence “overwhelmingly” demonstrated that she had fraudulent intent.


The Moral?  Failing to keep records hurt the taxpayer in two ways.  It implied that she was cheating, and it probably led to a much higher tax — and certainly higher fraud penalties – than if she had kept records and filed properly in the first place.  Even a cave man can figure that out.


Cite: Hovind, T.C. Memo 2012-281.


Update, 10/5/12: Peter Reilly has more.


 


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Why the tax law is so picky about documenting travel deductions

				Wednesday, September 19th, 2012 by Joe Kristan

				

					
Any entrepreneur who has ever been audited knows that the IRS agent will be a stickler for documentation of your travel and entertainment expenses.  That’s because the tax law (Code Section 274) requires you to substatiate with receipts and records:


    

  • the amount of the expense;
    • 

  • the time and place of the travel, meal or entertainment,
    • 

  • the business purpose of the expense, and
    • 

  • the business relationship of other taxpayers involved.
    • 



Why is the tax law so picky?  Why are these requirements stricter than those for other expenses?  A Tax Court case yesterday provides a hint.


An airline pilot had a side business as a real estate broker/advisor.  That business didn’t go so well, according to his Schedule C; it showed a loss of $23,124 in 2007.  The IRS came along and disallowed some expenses.  The Tax Court takes up the story (my emphasis):


Petitioner reported hotel, rental car, and meal expenses relating to a trip to Hawaii in February 2007 which lasted approximately 11 days. Petitioner did not claim a business expense deduction for the cost of his airline ticket to or from Hawaii; however, he did claim as a business expense deduction the cost of an airline ticket for a third party. No explanation was given as to who this person is or what business purpose was furthered by this expenditure. Petitioner’s records reflect that he paid for multiple hotel rooms for the same nights and that there were multiple occupants in the rooms. Some of the expenses were not evidenced by receipts or reflected in the bank records. Petitioner’s explanation for the travel to Hawaii was that he was scouting potential properties for an unnamed client. On the basis of the record, petitioner has not established that these expenditures were ordinary and necessary business expenses, and we disallow all claimed business expense deductions relating to this travel.


Of course.  Scouting properties for an unnamed client, who never paid him.  With a whole squad of assistants.  No wonder he lost money.


Petitioner claimed deductions for hotel and meal expenses relating to travel to Yosemite National Park on December 23, 2007. Petitioner did not provide the Court with any evidence as to his real estate brokerage activity in his travel to Yosemite.


Yogi Bear needed a new home?


The case also shows deductions for trips to Tahoe in February, Phoenix in March and trips to San Francisco, as well as one to his parents’ hometown, Dayton, Ohio.  All expenses were disallowed for lack of adequate substantiation.


In short, the tax law realizes that taxpayers will be tempted to try to claim leisure travel as “business” expenses.  “Scouting property” is one of the oldest, and lamest, ways to explain otherwise inexplicable “business trips” to resort destinations.


The Moral?  If you want to deduct travel, meal and entertainment expenses, keep your receipts.  If you use your own car, log your miles.  For all expenses, write down who you are meeting with and the business purposes.  Even when the expenses are legitimate, if you fail to document them properly, they are gone.


Cite: Wallach, T.C. Summ. Op. 2012-94


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You don’t have to send it by U.S. Mail, but details matter.

				Tuesday, September 11th, 2012 by Joe Kristan

				

					
Thanks to electronic filing, we can do most of our tax business nowadays without a trip to the post office to get a stamped postmark for our return filings.  But not everybody e-files, and some filings still have to go by paper.


A few years ago, the IRS broke its old tradition and agreed to accept some private delivery service postmarks as good for the “timely-mailed, timely-filed” rule — the rule that says that if you get it mailed by the filing deadline, it doesn’t matter when it shows up at the IRS.  But an Illinois couple yesterday learned the hard way that not all private delivery options are created equal.  They used FedEx “Express Saver Third business day” service to mail a petition to the Tax Court.  That turned out to be a false move.  From the Tax Court opinion (my emphasis and links):


In Notice 2004-83, 2004-2 C.B. 1030 (2004 notice), the Commissioner updated the list of companies and classes of delivery service that constitute designated private delivery services for purposes of section 7502. Thus, effective January 1, 2005, and insofar as FedEx is concerned, the list of designated private delivery services was as follows: FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2 Day, FedEx International Priority, and FedEx International First. The 2004 notice expressly states that FedEx is not designated with respect to any type of delivery service not expressly identified. Thus, “Express Saver Third business day” service is not a designated private delivery service.


The petition didn’t arrive in time, and the taxpayers lose their chance to fight their case in Tax Court.  They now have to pay up and sue for a refund in District Court or the Court of Claims.


The moral?  Private delivery postmarks can be a life-saver, especially with 24-hour Fed-Ex/Kinkos  late hours in this age of postal service cutbacks.  But if you use them, be sure you use one of the designated services.  And Jiffy Express isn’t one of them.


Oh, and the IRS should be more liberal in designating qualifying private delivery services as the US Postal Service totters.  You shouldn’t have to use the high-priced spread.


Cite: Scaggs, TC Memo 2012-258 (click here if link doesn’t work).


The TaxProf has more.


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Split-dollar roll-out clobbers executives

				Tuesday, August 28th, 2012 by Joe Kristan

				

					
Earlier in my career “split dollar” life insurance was all the rage.  A company and its executive would enter into an insurance policy on the executive.  The executive would be the beneficiary of the policy and the corporation would pay the premiums; the policy ownership was “split” because the company was entitled to recover the premiums on the executive’s death before the executive’s beneficiaries benefited.  The executive would pick up an amount in compensation, but it was based on outdated IRS tables, making it a good deal for the employee.  They spread quickly because they were also a good deal for the insurance brokers.


The policies have become less popular since the IRS tables have been updated, but they were always fraught with other risks, as two executives learned in Tax Court yesterday.


The executives worked at N & J Management.  They entered into new split-dollar policies with the company in 2002, but they decided to close out the split-dollar deal in 2003 when the IRS changed its rules, according to the court opinion.  By that time the company had paid $842,345 in premiums.  It was agreed to turn the policies over to the employees.  Rather than paying back the entire premium, the employees had their accountants compute the present value of the premium recovery based on their current life expectancy; that came out to $131,969.


The IRS didn’t care for this present value thing, and they assessed additional tax based on the difference between the $842,345 in premiums paid by the company and the $131,969 the employees paid the company for the policies.  The Tax Court sided with the IRS (my emphasis):


     In December 2003 upon rollout of the SDLIAs, the income petitioners realized under section 61 or alternatively the taxable value of property transferred to them under section 83 was the $710,376 difference between the $842,345 that N & J Management paid in premiums on their behalf and that was owed by them and the $131,969 they reimbursed N & J Management. Clearly, petitioners realized an accession to wealth of $710,376 for the additional premiums N & J Management paid. This occurred in the context of and related to petitioners’ employment with N & J Management, and the $710,376 constitutes compensation income to them.


     Following the termination of the SDLIA arrangements, petitioners had no risk of forfeiture of the economic benefit of the $710,376 not reimbursed to N & J Management. Petitioners had complete ownership of the policies and were free to transfer the cash value of the polices free of encumbrances. Petitioners had no service requirements or other employment-related conditions that they needed to fulfill with regard thereto.


The present value computation was clever, and it does have some logic behind it; the value to the employer of the reimbursement right was dependent on the employee life expectancy.  But the court said that wasn’t the right way to value the benefit:


Petitioners could not access the cash surrender value and could not sell or dispose of or otherwise transfer their ownership interests in the policies or access the cash surrender value until N & J Management was either reimbursed the $842,345 or gave up its reimbursement rights. N & J Management gave up its reimbursement rights to the $710,376 balance and released petitioners from any further indebtedness on the amount not reimbursed. In essence, the economic benefit of the $710,376 was transferred to petitioners in December 2003 when the SDLIA arrangements were terminated, when N & J Management gave up its additional reimbursement rights, and when  N & J Management was removed from the picture relating to the life insurance policies.


It’s much like the forgiveness of a debt.  If your mortgage holder forgives the mortgage on your house, your net worth goes up by the whole amount of the forgiven mortgage, not the present value of the principal over its remaining term.  Decision for IRS.


Cite:  Neff, T.C. Memo. 2012-244


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Even tax bloggers need good records for their 1040s

				Wednesday, August 22nd, 2012 by Joe Kristan

				

					
Nobody has been blogging taxes longer than Kerry Kerstetter.  Before the TaxProf started his blog in 2004, his “Tax Guru” blog was about all there was for some time for company after the 2001 beginning of the Tax Update.  Much of what he posts isn’t to my taste, and in recent years he mostly has reposted political cartoons, but he seems competent enough.  That’s why I find yesterday’s Tax Court case shocking (assuming that the Kerry M. Kerstetter in the case is the same Arkansas tax practitioner who does Tax Guru).


It’s not shocking that a tax practitioner would lose a case.  The tax law is hard, and there are plenty of areas for dispute.  It’s the way this case was lost that is a dazer.  From the Tax Court opinion (my emphasis):


 Petitioners contend that interest paid on credit card debt reflects borrowing to pay business expenses. Their generalized assertions cannot be verified or traced in the documentary evidence. 


His joint return claimed a big net operating loss carryforward to offset taxes for 2001 and later.  The Tax Court disallowed the NOL carryforward:


Petitioners also attempt to use self-serving and conclusory assertions rather than evidence with respect to the net operating loss carryover, demanding that respondent’s representatives identify “specific documents” needed to substantiate their carryovers. Petitioners have the burden of proving the amounts of the losses and that they have not been absorbed in other years. See, e.g., Keith v. Commissioner, 115 T.C. 605, 621 (2000); Sandoval v. Commissioner, T.C. Memo. [*8] 2001-310, aff’d without published opinion, 67 Fed. Appx. 252 (5th Cir. 2003). They have not shown either, and none of the claimed carryovers may be allowed.


So the issue was documentation.  They failed to provide support for deductions claimed on the return, at least to the judge’s satisfaction – a common mistake, but one that practitioners certainly know about.


This is the most surprising item, to me:


Petitioners’ 2001 tax return was due, with extensions, October 15, 2002, but was not filed until May 31, 2003, the same date on which their 2002 return was filed. Their 2003 return was due, with extensions, October 15, 2004, but was not filed until July 9, 2005, two days before their 2004 return was filed. Petitioners did not have reasonable cause for late filing of their returns. 


My return is often the last one I get to, and I’ve done my share of October filings.  The cobbler’s children always go barefoot, as they say.  But missing the extension deadline for multiple years?


It’s certainly possible that there is more to the story than the Tax Court opinion reveals, and maybe there will be an appeal.  As things stand, the taxpayers are on the hook for back taxes and the 20% “accuracy-related penalty.”  Regardless of the ultimate outcome, we can draw some lessons from this case:


- File your return on time.  There is little or no additional risk of being audited for filing an extended return, but the chances of getting examined go way up when you blow the extension deadlines.


- Keep your old records.  The taxpayers failed to produce records of their loss carryforwards to the court’s satisfaction.  Keep the tax records for loss years as long as the carryforward years to which you applied the losses remain open.


Anthony Nitti has more.


Cite: Kerstetter, T.C. Memo 2012-239


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“Self-Rental rule” trips up trucking company

				Thursday, August 9th, 2012 by Joe Kristan

				

					
http://www.rothcpa.com/misc/20090115-1.JPGThe perennial tax problem for owners of “C corporations” is getting cash out of the corporation without it being taxed twice.  Unlike “S corporation” income, C corporation income is taxed twice: first under the corporate income tax rules when it is earned, and again as taxable dividend income when distributed to the shareholders.


A common tactic to extract C corporation income without a second tax is to rent property to the corporation.   While the owner has to report the rental payments as income, the corporation gets a rental expense deduction, netting to only one tax.  But this plan has its own risks, as a C corporation owner learned yesterday in Tax Court.  The Tax Court held that the “self-rental” rule kept the taxpayer from deducting rental losses from leases of equipment to his corporation.


Tax Court Judge Wells sets the stage (my emphasis):


Mr. Veriha is the sole owner of John Veriha Trucking, Inc. (JVT), a corporation with its principal place of business in Wisconsin. JVT was a C corporation during 2005 but has since elected S corporation status. Petitioners were both employed by JVT during 2005, and Mr. Veriha materially participated in JVT’s business. JVT is a trucking company that leases its trucking equipment from two different entities, Transportation Resources, Inc. (TRI), and JRV Leasing, LLC (JRV). The trucking equipment JVT leases consists of two parts: a motorized vehicle (tractor) and a towed storage trailer (trailer). 


     TRI is an S corporation in which Mr. Veriha owns 99% of the stock; his father owns the remaining 1%. TRI is an equipment leasing company with its principal place of business in Wisconsin. TRI owns only the tractors and trailers that it leases to JVT. During 2005, TRI and JVT entered into 125 separate lease agreements, one for each tractor or trailer leased. TRI’s only source of income during 2005 was the leasing agreements with JVT.


     JRV is a single-member limited liability company, and Mr. Veriha is its sole member. JRV is an equipment leasing company that owns only the tractors and trailers that it leases to JVT. During 2005, JRV and JVT entered into 66 separate lease agreements, one for each tractor or trailer leased. JRV’s only source of income during 2005 was the leasing agreements with JVT.


In 2005 TRI had income from its rental, but JRV, the single member LLC, reported a loss.  Rental income and loss is normally “passive,” and passive losses are only deductible to the extent of passive income.


When the passive loss rules were enacted, the IRS feared that business owners would set up deals with their businesses to generate passive income, enabling them to deduct otherwise deferred passive losses.  To combat this, the IRS issued regulations holding that net income from renting to your own business would not be passive if the income from the business isn’t itself passive.  The IRS used these regulations to keep Mr. Veriha from deducting his rental losses against his rental income.  The taxpayer argued the losses of JVT should be lumped together with the income from TRI, with only the net income of the two treated as non-passive.


The Tax Court sided with the IRS:


Section 1.469-2(f)(6), Income Tax Regs., explicitly recharacterizes as nonpassive net rental activity income from an “item of property” rather than net income from the entire rental “activity”. Section 469 and the regulations thereunder distinguish between net income from an “item of property” and net income from the entire “activity”, which might include rental income from multiple items of property. 


…we conclude that each individual tractor and each trailer was a separate “item of property” within the meaning of section 1.469-2(f)(6), Income Tax Regs. However, because respondent has not contested petitioners’ netting of gains and losses within TRI, only TRI’s net income is recharacterized as nonpassive income.2


That last sentence has to be scary to anybody renting multiple properties, like a trucking fleet, to a controlled business.  The Tax Court is saying that the IRS could have required the taxpayer to determine the income from each truck and tractor leased to the business, with all income leases non-passive and all losses passive.  The Tax Court in its footnote spells it out:


We note that this result is necessarily more favorable to petitioners than the result would have been had respondent contended that it was necessary for the income from each tractor or trailer within TRI and JRV to be recharacterized as nonpassive.


That implies that the IRS was just being “nice” this time, and another taxpayer with similar facts could do much worse.


The moral: Taxpayers who rent to their own businesses — at least those in which they ”materially participate” —  need to remember that they can’t offset passive losses with that rental income.  If they rent many items to their business, they need to make sure that every lease generates a profit, or the IRS might split them out and disallow all the losses.


Cite: Veriha, 139 T.C. No. 3.


More on the passive loss rules here.


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What happens when a real attorney tries tax protest arguments?

				Wednesday, August 1st, 2012 by Joe Kristan

				

					
Arguments that you don’t have to really pay federal income taxes never go away despite a long and dismal record of failure.  They are typically advanced by self-educated folks, often claiming to have spent hundreds of hours researching the tax law to prove that it doesn’t exist.  Non-lawyers tend to do poorly in advancing legal arguments.  If a real lawyer tried these arguments, might it go better?


Nope. 


A Maryland Attorney stopped filing tax returns after 2004.  The IRS eventually noticed.  The result was assessment of additional tax and penalties for fraudulent failure to file.  The attorney took the matter to Tax Court, where Judge Goeke sets the scene:


Petitioner testified that during 2006 “without looking for it” he discovered information which led him to conclude that he was not required to file Federal tax returns or pay Federal income taxes. As a result, petitioner has not filed a personal Federal tax return for any year since 2004.6 However, petitioner did make a $2,000 estimated tax payment to the U.S. Treasury for the 2005 tax year and also made a payment to the U.S. Treasury of $45,000 in April 2006, in connection with the filing of a Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, for 2005. The $45,000 payment was credited to petitioner’s 2005 income tax account.7 Petitioner did not make any payments with respect to his 2006 tax.


So he discovered the secret to not paying tax but extended his 2005 return anyway?  Old habits are hard to break, I suppose.  The IRS started poking around, subpoenaing his bank records.  He didn’t care for that:


After learning of the subpoenas duces tecum issued to his banks, petitioner filed a motion to dismiss seeking to have his case dismissed without prejudice. Petitioner mailed a letter to M&T Bank in which he stated: “Because I am dismissing this case, the Subpoena issued by the IRS to M&T Bank should no longer be valid, and M&T Bank should not be required to respond by producing copies of my account records.” Shortly after he mailed this letter to M&T Bank, we denied petitioner’s motion to dismiss.


I know attorneys are “officers of the court,” but I don’t think that lets them quash subpeonas.


So how did the arguments fare in Tax Court?  Badly:


Petitioner repeatedly claims his arguments are not frivolous, but we disagree. Regarding petitioner’s constitutional arguments, courts have previously stated that “The constitutionality of our income tax system — including the role played within that system by the Internal Revenue Service and the Tax Court — has long been established.” Crain v. Commissioner, 737 F.2d at 1417-1418; see also Powers v. Commissioner, T.C. Memo. 2009-229; DiCarlo v. Commissioner, T.C. Memo. 1992-280. We therefore hold these constitutional arguments are frivolous.


The judge suggested that there might be more behind the arguments than an accidental discovery of the secret to tax-free lawyering:


Petitioner argues that he stopped filing tax returns only upon discovering information in 2006 which led him to conclude that he was not required to file tax returns or pay taxes. We believe it more likely that petitioner stopped filing tax returns because of his larger tax burden resulting from the increasing profitability of his law practice.


Rather than making the arguments more effective, it seems that being a lawyer made things worse for the taxpayer:


Petitioner is a highly intelligent individual with graduate degrees in both engineering and law. He is an accomplished businessman and attorney, having formed his own successful law practice which he incorporated as an S corporation for tax reasons after an accountant suggested doing so. Although he does not practice in the area of tax, nor did he take any tax courses in law school, petitioner has the intelligence and ability to recognize the frivolous, incorrect, and completely discredited nature of the arguments he has made in support of his failure to pay Federal taxes or file a Federal tax return. We find these facts are further evidence of fraud.


The judge upheld the assessed tax and the fraudulent failure to file penalties. 


The Moral? Crackpot arguments don’t become legal scholarship in the hands of a trained lawyer.  Garbage in, garbage out.


Cite: Worsham, T.C. Memo 2012-219.


UPDATE: The TaxProf has more.


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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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Tax Court waves off aircraft dealership expenses as “start-up” costs

				Thursday, July 26th, 2012 by Joe Kristan

				

					
A Schedule C taxpayer with an established aerial photography busienss decided to branch out into selling light aircraft.  He reported the aircraft dealership expenses on the same Schedule C as his photography venture, with a 2007 loss of about $90,000, on $10,000 of income.


A big loss on a small income tends to attract IRS examiners.  The IRS said the loss disallowed the loss under the “hobby loss” rules.   Hobby loss rulings are awkward, requiring the IRS and the courts to devine whether the taxpayer really sought to make money in a money-losing operation.  The Tax Court didn’t have to use legilimency here, as it found another way to disallow the expenses.


The tax law requires taxpayers to capitalize “start-up” costs — expenses incurred in setting up a business before it begins operations.  Once operations begin, taxpayers can fully deduct up to $5,000 of such costs.  Any costs over that amount have to be amortized over 15 years.  The tax court explains (citations omitted, emphasis added):


Until the business starts operating as a going concern, expenses related to that activity are not ordinary and necessary expenses currently deductible under section 162 but rather are startup or preopening expenses.  The Code defines startup expenditures as any amount paid or incurred in connection with investigating the creation or acquisition of an active trade or business, creating an active trade or business, or any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of the activity’s becoming an active trade or business and which, if paid or incurred in connection with the operation of an existing active trade or business would be allowable as a deduction for the taxable year in which paid or incurred.


 The court said that the “Quicksilver” aircraft dealership was a separate business from the photography operation, and that it was still in the “startup” process in 2007:


During 2007 petitioner expanded his hangar, attended an FAA course, communicated with Quicksilver regarding his interest, and was in the process of building a demonstration model. However, petitioner did not finish the demonstration model until January 2008 and did not manufacture any LSAs for sale. He did not advertise his services or products and did not hold himself out as a dealer or repairman for Quicksilver. We conclude that in 2007 petitioner did not commence the business of being a Quicksilver dealer, for which he was preparing.


The Tax Court disallowed the expenses that it felt were “start-up” costs.


So when does the “start-up” period of a business end?  It’s not always clear.  For a retailer, it’s no later than when you open the doors to the public.  If you are a manufacturer, the start of production is probably key. 


The Moral? There is a big difference between deducting business expenses now and start-up expenses over 15 years.  If you are starting a new business, keep the limitations on start-up expenses in mind and try to defer expenses until you are up and running where possible.  If you have an existing business and are starting a new line, the start-up rules can still apply.  Be sure to carefully segregate the expenses of the existing business from the new business so the IRS can’t defer them as start-up costs.


Cite: Bramlett, T.C. Summ. Op. 2012-73.


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Tax Roundup, June 28, 2012: Obamacare Judgement Day and other masterminded schemes

				Thursday, June 28th, 2012 by Joe Kristan

				

					
Flickr image courtesy Evil Erin under Creative Commons license.


Haven’t filed your FBAR Form TD F 90.22-1 for foreign financial accounts?  File it now!  It’s due June 30.


Today is Judgement Day for the Supreme Court decision on the Affordable Care Act, AKA Obamacare.  Key tax-related provisions on the line:


- A .9% surtax on single taxpayer wages over $200,000 and joint wages over $250,000, effective in 2013.


- A 3.8 % surtax on “unearned” income – interest, dividends, capital gains and “passive” income from pass-through business activities, when AGI exceeds $200,000 for single filers and $250,000 for joint filers, effective in 2013.


- A $2,500 limit in flexible spending account contributions, effective in 2013


- Increase in the AGI floor for medical deductions starting in 2013 from 7.5% of AGI to 10%.  The increase will be deferred through 2016 for taxpayers over age 65.


- The IRS-enforced penalties for failure to buy health insurance, effective in 2014.


Of course, the 10% tax on tanning booths has been in effect for some time.  We will post on the decision later today.


Why are capital gains taxed at a lower rate? The Tax Policy Blog has a post appropriately-titled “Why Capital Gains are taxed at a Lower Rate.”


First, the tax is not adjusted for inflation, so any appreciation of assets is taxed at the nominal instead of the real value. This means investors must pay tax not only on the real return but also on the inflation created by the Federal Reserve.


Second, the capital gains tax is merely part of a long line of federal taxation of the same dollar of income.  Wages are first taxed by payroll and personal income taxes, then again by the corporate income tax if one chooses to invest in corporate equities, and then again when those investments pay off in the form of dividends and capital gains.  This puts corporations at a disadvantage relative to pass through business entities, whose owners pay personal income tax on distributed profits, instead of taxes on corporate income, capital gains, and dividends.  One way corporations mitigate this excessive taxation is through debt rather than equity financing, since interest is deductible.  This creates perverse incentives to over leverage, contributing to the boom and bust cycle.


Finally, a capital gains tax, like nearly all of the federal tax code, is a tax on future consumption.  Future personal consumption, in the form of savings, is taxed, while present consumption is not. By favoring present over future consumption, savings are discouraged, which decreases future available capital and lowers long term growth.


The capital gain rate is the biggest reason why the highest-income taxpayers have a lower effective rate.  The reason their income is high is usually becuase they have a once-in-a-lifetime windfall from the sale of a business or asset.  It is the biggest reason used for the push for the inane “Buffett rule.”  As the Tax Policy Blog post points out, though, the U.S. already has one of the highest effective tax rates on capital gains amoung the major economies, behind only Italy, Denmark and France.


Tax Court Denies Charitable Deduction for Home Demolished by Fire Department in Training Exercise (TaxProf)  The Tax Court once again held that allowing a fire department to burn down a home is not the same thing as giving a home to the fire department.  The right to burn a building is a very different thing than full ownership of the building.  The decision should be no surprise, as we discussed back in February.  More from Anthony Nitti.


Why you should use the EFTPS program to monitor your payroll tax deposits online, even if you outsource your payroll function: Operator of Payroll Companies Charged in North Carolina with Federal Fraud and Money Laundering Crimes.  If your payroll service steals money  you set aside for payroll taxes, the IRS still wants you to pay up. 


 



 



 



 


Jason Dinesen, Planning for Alternative Minimum Tax in 2012.  If Congress doesn’t re-enact the “AMT Patch,” you might have an $8000 or so tax increase due in April.


 


Watching the watchdogs:  Tax Court Finds IRS Compliance Officer Liable for Civil Fraud Penalty (Jack Townsend).  She claimed deductions that the court decided were bogus.


 



 


Is it right to call somebody who organizes a really stupid crime a “mastermind?” From Kansascity.com:


A California man pleaded guilty Tuesday to a tax fraud scheme that federal prosecutors allege was masterminded by a Kansas City man.


The plea of John V. Perdido of Temecula, Calif., is the second among 14 defendants in the alleged conspiracy to receive nearly $100 million in fraudulent refunds from the Internal Revenue Service. Perdido received a refund of $805,749 and spent more than half of it on property and a car in the Philippines among other things.


The alleged conspirators filed for big federal refunds based on the idea that we all have huge amounts of cash on deposit with the federal government in our names, which we can tap if we file the right tax forms. Another Professor Moriarty, that mastermind.




 


 


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Roth IRA plan fails for Lake of the Woods investors.

				Wednesday, June 20th, 2012 by Joe Kristan

				

					
Wikipedia photo


A few years ago the IRS tried to close down a St. Louis-area tax firm based on spectacular charges of book-cooking and improper deductions.  The firm survived, but the pain lingers for their clients.  When the IRS goes after a preparer, pretty much all of their clients get examined to build the IRS case.  That led to bad news in Tax Court last week for a Missouri couple.


The couple, the Repettos, invested in some real estate development activity at Lake of the Woods in the Ozarks.  The St. Louis firm had the couple set up two C corporations, “Yolo” and ”WGR,” to be owned by their Roth IRA.  The C corporations were to provide “services” to the real estate company for $4,800 month.   The services:


assistance with entering accounting information into the computer accounting application quickbooks; assistance with computer; assistance with printing reports; accessing internet for material research; processing email; soliciting and receiving bid [sic] from potential subcontractors; assistance with marketing communication; assistance with interior selections; assistance with mail processing; basic office support such as answering telephone, returning phone calls, and sending/receiving packages.


The effect was to get $57,600 into a Roth IRA annually, where the usual Roth limit is $5,000 per year.  The IRS called foul, and the Tax Court upheld the call.  The court said that there was no real substance to the Roth-owned corporations:


The invoices in the record strongly support our conclusion that the services agreements and payments were mechanisms to transfer value to the Roth IRAs. The record contains only two invoices, for $4,800 and $4,000, for the services that Yolo allegedly performed for SGR. The invoice for $4,800 bears as its date a notation “Monthly 2005″, and the invoice for $4,000 bears as its date a notation “Monthly 2006″. The invoices describe the allegedly provided services as “Services for Administrative support”, “Office support”, “Internet: email processing, material research, marketing information”.


The record contains only one invoice for services that Yolo allegedly performed for WFR. The invoice is for $2,116, and it describes the services as “Services for administrative support” and “Office support”. This invoice also bears as its date a notation “Monthly 2005 and 2006″. There are no invoices issued by WFR to SGR in the record.


…


We agree with respondent that petitioners have failed to prove that the payments under the services agreements were necessary or reasonable. In addition, SGR’s and WFR’s form invoices fall short of satisfying the substantiation requirements of the Code. We sustain respondent’s disallowance of the deductions SGR and WFR claimed for facilities support.


A similar pattern involving a Kansas City-area preparer exploded in Tax Court last year.  As in the Kansas City case, the Tax Court here upheld penalties for the taxpayers — in this case for failure to properly disclose a “reportable transaction.”


The Moral?  When the IRS goes after your preparer, your return may get caught in the crossfire.  The IRS is on the warpath against preparers that it perceives as abusing the system, so keep that in mind if you are considering a preparer who seems to be doing things nobody else is willing to do.


Cite: Repetto, T.C. Memo. 2012-168


Anthony Nitti has more.


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