Archive for the ‘Tax Court’ Category

Math Is Hard (Tax Court Edition)

Monday, November 3rd, 2014

One of my favorite sayings at the poker table is, “Math is hard.” Yesterday, the Tax Court explained some basic math to a petitioner who almost completely struck out.

Eugene Kernan didn’t file tax returns since sometime before 2000. Eventually the IRS caught up to him and issued notices of deficiency for 2001 through 2006. The IRS wanted the tax due, interest, and penalties for fraudulent nonfiling (or late filing if that wasn’t upheld) and the late payment penalty. Mr. Kernan though he didn’t have to file at all.

When the findings of fact include the words “tax avoidance,” things aren’t looking up for the petitioner.

During the years at issue Mr. Kernan had income from at least two sources: he sold various tax avoidance products, and he performed various paralegal functions, including advising people in matters before the Internal Revenue Service (IRS). Deposits into Mr. Kernan’s personal checking account from those business activities exceeded $79,000 per year.

The Tax Court decision notes that Mr. Kernan “…owned a Web site titled ‘The American Republic.’” I don’t know if he still owns it, but the website is still up and still advertising his CD-ROM titled “How to STOP the IRS.” A helpful hint to anyone who buys the cd: Yes, you must pay your taxes. But I digress….

A trial was held and the Court asked both parties (the IRS and the petitioner) to file briefs. The Court limited the size (in pages) of the briefs. Math is hard, but 88 is greater than both 75 and 30. The Court asked for a 75-page brief and a 30-page answer (those were the maximum lengths). I remember a commercial from when I was growing up: “When E.F. Hutton talks, people listen.” Well, when a judge tells you to limit something to x, you had better listen.

Mr. Kernan avoided the Court’s page limits in perhaps the least creative way of all; he just ignored them…

The generous page limit for the opening brief was to accommodate proposed findings of fact, yet Mr. Kernan’s proposed findings of fact were only two pages and consisted of argument, not findings of fact. Counting pages in the manner instructed by the Court, Mr. Kernan’s opening brief came in at 88 pages. The Court did not need to go to great effort to discover Mr. Kernan’s excess pages; he numbered them as instructed. His page 1 begins after his table of authorities, and his signature appears on page 88. Perhaps Mr. Kernan is fond of the number 88; his answering brief also came in at a whopping 88 pages, not counting attachments.

The petitioner’s briefs were stricken.

Indeed, Mr. Kernan acknowledged in his objection to respondent’s motion to strike that “there is no doubt that the Tax Court ‘has the right to set limit[s] as to brief length and has discretion as to whether to accept and/or not consider deficient briefs’.” Accordingly, we will deem Mr. Kernan’s opening and answering briefs stricken in a separate order.

As for the case itself, Mr. Kernan may want to read the Tax Protester FAQ or the IRS’s webpage on frivolous tax arguments. Either would have explained that you have to file a return.

However, Mr. Kernan did win one argument: He honestly believed (in the view of the Court) that he didn’t have to file a return, so the fraudulent failure to file penalty was not upheld. However, he does owe the failure to file and failure to pay penalties (and the estimated tax penalty). And the Court warned Mr. Kernan that if he keeps making frivolous arguments, he’ll likely have to pay a penalty in Tax Court for making frivolous arguments.

Case: Kernan v. Commissioner, T.C. Memo 2014-228

A Passive Activity Case Goes to the Taxpayers

Wednesday, August 20th, 2014

We’re going to see a lot more IRS activity regarding “passive” activities in the coming years. The Affordable Care Act (aka ObamaCare) added a new Net Investment Tax that impacts passive activities. Many taxpayers will be attempting to state activities are active (that the taxpayer materially participates) rather than passive to avoid this tax. Today, the Tax Court looked at a taxpayer who claimed large losses from his business (it will be a few years before we see Net Investment Tax cases at the Tax Court). He said he was actively involved in the businesses; the IRS said he wasn’t.

The Tax Court noted that a passive activity is one where a taxpayer is not materially participating in.

A taxpayer materially participates in an activity for a given year if, “[b]ased on all of the facts and circumstances * * * the individual participates in the activity on a regular, continuous, and substantial basis during such year.” Id. A taxpayer who participates in the activity for 100 hours or less during the year cannot satisfy this test, and more stringent requirements apply to those who participate in a management or investment capacity. See sec. 1.469-5T(b)(2)(ii) and (iii), (f)(2)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 5726, 5727 (Feb. 25, 1988).

Yes, this relates to temporary regulations issued over 16 years ago. Perhaps we’ll see final regulations given the Net Investment Tax. But I digress….

In the decision, the Court noted that while the petitioner’s son managed the day-to-day business, the petitioner himself was anything but an absentee owner.

Although Mr. Wade took a step back when Ashley became involved in the companies’ management, he still played a major role in their 2008 activities. He researched and developed new technology that allowed TSI and Paragon to improve their products. He also secured financing for the companies that allowed them to continue operations, and he visited the industrial facilities throughout the year to meet with employees about their futures. These efforts were continuous, regular, and substantial during 2008, and we accordingly hold that Mr. Wade materially participated in TSI and Paragon.

But what about the petitioner’s wife? The IRS argued that she wasn’t involved in the business (and she wasn’t), so her share of the loss is passive. The Court found that didn’t matter:

This argument is irrelevant because for purposes of the passive loss limitation, we treat married taxpayers who file a joint return as a single taxpayer, sec. 1.469-5T(f)(3), Temporary Income Tax Regs., supra, and because we treat participation by a married taxpayer as participation of his or her spouse, sec. 1.469-1T(j)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5711 (Feb. 25, 1988). Mr. Wade’s material participation in the companies is sufficient to establish material participation for both petitioners.

In a footnote, the Court noted why the passive activity loss rules were enacted:

Congress enacted sec. 469 to reduce the opportunity “for taxpayers to offset income from one source with tax shelter deductions and credits from another.” S. Rept. No. 99-313, at 713 (1986), 1986-3 C.B. (Vol. 3) 1, 713. Congress’ concern was over taxpayers who invested in businesses simply to benefit from losses. The tests and standards in sec. 469 were not meant to apply to taxpayers in petitioners’ situation.

So here the petitioner was able to show he was active on a continuous basis in his businesses, and that made the losses active rather than passive. Hopefully the IRS can get more of these cases right at audit and appeals–they’ll be dealing with many more of these over the coming years.

Case: Wade v. Commissioner, T.C. Memo 2014-169

The Only Thing Not Thrown at the Petitioner Was the Kitchen Sink

Tuesday, May 27th, 2014

There’s a time to be a protester and there’s a time not to be. In Tax Court, it’s imperative you have legitimate arguments; you can pay a very high price for frivolity. Today’s petitioner learned that…perhaps.

The petitioner neglected to file tax returns from 1999 through 2007. (I suspect this might continue to future years at it does take some time for a case to get to trial at Tax Court.) He faced the Failure to File Penalty, the Failure to Pay Penalty, the Underpayment of Estimated Tax Penalty, and the Fraudulent Failure to File Penalty. That’s the first time I’ve ever seen a Fraudulent Failure to File Penalty. He timely filed a Tax Court petition.

The petitioner didn’t show up for trial, and something else I hadn’t seen before:

We hold petitioner in default. He has failed to comply with the Rules of the Court. He has not cooperated in the preparation of these cases for trial, he has failed to comply with Court orders, and he did not appear for trial. His responses are filled with tax-protester rhetoric. Such conduct provides ample basis for holding him in default.

So what is the Fraudulent Failure to File Penalty?

Section 6651(f) imposes an addition to tax of up to 75% of the amount of tax required to be shown on the return where the failure to file a Federal income tax return is due to fraud. “[R]espondent must prove by clear and convincing evidence that petitioner underpaid his income tax and that some part of the underpayment was due to fraud.” There is no question that petitioner’s failure to file a return for each of the years in issue resulted in underpayments for each year. To establish fraudulent intent, the Commissioner must prove that a taxpayer intended to evade a tax known or believed to be owed by conduct intended to conceal, mislead, or otherwise prevent the collection of tax. Not only do respondent’s averments show such intent, but petitioner is deemed to have admitted that his failure to file returns for the years in issue “was not due to mistake” and “was due to * * * [his] fraudulent intent to evade taxes”. We have adequate grounds on which to sustain respondent’s section 6651(f) additions to tax for all years in issue. [Internal citations omitted.]

All of the other penalties were upheld, too. Rubbing salt into the wounds the IRS asked for a penalty for filing a frivolous tax court petition.

Among his frivolous arguments, petitioner claims that he is not subject to Federal income tax, that the only persons required to pay Federal income tax are those people working directly for the Federal Government or the U.S. military, and that the Internal Revenue Code does not establish any liability for the payment of Federal income tax. A position maintained by a taxpayer is frivolous where it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.”

But the Tax Court didn’t give him a penalty. Rather, there were two Tax Court cases filed, so the Court assessed two penalties of $25,000 each–the maximum–for wasting the court’s time. That’s also the first time I’ve ever seen that done.

A helpful hint to anyone considering preparing a frivolous Tax Court case: Don’t! Other than making tax bloggers laugh, you will find that Tax Court judges will have a somewhat different reaction…a reaction that could separate substantial sums of money from your wallet.

Case: Jones v. Commissioner, T.C. Memo 2014-101

It’s Probably Not Good for Your Case When the Court Considers Sanctioning Your Attorney

Monday, April 28th, 2014

The Tax Court had a routine decision today in a collection matter. The case itself (Best v. Commissioner) isn’t particularly interesting; the Court upheld the IRS’s collection efforts. It’s the last page and a half of the decision that caught my attention.

The petitioners in the case had filed a previous Tax Court case which they settled back in 2009.

We sustained substantial portions of the deficiencies in tax that respondent determined along with additions to tax for both failure to timely file a return and failure to timely pay tax and for failure to pay estimated tax. We entered decision in docket No. 22241-07 on January 2, 2009. Petitioners were represented in that case by their present counsel, Donald W. MacPherson.

The petitioners lost today, and they also were sanctioned $5,000 for frivolous arguments.

The interesting part is at the end of the decision.

Section 6673(a)(2)(A) empowers us to impose on a taxpayer’s counsel who multiplies the proceedings in any case unreasonably and vexatiously the excessive costs reasonably incurred on account of such conduct. We may sua sponte impose such costs. See Edwards v. Commissioner, T.C. Memo. 2002-169, aff’d, 119 Fed. Appx. 293 (D.C. Cir. 2005); Leach v. Commissioner, T.C. Memo. 1993-215.

As to what Judge Halpern saw that led him to this extreme, the opinion notes,

Although we have found petitioners deserving of a section 6673(a)(1) penalty, we believe that Mr. MacPherson’s conduct may be deserving of a sanction for unreasonably and unnecessarily bringing and prolonging these proceedings. Indeed, in his declaration in support of petitioners’ response to respondent’s motion to impose a sanction on petitioners, he acknowledges that, following the earlier deficiency proceeding in this case, petitioners “had a major collection problem and * * * I decided to try the assessment issue believing there is some chance of lack of proper assessment which will result in voiding the assessment and causing the clients to be free of the debt as a result of the statute of limitations”. He concedes, however: “I concluded many years ago that the ’23C issue’ was a ‘dead letter’ in so far as obtaining the 23C.”

The goal of the Tax Court is for the two sides, whenever possible, to settle their cases and to move expeditiously. The only time I can remember an attorney being sanctioned was when an attorney filed a pro se action in his mother’s estate. The Tax Court was not amused by what appeared to be delaying tactics of the probate case in King County (Washington) Superior Court and the Tax Court. In that previous case, the attorney filed a probate action in 1995; he filed a Tax Court action in 2000. Come 2008 and both actions were still ongoing. As I wrote back in 2008, the thirteenth time wasn’t the charm.

In this case, the Court sees an attorney take years on a collection matter, when he (the attorney) admits that his clients have a collection issue, and that the main issue being argued wouldn’t work. I do want to point out that the Court has not sanctioned the attorney today; he is being given an opportunity to show cause as why the Tax Court should not impose a sanction.

Case: Best v. Commissioner, T.C. Memo 2014-72

A Second Bite at the Apple? Yes, When You Don’t Read the Fine Print

Thursday, March 13th, 2014

I previously wrote about, a former Internet sports betting website. One of its executive, David Carruthers, made the mistake of changing planes at DFW. Unbeknownst to him, he had been indicted. His two-hour layover got extended…to 33 months at ClubFed. Sportsbetting on the Internet is generally against US law (though intrastate sportsbetting in Nevada is legal in certain situations).

Today, as I glanced through a Tax Court case on one Gary Kaplan, I saw the dollar amounts and did some math. Mr. Kaplan was assessed tax for two years totaling $24,369,493, and additions to tax totaling $12,358,596. That’s a total bill of $36,720,089, and certainly reason to petition the Tax Court.

Mr. Kaplan is the founder of He took the company public on the London Stock Exchange in 2004. Mr. Kaplan transferred his shares of the business into trusts, and those trusts then sold shares. Mr. Kaplan never filed (or paid) tax returns, so the IRS created substitute for returns and assessed the tax and penalties noted above. This occurred after Mr. Kaplan was arrested and made a plea bargain on the criminal case.

Plea bargains are binding documents. They’re binding on the government, too. And that’s the major issue of the case: Did the plea bargain stop the IRS from assessing tax and penalties? Two excerpts from the plea agreement are quite on point:

[T]he Office of the United States Attorney for the Eastern District of Missouri agrees that no further federal prosecution will be brought in this District relative to the defendant’s participation in the BETONSPORTS ORGANIZATION, as described in the Third Superseding Indictment, of which the Office of the United States Attorney for the Eastern District of Missouri is aware at this time. In addition, the Office of the United States Attorney for the Eastern [sic] of Missouri and the Office of the United States Attorney for the Southern District of Florida, which has authorized the Eastern District of Missouri to enter into this agreement, agree that no federal prosecution will be brought in either District relative to the defendant’s involvement in a business venture known as Hope Mills Universal, of which said offices are aware at this time. In addition, the Office of the United States Attorney for the Eastern District of Missouri agrees that no federal criminal tax charges will be brought in this District relative to the defendant’s receipt of income from the BETONSPORTS ORGANIZATION, the sale of stock in BetonSports, plc and/or the investment of the proceeds in any such income or sale. [Emphasis added by the Tax Court.]

The second excerpt note that:

…[t]he defendant has discussed with defense counsel and understands that nothing contained in this document is meant to limit the rights and authority of the United States of America to take any civil, civil tax or administrative action against the defendant * * * except that the United States shall not seek civil forfeiture in connection with this case or any asset constituting or derived from the receipt of income from the BetOnSports Organization, the sale of stock in BetOnSports, PLC and/or the investment of the proceeds of any such income or sale. [Emphasis added by the Tax Court.]

The Tax Court noted that during the change of plea hearing the judge in the criminal case made sure that Mr. Kaplan knew that the government could initiate a civil tax proceeding:

[Court:] Do you understand, Mr. Kaplan, that there is a difference between a criminal tax proceeding and a civil tax proceeding?

[Petitioner:] Yes I do, Your Honor.

[Court:] And in this document, the U.S. Attorney’s Office has agreed it will not bring any criminal tax proceeding against you; however, that doesn’t preclude the initiation of any civil tax proceeding or administrative action against you.

[Petitioner:] I understand that. And we’ve agreed to that.

Mr. Kaplan argued that the statute of limitations barred the IRS’s actions. There’s an obvious problem with that: If you don’t file a tax return the statute of limitations never runs. Strike one.

The petitioner then argues that the plea agreement precludes the actions. The excerpts of the District Court’s questioning are particularly on point. The judge noted that this could happen; Mr. Kaplan said he knew it could. Strike two.

Mr. Kaplan’s last argument is that the IRS is precluded by judicial estoppel.

Under the doctrine of judicial estoppel, once “‘a party assumes a certain position in a legal proceeding, and succeeds in maintaining that position, he may not thereafter, simply because his interests have changed, assume a contrary position, especially if it be to the prejudice of the party who has acquiesced in the position formerly taken by him.’”

Unfortunately for Mr. Kaplan,

…because the plea agreement unambiguously reserved the Government’s right to bring a civil tax action against petitioner, petitioner suffered no detriment nor prejudice from any perceived “position” of the Government. For these reasons, petitioner’s judicial estoppel argument is without merit.

That’s strike three, and Mr. Kaplan owes the $36.7 million…plus interest.

If you ever make a plea deal with the government, you absolutely want to read the fine print. And if a judge points our that a civil tax proceeding could occur, you might want to inquire about that…especially if you have millions of dollar sitting around.

Case: Kaplan v. Commissioner, T.C. Memo 2014-43

The Moral Climate may have Changed but the Law Hasn’t

Tuesday, March 11th, 2014

Another professional gambler went to Tax Court seeking to stop Section 165(d) of the Tax Code–the section that stops a gambler from deducting losses in excess of wins. This ended up being a full decision of the Tax Court, so it’s worth taking a look at it.

Today’s taxpayer is a CPA from California who, in his off time, is also a professional gambler betting on horse racing. He filed his tax returns with two Schedule C’s: one for his tax practice and one for his gambling. He, though, took his gambling losses (in excess of wins) to help lower his accounting income. He also took a deduction for “Takeout” from horse racing. The IRS objected to both, and the dispute made its way to Tax Court.

Let’s deal with the more mundane “Takeout” issue. Horse race betting is a form of “pool” accounting. Individuals make wagers, they form a pool, the race happens with winners being declared, and the track pays out from the pool. The track deducts from the pool taxes and other business expenses. That’s the Takeout–it’s taken out of the pool. (It’s akin to the rake on a hand of poker).

The problem is that this isn’t an expense of the bettor; it’s an expense of the track. Thus, since the wagerer doesn’t pay it, he can’t deduct it. The Court succinctly came to that conclusion.

The more interesting part of the case is whether Section 165(d) is legal. The petitioner noted an excerpt from Tschetschot v. Commissioner (T.C. Memo 2007-38):

The moral climate surrounding gambling has changed since the tax provisions concerning wagering were enacted many years ago. Not only has tournament poker become a nationally televised event, but casinos or lotteries can be found in many States. Further, the ability for the Internal Revenue Service to accurately track money being lost and won has improved, and some of the substantiation concerns, particularly for professionals, no longer exist. That said, the Tax Court is not free to rewrite the Internal Revenue Code and regulations. We are bound by the law as it currently exists, and we are without the ability to speculate on what it should be.

The basis of petitioner’s argument is:

Petitioner responds to the last two sentences of the quoted excerpt from Tschetschot with the hope that “the judiciary is at some time [presumably, meaning this Court in this case] going to take a bold stance and help to reverse section 165(d) of the Internal Revenue Code.”

A law can be held unconstitutional if it doesn’t have a rational basis. The Tax Court looked at the Congressional commentary from when Section 23(g) of the Revenue Act of 1934 (which has identical language to the current Section 165(d)) was passed and found there was, indeed, a rational basis. First, here’s the commentary:

Section 23(g). Wagering losses: Existing law does not limit the deduction of losses from gambling transactions where such transactions are legal. Under the interpretation of the courts, illegal gambling losses can only be taken to the extent of the gains on such transactions. A similar limitation on losses from legalized gambling is provided for in the bill. Under the present law many taxpayers take deductions for gambling losses but fail to report gambling gains. This limitation will force taxpayers to report their gambling gains if they desire to deduct their gambling losses.

The Tax Court’s conclusion is that Congress must change the law:

The basis for the enactment of section 23(g), as set forth in the last sentence of the foregoing committee report, still pertains to taxpayer reporting of gambling gains and losses. Therefore, it still constitutes a “rational basis” for the continued application of section 165(d) to the losses. There being no constitutional impediment to the continued application of section 165(d), we reiterate our admonition in Tschetschot that this Court “is not free to rewrite the Internal Revenue Code and regulations * * * [but is] bound by the law as it currently exists”. [footnote omitted]

Thus, until Congress changes the law a professional gambler cannot deduct gambling losses in excess of wins.

Case: Lakhani v. Commissioner, 142 T.C. No. 8

He Cracked the Code (but Won’t be Happy with the Result)

Thursday, February 27th, 2014

Back in 2007, Peter Hendrickson wrote a book titled Cracking the Code: The Fascinating Truth About Taxation in America. I haven’t read it, nor would I advise you to. Today, Judge Buch of the Tax Court demolished each and every argument in the book.

But I’m starting with the decision rather than the case itself. Steven Waltner challenged the IRS’s collection of a frivolous tax submissions penalty in Tax Court. He paid the IRS so that issue was moot. However, each side asked for sanctions on the other side (that being Mr. Waltner and the IRS) alleging misconduct.

Judge Buch notes,

This case has occupied an inordinate amount of the Court’s time. The Court could have disposed of the entire matter summarily by reference to Crain v. Commissioner or any number of other cases that stand for the proposition that we need not address frivolous arguments. [footnotes omitted]

Well, why does the decision go on for another 40 pages?

The Court has taken the time, however, to address those arguments because Mr. Waltner appears to be perpetuating frivolous positions that have been promoted and encouraged by Peter Hendrickson’s book Cracking the Code: The Fascinating Truth About Taxation in America (2007). Indeed, it appears not merely that Mr. Waltner’s positions are predicated on that book but that his returns and return information have been used to promote the frivolous arguments contained in that book. Consequently, a written opinion is warranted.

It’s not that the IRS didn’t err; they did. It’s what the IRS counsel did after making mistakes that contrasts with what the petitioner (Mr. Waltner) did. I’ll let Judge Buch take it:

Respondent’s counsel sought discovery that went beyond the scope ofthis case, and the Court issued orders excusing Mr. Waltner from responding to those requests. Likewise, respondent’s counsel was evasive in answering some of Mr. Waltner’s discovery requests, and the Court ordered respondent to supplement those responses. In each instance, once the Court ruled, respondent’s counsel cured the defect, through either supplementing his responses or accepting the Court’s determinations that his requests were improper.

Mr. Waltner sought to avoid answering every discovery request.

There’s more, though, a lot more. It appears that the petitioner’s aided a Web site used to market Cracking the Code. The Court then takes 30 pages to demolish the arguments in the book. Here are some additional excerpts of Judge Buch’s opinion:

Cracking the Code is written by Peter Eric Hendrickson. Nowhere in his book does Mr. Hendrickson set forth his credentials, other than on the back cover where he vaguely identifies himself as “researcher, analyst and scholar”. Add to that felon and serial tax evader.

Well, you have a lot of free time to research when you’re at ClubFed.

It is this passage that is quoted at the beginning of Cracking the Code. It is fitting because the book is largely an exercise in twisting the meaning of words into what the author wants them to mean, even if statutes, regulations, and case law define those words otherwise…

Having spent the immediately preceding chapter misinterpreting the word “including”, the author turns to the same Latin phrase discussed above and then proceeds to misinterpret it…

This chapter provides an example of how one illogical conclusion can be used to bolster another…

Turning to the subject of withholding, the author sets forth one of his fundamental, and fundamentally incorrect, positions regarding tax reporting. Having erroneously concluded that the term “employee” includes only government employees (and a few selected others), the author concludes that “this kind of withholding only applies to the pay of federal government workers”…

The positions advocated in Cracking the Code have routinely been rejected, with its author being criminally convicted and its adherents being sanctioned.

I could go on, but I think you get the point; I’m certain Mr. Waltner gets the point. While he only received a $2,500 sanction, he has other Tax Court cases in the pipeline. I also suspect that others are using arguments in Cracking the Code. They may want to rethink that. As Judge Buch stated, “And future litigants are on notice that the positions advanced in Cracking the Code are frivolous and relying on those positions may result in sanctions.”

Case: Waltner v. Commissioner, T.C. Memo 2014-35

The Third Time Wasn’t the Charm

Tuesday, August 27th, 2013

The cliche goes, if you don’t succeed at first, try, try again. Of course, where you and I would never go, the Bozo side of the tax world loves to venture. The Tax Court today got the chance to look at a two-time Tax Court loser. Would his third chance at Tax Court give a better result?

The first case was for the 1991 tax year. I’ll let the Tax Court describe the issue (the quote is from today’s ruling):

The principal issue arose from a dispute between petitioner and his brokerage house, which eventually liquidated his account by selling the securities in it. Petitioner failed to report on his 1991 tax return the capital gain realized on the sale of these securities, contending that his brokerage house had engaged in a “tortious conversion” of his account and that it, rather than he, was taxable on gains realized when the stock was sold. Golub I, 78 T.C.M. at 373. We determined that petitioner in effect was attempting to relitigate in this Court securities law claims that were subject to an arbitration proceeding in which he had refused to participate. See id. at 373, 378. We concluded that petitioner “received substantial amounts of income in 1991,” that he “failed to pay tax on those amounts,” and that “[h]is defense to that failure is frivolous and wholly without merit.” Id. at 378.

He lost, and also had to pay a $10,000 penalty for taking a frivolous position at Tax Court.

The second case involved an appeal of a Collections Due Process (CDP) hearing; the IRS was attempting to collect the tax debt from 1991.

The IRS Appeals Office sustained the tax lien, and we upheld that determination…We concluded that the IRS had followed all appropriate procedures in filing the notice of tax lien, and we specifically rejected petitioner’s argument that the IRS had “improperly offset his income tax refund for tax year 2004 against his outstanding tax liability for tax year 1991.” As we explained, section 6402 of the Code explicitly authorizes the IRS “to credit an overpayment to offset an outstanding income tax liability.”

On to the present. Here, the petitioner was having a problem with the IRS regarding 2008. He thought there was an overpayment of $24,627 (so he should receive a refund of that amount); the IRS thought he owed $17,373. The difference was $42,000 that allegedly was, “’2008 estimated tax payments and amount applied from 2007 return.’” The matter went to another CDP hearing. I’ll let the Court describe that hearing:

Although petitioner’s position at the hearing was not entirely clear, he appeared to argue (once again) that the Tax Court decision sustaining deficiencies and penalties for 1991 was unconstitutional and should be vacated; that the IRS’ application to his 1991 tax liability of overpayments and credits from other tax years was thus erroneous; and that these overpayments and credits should have been applied instead to his tax liability for 2008. Petitioner failed to provide any evidence at the hearing that he had made quarterly estimated tax payments for 2008 or that the IRS had misapplied any overpayments or credits.

He lost at the CDP and appealed to Tax Court.

When you go to Tax Court, you need proof–evidence that the IRS erred. This could be arguing that the IRS is interpreting some part of the Tax Code or a regulation incorrectly. It could be that you have evidence showing payments made that the IRS refused to honor. It could be that the IRS’s position on a payment plan (installment agreement) or an offer in compromise is unreasonable. All those are good arguments at Tax Court. However:

We operate at a disadvantage in assessing petitioner’s arguments because the summary judgment papers he filed, some 90 pages in toto, are devoted almost exclusively to rehashing arguments about his 1991 tax liability and the legitimacy of this Court’s (long since final) decision sustaining the IRS determinations of deficiencies and penalties for that year. To discern from petitioner’s papers anything relevant to the actual controversy before us is to search for needles in a haystack. However, his position appears grounded on an assertion that the IRS improperly failed to credit his 2008 account with $42,000 in payments comprising “2008 estimated tax payments and amount applied from 2007 return,” as claimed on his 2008 Form 1040, line 63. Petitioner submitted no evidence, to the IRS or this Court, that he made any quarterly estimated tax payments toward his 2008 tax liability.

The Court goes on to note that the IRS is specifically authorized by both statute (the Tax Code) and regulations to offset overpayments and apply them to outstanding tax.

…[P]etitioner’s argument reduces to the contention that he has no 1991 tax liability because our decision sustaining the 1991 deficiencies and penalties was unconstitutional. This argument is frivolous. We accordingly grant summary judgment for respondent.

The Court then looked at whether the petitioner should get another penalty for being frivolous. Not only had he been sanctioned once previously by the Tax Court, “…[T]wo U.S. District Courts and the Court of Appeals for the Second Circuit had previously imposed sanctions against petitioner, prohibiting him from using their resources to advance frivolous attacks against his former brokerage house and other securities defendants.”

I think you know where this is headed:

Petitioner’s filings in this summary judgment proceeding consist mainly of incoherent verbiage that he has cut and pasted from previous filings in this and other courts…At the end of the day, petitioner’s position is that he has no tax liability for 1991 because the IRS and the judicial system have conspired to deprive him of his constitutional rights. That is a frivolous position that has been rejected repeatedly, and sanctions are once again appropriate.

We take petitioner at his word when he avers that he “will never cease” litigating his 1991 tax liability. He should understand, however, that this persistence will come at an ever-increasing price. We therefore impose a penalty in the amount of $15,000 under section 6673(a)(1).

I should point out (for the record) that not only did the IRS make a motion for summary judgment (which was granted), the petitioner had also done so. “We have also considered petitioner’s cross-motion for summary judgment. We find it wholly without merit and entirely frivolous….”

Case: Golub v. Commissioner, T.C. Memo 2013-196

While I Was Out…

Thursday, August 8th, 2013

Ten days off in a row should have been enough…but it wasn’t. In any case, here are some of the posts that the tax blogosphere had that might be of interest:

Jason Dinesen asked, “What’s the upside of preparer regulation for Enrolled Agents?” While at the National Association of Enrolled Agents annual meeting, I asked that question, too. The NAEA officials all swore it was a wonderful thing. The only thing I can deduce is that the RTRP program should lead to more Enrolled Agents. That said, I remain opposed to the RTRP program.

National Public Radio (NPR) noted that statistics show that the IRS targeting was worse for conservative groups than liberal groups. Republicans asked Democrats to bring just one liberal or progressive group to hearings that was impacted. To date, none have been found.

Jason Dinesen’s client who went through a nearly 28-month identity theft nightmare with the IRS finally received her tax refund.

The IRS released a draft of Form 8960. What’s that? It’s the new ObamaCare 3.8% Investment Tax. It does appear that the IRS smartly didn’t link the form to Other Income (as I previously noted, gambling income is not subject to this tax). As Paul Neiffer reported, there are only 33 lines to calculate this tax. As I tell my friends, I have lifetime employment…for all the wrong reasons.

Joe Kristan has a report on an interesting court decision: Can suing be your trade or business? The court held that it could be.

Meanwhile, the Tax Court held that a business owner whose business made a whopping $877 must take a salary of nearly $31,000! Joe Kristan has more on what is a very raw deal for the taxpayer. I do agree with Joe’s conclusion: “When advancing and withdrawing funds from an S corporation, be sure to generate the appropriate prissy paperwork.” If you have a loan, make it look like a loan: Charge interest and record it! It’s possible that with good paperwork the owner wouldn’t have received such a ridiculous result.

A Gambler Gambles to Tax Court…and Loses

Tuesday, July 9th, 2013

With the World Series of Poker main event in progress here in Las Vegas, the Tax Court coincidentally released a decision of a former “Bracelet” winner. (If you win any event at the WSOP, you not only win cash, but a specially inscribed gold bracelet to commemorate your victory.) The petitioner today may be an excellent poker player, but his strategy at Tax Court was that of a loser.

John Hom won the 2002 $3,000 limit hold’em event at the WSOP; he won $174,840 back then. He has numerous tournament poker wins and cashes dating back to 1994. He is also a licensed civil engineer.

The Tax Court case dealt with 2005 – 2008. The IRS sent the petitioner a Notice of Deficiency. Mr. Hom alleged:

1. The Notice of Deficiency is invalid because the address and telephone number of the local office of the National Taxpayer Advocate wasn’t present;
2. He should be allowed to deduct additional gambling losses for 2006-2008;
3. He did not receive unreported wages from his C-Corporation;
4. He should be allowed to deduct additional gambling expenses;
5. He should be allowed to deduct other expenses for a laundromat he owns; and
6. He should not be subject to the accuracy-related penalties for 2005 and 2006.

There are a number of red flags in the background information. First, “…petitioner ignored information document requests from the…IRS….” This was during the examination of Mr. Hom’s returns. It is important to fully cooperate during an examination (audit). Not only will this aid you with the examiner (good will is important during an audit), but if you fully cooperate you can shift the burden of proof to the IRS if the matter goes to Tax Court. His lack of cooperation continued, too:

Petitioner did not cooperate with respondent’s examination or with the Appeals Office. Petitioner refused to turn over requested records; he ignored information document requests, and the IRS had to resort to a court order to gain access to petitioner’s records.

Second, the corporate tax returns for 2004 – 2008 were not filed until April 2010. Late filing returns is always a red flag. Mr. Hom also late-filed all of his personal tax returns for the years in question.

Mr. Hom was considered a professional poker player. He filed a Schedule C for his poker playing business. It’s never a good sign when you look at gambling losses and see the word “Unknown” noted for losses in some years. A gambler must keep a gambling log. This is especially the case when you’re a professional gambler; if you’re in a business both the IRS and the Tax Court expect you to conduct yourself in a business-like manner.

Now, to the actual issues:
1. The Court held that the petitioner wasn’t prejudiced by the minor technical issue of not including the actual address and phone number of the Taxpayer Advocate. Interestingly, another entity controlled by Mr. Hom, John C. Hom & Associates, filed its own Tax Court case. Earlier this year, the Tax Court ruled (in a full decision) that not including the actual phone number and address didn’t make the Notice of Deficiency invalid. There was a second issue in that case: Whether the corporation could file a Tax Court case as the corporation was suspended. It couldn’t, as “The capacity of a corporation to engage in such litigation [in this Court] shall be determined by the law under which it was organized.” But I digress….

2. Could Mr. Hom take additional gambling losses? The Court was succinct in its ruling:

Citing Cohen v. Commissioner, 266 F.2d 5, 11 (9th Cir. 1959), remanding T.C. Memo. 1957-172, petitioner contends that respondent’s disallowance of petitioner’s claimed gambling losses in their entirety rendered the deficiency determination “arbitrary or erroneous”, thereby shifting the burden of proof to respondent. However, respondent disallowed petitioner’s claimed gambling losses because petitioner’s gambling records did not clearly show petitioner’s gambling losses and petitioner was uncooperative. Respondent accurately determined petitioner’s gambling income but disallowed petitioner’s claimed losses because petitioner failed to substantiate them.

There’s a second related issue which was discussed later in the ruling.

3. Did he receive unreported wages? The petitioner contended that the money were loans. Loans require interest, a note, and a repayment schedule. “Moreover, petitioner admitted at trial that (1) he did not execute a note to memorialize the purported loan, (2) JCHA did not pay interest on the purported loan, and (3) there was no repayment schedule on the purported loan.” Additionally,

Petitioner failed to introduce credible evidence showing that respondent’s characterization of the amounts that he withdrew from JCHA’s account as wages was erroneous. The evidence of petitioner’s services to JCHA, discussed further below, suggests strongly that the amounts withdrawn were compensation for his services as an engineer and as an officer of the corporation.
We sustain respondent’s determination on this issue.

2A. Did the petitioner have additional gambling losses that he can deduct under the Cohan rule? “Where a taxpayer establishes that he or she incurred a deductible expense but is unable to substantiate the precise amount, we may, bearing heavily against the taxpayer who has failed to maintain records, approximate the amount of the expense…However, we must have sufficient evidence upon which to make a reasonable estimate to apply the Cohan rule.” Let’s look at the Court’s ruling in regards to 2007 and 2008:

Petitioner had gross receipts from casino poker of $149,687 and $2,769 in 2007 and 2008, respectively. Petitioner introduced no evidence showing how often he played casino poker in 2007 and 2008. However, petitioner’s 2007 gross receipts from casino poker were won on four dates in 2007, including $136,695 at Grand Sierra Casino on February 27, 2007. This suggests that petitioner’s casino poker earnings were won in relatively few events. Petitioner was a skillful and seemingly successful poker player. Unlike cases involving slot machine players with continuous play but occasional jackpots, petitioner did not necessarily suffer any losses from playing casino poker in 2007 or 2008…We therefore have no basis upon which to estimate petitioner’s gambling losses for those years. Accordingly, petitioner is not entitled to deduct any additional gambling losses for 2007 and 2008.

It’s clear from reading between the lines of the decision that Mr. Hom did not keep a gambling log. He did not keep receipts of his tournament buy-ins. Had he done so, he would likely have had the documentation necessary to prevail. The Tax Court won’t help you unless you help yourself. If you’re a gambler and you’re not keeping a gambling log, expect to lose at audit, appeals, and at the Tax Court.

4. The petitioner argued he should be able to deduct additional gambling losses. This was a two-part argument. First, that he had additional transportation and lodging expenses. Unfortunately, he didn’t keep records and Section 274(d) of the Tax Code requires substantiation. Mr. Hom lost this argument.

Second, Mr. Hom argued that he should be able to deduct “rake” and tournament entry fees as gambling expenses.

Petitioner testified that he incurred rake fees of $2 to $4 per hand to play poker at However, petitioner failed to introduce credible evidence corroborating his testimony. Petitioner’s testimony standing alone is not reliable, and we have no basis upon which to estimate petitioner’s rake fee expenses for the years in issue…Accordingly, petitioner is not entitled to deduct any rake fees.

The reality is that the Court got this right, but for the wrong reason. Mr. Hom’s winnings at already reflect the rake. Let’s say you play a hand of poker, and you win a pot of $100 after a rake of $3. Your account is credited with a win of $100; the $3 of rake has already been taken. Put another way, if you want to deduct rake, you must gross-up your poker winnings by the amount of the rake!

Mr. Hom did succeed in getting some tournament entry fees deducted. He could prove he entered a few tournaments, so the Court estimated and did allow an additional deduction of just over $200.

5. The petitioner wanted to deduct more expenses for a laundromat. Unfortunately, he didn’t provide proof of those expenses. That’s a good way to lose at Tax Court, and the petitioner did just that on this issue–he lost.

6. Finally, the petitioner argued that he shouldn’t be subject to the accuracy-related penalty. “The evidence of failure to maintain records, unreported income, and unsubstantiated loss and expense deductions claimed by petitioner is sufficient to prove negligence and satisfies respondent’s burden of production.” Mr. Hom lost this argument.

For a professional gambler (and anyone else running a business), there are several important takeaways from this decision.

1. Keep good records! If you have a gambling log (if you’re a gambler), a mileage log (if you’re deducting mileage), invoices, etc., you will do far, far better in audit, appeals, and at the Tax Court. The petitioner in this case apparently did none of these; that’s a good way to make Tax Court a bad gamble.

2. File timely returns. If you don’t timely file, the IRS will start investigating. Undoubtedly, Mr. Hom received 1099s and/or W-2Gs. When there was no tax return, the IRS came calling. Had Mr. Hom timely filed all returns, it’s possible he would never have been audited.

3. Keep your business entities in good standing. If a business entity is not in good standing, it loses its rights. If you have a corporation, make sure the filing fees paid to the Corporations Commissioner or Secretary of State are timely paid. Most states allow this to be done online.

4. Cooperate with the IRS in an examination (or appeals). It will make your case go far, far smoother. I recently had an examination where the IRS wanted bank records (from a past year). We asked the bank to supply us with the requested records; the bank kept sending us the wrong records. We let the IRS know exactly what was going on. The IRS eventually did not believe us (how could a bank be that messed up)…so they issued a summons. The IRS changed their mind on our cooperation when the bank sent the same wrong records to the IRS! (Yes, that bank is that messed up.) That audit went relatively well because we cooperated.

Case: Hom v. Commissioner, T.C. Memo 2013-163