Archive for the ‘Tax Court’ Category

Miccouskees Reach End of the Road

Monday, March 22nd, 2021

The Miccouskee Tribe runs a very successful casino outside of Miami.  The tribe itself is a sovereign nation and is exempt from federal taxation.  However, its members are US citizens and owe tax on all their income.  The tribe offered some unique (if bad) advice to its members: Don’t report the income–which is taxable–to the IRS, and don’t list distributions from the tribe on anything.  The then chairman of the tribe noted that if the IRS ever found about the income, trouble would ensue.  And that (as you might expect) happened.

The IRS found out and issued notices of deficiency.  Two members of the tribe fought the notices in Tax Court and had a partial victory (they lost on the tax and most of the penalties, but did have the accuracy-related penalty removed).  They appealed to the 11th Circuit.  Last week, the Court handed down its opinion upholding the Tax Court.

First, as I’ve said in the past everything is income unless Congress exempts it.  And there’s nothing in the Code exempting class II gaming: “[T]he very statute that allows tribes to run class II gaming activities—the Gaming Act—also says that any “per capita payments” made from those activities must be “subject to Federal taxation.””  The members argue that the Miccosukee Settlement Act or “land lease” payments exempt them from tax.

Unfortunately for the members, the Miccosukee Settlement Act is about a highway, and does exempt income from that highway building from federal taxation.  The casino (and income from the casino) has nothing to do with that, so the members lose.  Then they argue that the payments are exempt because they are from a lease of the tribe’s lands.  There’s a problem: you need a lease if you’re going to argue that a lease exempts the income from taxation.

The tax court found that there was no lease agreement, and that finding was not clearly erroneous. Indeed, [the members] have not pointed to anything in the record even resembling a lease agreement. And a closer look reveals why: no lease ever existed. [Citations omitted]


But there’s more–to have exemption, there must be clear statutory exemption.  The Court found there was none.  And the payments from the casino do not derive from the land, so the lease is irrelevant anyway.

So the Miccosukee members are out of luck.  They could appeal (either asking for en banc review by the entire circuit or to the Supreme Court), but neither is likely to be granted.  It appears to be the end of the line for the battle, and the members of the tribe need to start writing their checks to the IRS.

Case: Clay v. Commissioner

Bozo Tax Tip #7: Be Frivolous

Thursday, April 4th, 2019

I’d love to be frivolous during tax season. But the inbox is full, the piles of paper don’t go anywhere unless I move them, and my next day off is April 16th. I can get a good laugh when I get an email letting me know that, “Russ, you’re full of ****. There is no law mandating anyone file a tax return or pay income tax.” Yes, I received such an email today. It appeared that it was over one page, but after the first sentence I hit the delete key.

I’ve written about Richard Hatch. He got 51 months at ClubFed for his bout of frivolity. Wesley Snipes tried to say that only foreign-source income was taxable. He got 36 months at ClubFed.

Tax Court judges don’t have the same sense of humor that I do about frivolous arguments. Michael Balice found that out:

Petitioner has responded to this motion by contending (among other things) that he is not subject to IRS deficiency procedures and that wages are not “income” because they result from the exercise of his “irrefutable right to work.” We will grant the motion for summary judgment and sustain the tax deficiencies and additions to tax determined by the IRS. We will also require petitioner to pay under section 6673(a) a penalty to the United States in the amount of $25,000 for asserting frivolous positions in this Court.

I’ll make this simple: Yes, Virginia, there is an income tax and you must pay it. Or as my favorite author, Rex Stout, put it, “Either pay [the income tax] or suffer a loss of privileges.”

Up In Smoke…Again

Thursday, December 20th, 2018

Where there’s smoke, there’s fire. Where there’s a marijuana business, there’s Section 280E and the desire to find a means around it. The Tax Court looked at two cases today involving semi-legal marijuana dispensaries (legal on the state level, but decidedly illegal on the federal level). Would inventiveness allow the deduction of general and administrative expenses? Would a dispensary get out of the Section 6662(a) accuracy-related penalties because what they did was reasonable?

In the first case, a marijuana dispensary knew about the problem of Section 280E. That section disallows all deductions except Cost of Goods Sold for a business trafficking in illegal drugs. So what are means around that? Well, you can have a second line of business, but it has to be real and the books have to clearly separate this out. But that wasn’t what this dispensary came up with.

Why not have a management company provide management services to the dispensary? And we’ll be able to deduct all the expenses of the management company (including general and administrative expenses)–that’s a different business. It was a Eureka! moment for the dispensary…until the IRS disallowed all of the expenses of the management company. (The IRS also disallowed the general and administrative expenses of the dispensary, and additional Cost of Goods Sold expenses of the dispensary.) The dispute ended up in Tax Court.

First, Section 280E is very clear about deductions for illegal drugs:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Marijuana is a Schedule I drug federally; thus, only Cost of Goods Sold can be deducted. The petitioners’ argument that it’s legal on the state level doesn’t hold up; it’s illegal federally. Out go the G&A expenses of the dispensary.

But what about the management company? The IRS argued that the management company was trafficking in controlled substances; the petitioners said it was simply a managing company:

Petitioners argue that, as a management services company, Wellness did not itself engage in the purchase and sale of marijuana. But the only difference between what Alternative did and what Wellness did (since Alternative acted only through Wellness) is that Alternative had title to the marijuana and Wellness did not. Wellness employees were directly involved in the provision of medical marijuana to the patientmembers of Alternative’s dispensary. While Wellness and Alternative were legally separate, Wellness employees were engaged in the purchase and sale of marijuana (albeit on behalf of Alternative); that was Wellness’ primary business. We do not read the term “trafficking” to require Wellness to have had title to the marijuana its employees were purchasing and selling. Neither that section nor the nontax statute on trafficking limits application to sales on one’s own behalf rather than on behalf of another. Without clear authority, we will not read such a limitation into these provisions…

Petitioners also argue that applying section 280E to both Alternative and Wellness is inequitable because deductions for the same activities would be
disallowed twice. These tax consequences are a direct result of the organizational structure petitioners employed, and petitioners have identified no legal basis for remedy.

Thus, the management company (which was an S-Corporation) can’t take business expenses and its shareholders have unreported income.

Overall, the first case was quite inventive in trying to find a way around Section 280E. But once again the deductions went up in smoke.

The second case was looking at another dispensary and whether it was subject to an accuracy-related penalty. The Tax Court had previously ruled that the IRS was correct in disallowing deductions for the dispensary when they tried to capitalize those expenses under Section 263A(a)(2)—another inventive attempt to get around Section 280E that failed.

There wasn’t any dispute that the amount of underreporting was significant enough that this dispensary could be liable for the penalty. Rather, the issue was on whether or not the dispensary’s position on its returns was reasonable. As Judge Holmes notes,

In any event, Olive did not become final and unappealable until years after Harborside filed the last of the returns at issue in these cases. And Harborside also points out that, apart from CHAMP and Olive, there was very limited guidance available to marijuana dispensaries. Harborside correctly points out that the IRS has never promulgated regulations for section 280E and didn’t issue any guidance on marijuana businesses’ capitalization of inventory costs until 2015. See Chief Counsel Advice 201504011 (Jan. 23, 2015).

Judge Holmes draws the conclusion I would draw:

This leads us to the conclusion that Harborside’s reporting position was reasonable. Not only had its main argument for the inapplicability of section 280E to its business not yet been the subject of a final unappealable decision, but as discussed at length in Patients Mutual I, the meaning of “consists of” as used in section 280E is subject to more than one reasonable interpretation. Even by 2012–the last of the tax years at issue here–the only addition to this caselaw was our own opinion in Olive, and it too was still years away from a final appellate decision. [citation omitted]

There’s more:

As to Harborside’s good faith: We released Olive shortly after Harborside’s 2012 tax year ended, and Harborside began allocating a percentage of its operating expenses to a “non-deductible” category starting that year and did not even wait for Olive to be affirmed on appeal…We therefore find that Harborside acted with reasonable cause and in good faith when taking its tax positions for the years at issue. Harborside isn’t liable for penalties.

Another point in their favor: They kept excellent records. This is something I cannot overstate: If you’re in business, you are expected to keep good records. If all of your expenses are substantiated, you will be in much better shape than a business that doesn’t have such substantiation.

So what’s the other takeaway from today’s decisions? First, marijuana dispensaries will likely keep trying to find a way around Section 280E. And the Tax Court will continue to slap such schemes down. It will take Congress to pass a law legalizing marijuana on the federal level before marijuana dispensaries can ignore Section 280E.

Alternative Health Care Advocates, et. al., v Commissioner, 151 T.C. No. 13
Patients Mutual Assistance Collective Corporation v Commissioner, T.C. Memo. 2018-208

This Name Looks Vaguely Familiar

Thursday, November 1st, 2018

I’m a tax nerd. I read Tax Court decisions. Today, one caught my eye: W.T. Snipes v. Commissioner. This name looks vaguely familiar.

Yes, it’s the Wesley Snipes. Mr. Snipes, for those who don’t remember, visited ClubFed for failing to file tax returns in the early 2000s. Today’s decision begins,

P[etitioner] has Federal income tax liabilities of approximately $23.5 million for tax years 2001-06. These liabilities are largely a result of P’s failure to file Federal income tax returns. R[espondent] assessed these deficiencies, filed a notice of Federal tax lien (NFTL), and issued notice and demand for payment of the liabilities, and, when P did not pay, issued to P a notice of the filing. P timely requested a collection due process hearing under I.R.C. sec. 6330(d) and stated that he wanted a collection alternative–i.e., an offer-in-compromise (OIC) or currently not collectible status–and wanted the NFTL withdrawn. P did not challenge his underlying tax liabilities. P made a cash OIC of $842,061, less than 4% of his total underlying liability.

The tax liability is now about $23.5 million. Interestingly, back in 2008 (when Mr. Snipes was tried for failing to file) he and his then-attorney, Robert Bernhoft, said he would pay his taxes. That apparently didn’t happen.

The Tax Court dispute is over Mr. Snipes’ having a Federal tax lien being put on him. Mr. Snipes submitted an Offer In Compromise (OIC) stating there was doubt as to whether the $23.5 million could be collected. When an OIC is submitted, the taxpayer must provide a complete listing of all of his assets and liabilities. In many cases an OIC is justified. Mr. Snipes alleged that a former financial advisor of his took out loans and disposed of assets and income on his behalf without his knowledge or benefit. Indeed, the advisor signed affidavits. The Tax Court had an issue, though: “However, petitioner did not provide any definitive or otherwise bona fide documentation showing the dissipation or diversion of his assets or income.”

Something I’ve said before in discussing the Tax Court, you need to provide absolute proof and documentation. It appears that didn’t happen in this case. But I digress….

Following review of petitioner’s case the settlement officer reduced petitioner’s [reasonable collection potential (RCP)] to $9,581,027 in an effort to compromise for settlement purposes. Petitioner maintained his original OIC of $842,061. The settlement officer ultimately concluded that it was not in the best interest of the Government to accept petitioner’s OIC. The settlement officer’s manager reviewed the settlement officer’s actions regarding petitioner’s case and her rejection of petitioner’s OIC.

Mr. Snipes didn’t accept the ruling, so the case went to Tax Court.

Petitioner contends that the settlement officer abused her discretion in refusing his OIC by failing to (1) calculate petitioner’s exact RCP, (2) exclude dissipated assets, (3) conduct an expedited transferee investigation into Mr. Johnson, (4) consider whether the NFTL would cause petitioner economic hardship, and (5) satisfy the review obligations of section 7122(e)(1).

The Court did not give Mr. Snipes good news. The exact RCP isn’t required. The petitioner asked for $842,061; the settlement officer calculated $9,581,027; that’s a big difference. Without, in the view of the Tax Court, credible documentation of his assets, Mr. Snipes lost his first argument.

The argument regarding dissipated assets is more interesting. Here’s what the Court said:

Even though the settlement officer included potentially dissipated assets in petitioner’s RCP, she did not abuse her discretion. She was properly following published guidance that directs settlement officers to reject an OIC where issues of transferee liability are present unless the taxpayer includes the transferee amount in his offer. Petitioner had multiple entities in which his multiple assets, particularly his real estate properties, were held. The settlement officer could not determine petitioner’s assets clearly. Moreover, petitioner did not provide bona fide or definitive documentation showing that he no longer owned the assets in question or to what extent, if any, he had benefited from their dissipation. He provided only affidavits by [his financial advisor]. The settlement officer was justified in her calculation of petitioner’s RCP. [internal citation omitted]

I can see some basis for an appeal here. Given that the financial advisor was willing to sign affidavits saying he disposed of assets, there’s likely proof that those assets were disposed. On the other hand, you shouldn’t assume with the Tax Court. Consider that if Mr. Snipes had included proof of disposition he might have won this argument (and he might have won at Appeals, too).

The argument on transferee issues was a loser. The Internal Revenue Manual pt. states,

It is not necessary to actually seek or obtain any specific legal remedy in order to address * * * [transferee/nominee/alter ego] issues in an offer. However, the offer file must be clearly documented with the basis for including the value of a transferred asset in the RCP. Care should be taken so that the determination to include assets held by others is reasonable.

This was a losing argument.

The next argument was economic hardship.

Economic hardship is considered a “special circumstance” under which a settlement officer can accept an OIC that is considered significantly below a taxpayer’s RCP…Factors indicating “economic hardship” include: (1) a long-term illness, medical condition, or disability that renders the taxpayer incapable of earning a living, where it is “reasonably foreseeable that taxpayer’s financial resources will be exhausted providing for care and support during the course of the condition”; (2) a situation where the taxpayer’s monthly income is exhausted by providing for care of dependents without other means of support; and (3) a situation where, although the taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and the liquidation of the assets would render the taxpayer unable to meet basic living expenses…Petitioner contends that payment of his RCP as calculated by the IRS would render him unable to meet basic living expenses. [internal citations omitted]

If you can prove that paying the RCP would cause you to be unable to pay your living expenses, you normally do qualify for an OIC based on economic hardship. There’s just one problem here:

The taxpayer must submit complete and current financial documentation to the Commissioner to prove economic hardship. Petitioner has not submitted complete and current financial data to respondent, as he did not provide definitive or bona fide documentation of his assets. Accordingly, petitioner’s settlement officer could not determine that he could not borrow against the equity of his real property interests or other assets, or that the liquidation of these interests would render him unable to meet basic living expenses. Petitioner did not make a showing of economic hardship necessary to qualify for special circumstances.

The final argument was that the review obligations of Section 7122(e)(1) were not met. Petitioner stated that the Appeals Office manager was not an ‘independent’ reviewer. The Court rejected that argument, noting that this is exactly how the proposed rejection of an offer is reviewed.

While I do expect this case to be appealed, for now the tax lien stands. As I said years ago, it would have been far, far easier (and far, far less expensive) for Mr. Snipes to have simply paid his taxes in the first place. Of course, I would have missed out on years of great blog materials but it would have saved Mr. Snipes millions of dollars.


W.T. Snipes v. Commissioner, T.C. Memo 2018-184

When It’s Too Good to be True (Tax Shelter Edition)

Tuesday, August 21st, 2018

When reading Tax Court decisions, always be on the lookout for the word “scheme.” It’s usually a heads-up that what you’re reading isn’t going to cut it (from a tax perspective). So when the decision begins,

These consolidated cases involve a complex tax shelter scheme featuring four C corporations, five individual shareholder-employees of the C corporations, five employee stock ownership plans (ESOPs), five S corporations, and (inevitably) a partnership. [emphasis added]

You know things aren’t going to end up well for the petitioners.

Rightly concluding that this scheme was too good to be true, the Internal Revenue Service (IRS or respondent) attacked it on numerous grounds for tax years that (owing to calender and fiscal year differences) span 2002-2005. We hold that the “factoring fees” and most of the “management fees” were not deductible expenses of the C corporations but rather were disguised distributions of corporate profits.

So what happened? Actually, a lot of transactions. Thousands of transactions. Make that many thousands of transactions–all designed to get rid of tax.

Implementation of the tax shelter scheme entailed many thousands of cash transfers among 15 entities and individuals. In their proposed findings of fact the parties often do not agree on the net results of these transactions, or even on what the dollar amounts remaining in dispute actually are. We have done our best to work our way through this fog.

First, let me give a fundamental rule in tax: Everything needs an economic substance to be legal. Business transactions can be designed in a tax advantaged way, but there needs to be a real transaction. The scheme involved factoring and management fees. I’m familiar with factoring; it’s common in the garment industry (among other industries). Factoring allows the sale of accounts receivable and the seller to immediately obtain cash; in exchange, the buyer collects the receivables and earns the difference between the sales price and the receivables. The problem was that the way this factoring worked wasn’t the way it works in practice.

While factoring receivables theoretically enabled the Water Companies to accelerate their incoming cashflow, this benefit was illusory given how the “factoring” operated. PMG could not function as a “factor” without the management fees it received from the Water Companies, as shown by the 10-month delay in PMG’s commencement of “factoring.” In effect, the Water Companies had to provide working capital to PMG (rather than the other way around) to enable PMG to purchase the accounts receivable. Given this circular flow of funds, the “factoring” generated no liquidity benefits for the Water Companies…

We conclude that the purported factoring arrangement with PMG had no economic substance but was a device to extract profits from the Water Companies in the guise of tax-deductible payments. The Water Companies derived no economic benefit from this arrangement, and the factoring fees they paid were not “ordinary and necessary” expenses of their business. [internal note omitted]

The factoring also failed an ‘arms-length’ test. When parties are related, the transactions have to follow what I call the disinterested buyer/seller model: What would a disinterested [buyer/seller] pay (or receive) for what’s being sold? A question this court pondered was whether these agreements in practice followed normal factoring practices.

In an arm’s-length factoring arrangement, the factor typically: (1) receives an assignment of accounts receivable from the client, (2) verifies the genuineness of the accounts and balances shown, and (3) immediately pays the client a lump sum equal to the face amount of the receivables less the agreed-upon discount. Mr. Zadek observed that PMG’s payment practices were erratic and regularly flouted these norms. On some occasions PMG would make payment before receiving executed assignments of the receivables and without verifying the account balances. On other occasions PMG would not make the stipulated upfront payment but would instead pay for the receivables in installments, sometimes in seven or eight tranches spread over many months. This was contrary to standard factoring practice, which aims to provide the client with immediate liquidity. The trial evidence supported Mr. Zadek’s conclusion that the timing of the supposed “factoring” payments was largely dictated, not by the terms of the MFAs, but by “when there was money in the bank to do it,” as Ms. Quarry testified.

Add in that the company itself and not the factor did the actual collection efforts (on past due accounts), and you have a facade of factoring and some big tax problems. But, like a bad infomercial, that’s not all! There are also excessive management fees. These were designed to change taxable income into untaxable income. Suffice to say, these didn’t work either.

The conclusion is one I (and others) have been stating for years: There is no Tax Fairy. If you (or your business) makes a lot of income, you will owe tax. Alchemy in the tax world works just as well as alchemy in the physical world: I’ve yet to see someone take lead and turn into gold or some other precious metal. Instead of spending millions on these tax shelter schemes, the businesses’ owners would have done far better using those millions to pay their taxes.

Case: Pacific Management Group v. Commissioner, T.C. Memo 2018-131

A Thriller of a Decision Upcoming

Sunday, June 3rd, 2018

The Wall Street Journal yesterday highlighted Judge Mark Holmes of the United States Tax Court. Judge Holmes’s opinions are extraordinarily readable even to those who know little about tax law. I’ve noted Judge Holmes’s writings in the past (on the TurboTax defense, on strip clubs and hair bands, on human egg retrieval, and ‘substance over form’); luckily for tax nerds, it’s likely we will be getting lots more opportunities to read Judge Holmes’s writings (he was recently nominated by President Trump for another 15-year term on the Tax Court).

Why did the Journal spotlight Judge Holmes? Because he is the judge dealing with the estate tax case of Michael Jackson. As the Journal noted,

There’s also a biting side to his work. This year, in a dissent, he compared his colleagues on the Tax Court to the tyrannical Roman emperor Caligula and his practice of posting tax laws “in fine print and so high that Romans could not read them.”

“It is our custom to reconsider an issue when a circuit court reverses us. And today we have to choose either a well-reasoned opinion by a highly respected judge in America’s heartland, or Caligula,” Judge Holmes wrote. “We pick Caligula. I gingerly dissent.”

An estate tax return is based on the value of the estate on the date of death. When Mr. Jackson died, he was in financial trouble. True, today there’s a show here in Las Vegas that features his music and his estate is worth a lot of money, but was that the case on the date of death? Judge Holmes will let us know, and almost certainly in a way that will educate and elucidate at the same time. If you’re a Journal subscriber, I strongly recommend this article.

What Portion of the Stipulation Didn’t You Read?

Tuesday, December 5th, 2017

A company owes withholding tax to the IRS. The case goes to Tax Court, where the issues are resolved, including a stipulated amount of withholding. Somehow the IRS forgets about the withholding. It then goes to a collection Appeals, where the withholding mysteriously gets ignored. The case comes back to Tax Court when the IRS issues a levy. The Tax Court remands the case back to Appeals; however, $70,000 of the withholding still gets ignored.

The Tax Court originally looked at this case in 2008.

On April 28, 2008, petitioner timely filed a petition with the Court relating to the notice of determination of worker classification. W. Mgmt., Inc. v. Commissioner, T.C. Dkt. No. 9745-08 (filed Apr. 28, 2008). The Court, on June 11, 2009, filed two stipulations of settled issues in which the parties resolved the issues raised in the notice of determination of worker classification and agreed that respondent would credit $195,708 to petitioner’s 1995, 1996, 1997, 1998, and 1999 income tax withholding…Shortly thereafter, petitioner appealed the Tax Court’s decision to the U.S. Court of Appeals for the Ninth Circuit, and respondent assessed the taxes and additions to tax reflected in the decision. Respondent did not, however, take into account the $195,708 of stipulated income tax withholding.

So that’s the first error: The original stipulation of withholding didn’t make it into the record. Unsurprisingly, the company asked for a collection due process (CDP) hearing noting that the IRS forgot about the stipulated withholding credits.

Meanwhile, the company lost the appeal to the Ninth Circuit. But,

In its opinion the court recounted respondent’s assurance that “any credits due to * * * [petitioner] will be administratively applied to * * * [its] tax accounts after the [Tax Court’s] [d]ecision becomes final.”

Somehow during the CDP hearing the Appeals Officer didn’t consider the stipulated withholding credits. That’s the second error: Somehow the Appeals Officer didn’t read the record of the Tax Court. The company went back to Tax Court, asking that the credits be put into the record.

The Court, on October 1, 2014, remanded petitioner’s case to allow an Appeals officer’s consideration of “any credits, specifically credits for income tax withholding, to which [p]etitioner may be entitled.” Steve Lerner, the Appeals officer assigned to the remand, determined that petitioner was entitled to $195,708 of credits but applied only $125,084 to petitioner’s accounts. On April 16, 2015, Appeals Officer Lerner issued petitioner a supplemental notice of determination that again sustained the levy notice.

And we have the third error. The company (rightly) wanted the missing $70,624 applied, so back to Tax Court we go. And IRS Appeals gets (again, rightly) a black eye:

On remand Appeals Officer Lerner agreed petitioner was entitled to $195,708 of income tax withholding but inexplicably credited petitioner only $125,084. By not taking into account $70,624 (i.e., $195,708 less $125,084) of stipulated credits, he reneged on respondent’s assurances to the Court of Appeals; failed to consider relevant issues relating to the unpaid tax; inappropriately balanced respondent’s need for the efficient collection of taxes with petitioner’s concern regarding the levy’s intrusiveness; and contravened applicable law and administrative procedure (i.e., section 3402(d) and Internal Revenue Manual pt. (Dec. 11, 2013)) requiring respondent to abate an employer’s employment tax liability to the extent it is paid by an employee…The administrative record belies respondent’s contention that Appeals Officer Lerner applied all of the stipulated credits to petitioner’s accounts. Because his determination lacked a sound basis in law and fact, Appeals Officer Lerner abused his discretion.

Yikes! As the Court noted, this is a case that should have been resolved on remand. Or could have been resolved the first time at Appeals. And should have been resolved way back in 2009. Consider that the company had to pay counsel for representation in a case which should never have needed to be filed. I hope the company asks the IRS to pay for their legal fees, and perhaps the IRS will pay up without the need for another trip to Tax Court. This is definitely a case where the company prevailed and the IRS’s position was completely unjustified.

Case: Credex, Inc. v. Commissioner, T.C. Memo 2017-241

The Shortest Tax Court Opinion I’ve Seen

Tuesday, October 31st, 2017

I’ve seen opinions of the Tax Court run to hundreds of pages on complex cases. Today, I perused what might be the shortest Tax Court decision I’ve ever seen. The petitioner erroneously filed as “Head of Household” when she should have filed as “Married, Filing Jointly (MFJ).” The IRS changed her filing status to “Single” rather than MFJ. Could she get the correct status?

Here’s the Opinion in full:

Petitioner meets the “married filing jointly” status requirements, does not meet the “head of household” or “single” filing status requirements, and thus is entitled to “married filing jointly” status. See secs. 1, 2, 6013, 7703; Ibrahim v. Commissioner, 788 F.3d 834, 840 (8th Cir. 2015) (holding that a married taxpayer who erroneously filed a “head of household” return could file jointly), rev’g and remanding T.C. Memo. 2014-8; Camara v. Commissioner, 149 T.C. ___, ___ (slip op. at 23-24) (Sept. 28, 2017) (stating that a married taxpayer may correct a “single” or “head of household” filing status claimed in error).

Contentions we have not addressed are irrelevant, moot, or meritless. [footnote omitted]

Presumably the petitioner, who was represented by counsel, had attempted to get the IRS to correct the error. One wonders why the IRS wouldn’t make the change to what is the correct filing status; thus, this case ended up at Tax Court. Then again, given some of the things I’ve seen perhaps I don’t need to wonder….

Case: Godsey v. Commissioner, T.C. Memo 2017-214

Can a Tunnel Bridge Agent be a Professional Gambler, Too?

Monday, October 2nd, 2017

The Tax Court looked at whether someone who worked full time as a Tunnel Bridge Agent could also be a professional gambler. There is a lot in the decision, including some things that I believe the Court gets wrong.

The opinion first describes the differences between being a professional gambler and an amateur gambler. If you are unaware of the differences in the tax treatment, this opinion is must-reading. Unfortunately, the opinion gets the definition of a professional gambler only half-right. “To be a professional gambler, the taxpayer must engage in gambling for profit,” is what the opinion states (citing Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987)). But the courts have held that you need to be gambling for your livelihood, a stricter standard. There are numerous amateur gamblers who do so for a profit (I am one of those), but I’m an amateur gambler. My livelihood comes from my tax practice, but I’m skilled (or lucky) enough to make money from poker.

In any case, today’s taxpayer, Mr. B, doesn’t even pass this test. His first problem is where he gambled and his recordkepping or, should I say, his lack of recordskeeping.

Boneparte gambled at horse racetracks and in casinos. At the casinos his preferred game was baccarat, but he also played other table games as well as slots. Sometimes he gambled alone, and sometimes he gambled with a friend. He gambled primarily in Atlantic City. He did not keep a contemporaneous written log of winnings and wagers.

If you’re in business, you are supposed to keep records. The IRS rules on gambling—and these date back to the 1970s—mandate a contemporaneous, written log. (Remember, those rules were written well before smartphones or any cellphone. Today, computer records would most likely be accepted.) But if you have no records, you’re going to have trouble substantiating that you’re a professional gambler. Yes, Mr. B had casino win-loss statements but (a) these are not guaranteed to be accurate (a point the Court missed in its opinion), and (b) professionals want to know what they’re succeeding in and failing in; the only way to do that is to keep your own records.

As an aside, it’s hard to be a professional gambler when you are playing games of pure chance with a house (casino) advantage. That’s why most professional gamblers play poker (where you’re playing against other players); a lesser number of professional gamblers partake in sports betting and “advantage” video poker (where there’s a small player advantage with perfect play). But I digress…

The Court then looked at the nine-factor test of whether an activity is engaged in for profit.

(1) [T]he manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisers; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer’s history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) elements of personal pleasure or recreation.

Mr. B. didn’t lose on all of the factors: Factor #4 (expectation of asset appreciation) was held not to apply. With the Court ruling that Mr. B. Isn’t a professional gambler, most of the rest of the opinion goes into calculation issues of his return and penalty calculations.

However, I want to point out an error the IRS made that I’ve seen in my practice. If a casino win-loss statement shows a net loss $14,887, and we know that the gambler had gross wins (before losses) of $18,000, his gross losses must be $32,887. That’s simple math. I once had to explain to an IRS Revenue Agent how this works; it took about a half-hour for him to grasp the concept. In this case, the IRS was holding this same idea that Mr. B’s gross loss was his total loss. The Court, though, understood basic math:

As explained above, two propositions are true: (1) the gains from wagering transactions for which there was gain total $18,000, and (2) the gains from wagering transactions for which there was a gain minus the losses from wagering transactions for which there was a loss equal -$14,887. It mathematically follows from these two propositions that the losses from wagering transactions for which there is a loss equal -$32,887 (i.e., $18,000 ! $32,887 = -$14,887). [Mr. B] is entitled to a section 165(d) deduction equal to this amount to the extent of gains from wagering transactions. This gain is $18,000. Therefore his section 165(d) deduction is $18,000.

Mr. B’s returns were self-prepared. He included his gambling on both a Schedule C and as Other Income. In almost all cases, you’re either a professional gambler or an amateur gambler (not both). The IRS assessed both the late filing penalty (Mr. B’s return was postmarked after the April deadline) and the accuracy-related penalty; both were sustained.

Mr. B gives a good example of someone who wanted to be a professional gambler because it would help him save on his taxes. Unfortunately for him, he neither treated his business professionally nor was he able to show the Tax Court that he was a professional gambler.

The Law Isn’t Fair, But You Have to Pay the Tax

Tuesday, August 29th, 2017

A California couple received an Advance Premium Tax Credit (part of the “Affordable Care Act,” aka ObamaCare). Through bureaucratic errors at Covered California, they’re unable to change their plan once they’re both employed to stop the credit, nor do they receive a Form 1095-A. It’s not as if they ever received the credits themselves; they went to insurers. The IRS assesses the repayment of the Advance Premium Tax Credit and assesses an accuracy-related penalty. The dispute ends up in Tax Court; do they have to pay the tax and penalty?

The facts of the case aren’t in dispute. The couple (for 2014) enrolled in a Silver plan based on lower income. When the wife took a job she promptly notified Covered California that their income increased; clearly, the credit needed to be adjusted. Months later, Covered California sent a letter to them…except the letter was never received.

What happened to that letter is unclear. The records from Covered California that were provided in this case are incomplete. But according to the records in evidence, “during Covered California’s first open enrollment period, Covered California was so busy that it was not uncommon that changes were not implemented.” What the record makes clear is that the [couple] made repeated efforts to get Covered California to take into account the change in household income, but it never did so. [footnote omitted]

They also notified Covered California of their address change; Covered California ignored that. They had an administrative hearing with the California Department of Health Care over Covered California’s errors; they lost on procedural grounds: “The Administrative Law Judge lacks jurisdiction to decide an issue involving an error on the part of Covered California for failure to recalculate the appellant’s eligibility for APTC after the appellant reported a change in income in January 2014.” They never received the Form 1095-A. They did note on their 2014 return that they had health insurance but they ignored the Advance Premium Tax Credit. The IRS assessed the tax (in the amount of the disallowed tax credit) and an accuracy-related penalty.

The couple correctly notes the Catch-22 they were caught in:

[The Commissioner argues] that if Petitioners are liable for the deficiency, then they would be no worse off financially than if the APTC had been terminated in early 2014. This is simply untrue and does not alter the fact that it was Covered California’s responsibility to ensure clients only received the Advance Premium Tax Credit for which they qualified. We would never have committed to paying for medical coverage in excess of $14,000 per year. We cannot afford it and would have continued to shop in the private sector to purchase the minimal, least expensive coverage or gone without coverage completely and suffered the penalties. * * *

* * * If we are deemed responsible for paying back this deficiency, it would be devastating and completely unjust. We hope and pray you are convinced that we have made every single effort to get Covered California to make proper adjustments to our reported income and subsequently to the Advance Premium Tax Credit we were qualified to receive without success. The whole purpose of the Affordable Care Act was to provide citizens with just that, affordable healthcare. This has been an absolute nightmare and we hope you will rule fairly and justly today.

Unfortunately, the Tax Court is not a court of equity:

In other words, the [couple] considered themselves to have been trapped in a health plan that they could not afford without the subsidy provided by the ACA. And they ask us to rule “fairly and justly” or, otherwise stated, equitably.

But we are not a court of equity, and we cannot ignore the law to achieve an equitable end. Although we are sympathetic to the [couple’s] situation, the statute is clear; excess advance premium tax credits are treated as an increase in the tax imposed. The [couple] received an advance of a credit to which they ultimately were not entitled. They are liable for the $7,092 deficiency. [citations omitted]

To add insult to injury, the couple were also charged with an accuracy-related penalty. Here, though, the law is on the couple’s side:

On the totality of the facts and circumstances, the [couple] acted reasonably and in good faith with respect to the underpayment of tax on their return. They did not receive a Form 1095-A showing the income they received in the form of an advance premium assistance credit, and they did not directly receive that income. They did not know nor should they have known that they had additional income required to be shown on their return, and consequently they are not liable for the accuracy-related penalty under section 6662(a).

This result is anything but equitable for the couple. They tried to have the credit adjusted but the bureaucracy ignored them. It just goes to show that when Ronald Reagan stated the following in 1986 he was dead-on accurate:

The nine most terrifying words in the English language are: I’m from the government and I’m here to help.

Case: McGuire v. Commissioner, 149 T.C. No. 9