Archive for the ‘Tax Court’ Category

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. 4.23.8.4.3 (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

Boston Bruins 2, IRS 0

Monday, June 26th, 2017

Bruins Logo

The United States Tax Court today looked at whether pregame road meals for a National Hockey League (NHL) team are “meals and entertainment” expense (which would be deductible at 50% of cost) or a “de minimis fringe” and deductible at 100% of cost. As you might be able to guess from the title of the post, the Bruins shutout the IRS today.

First, if you’re interested in some of all of the background work that must be done for hockey, the opinion is a must-read. For example, I did not know that the road team in hockey does not receive any of the ticket revenue for regular season games. But I digress….

The IRS allowed pregame home meals but did not allow pregame road meals as a de minimis fringe; the IRS claimed that road (away) meals were a meal and entertainment expense. Of course, the meals must also be business-related but both the IRS and the Bruins agreed on that. As you might imagine, diet matters to NHL players:

Each away city hotel prepares pregame meals (i.e., breakfast, lunch, or brunch) and snacks that meet the players’ specific nutritional guidelines to ensure optimal performance for the upcoming game and throughout the remainder of the season. The Bruins contract in advance with each away city hotel for the provision of pregame meals and snacks, and the food is made available to all traveling hockey employees. The Bruins initiate the meal contracting process by providing a custom meal menu to the prospective away city hotel requesting specific types and quantities of food. The Bruins tend to keep food options consistent at each away city hotel to avoid players’ having gastric problems during the game. The Bruins always order the same quantity of food to feed all traveling hockey employees.

The de minimis fringe exception first requires that the eating facility be available to all, and not discriminate in favor of highly compensated employees. NHL teams bring a lot more than just the players on a road trip:

During the years in issue the Bruins traveled to away games with various personnel, which typically included: between 20 and 24 players, the head coach, assistant coaches, medical personnel, athletic trainers, equipment managers, communications personnel, travel logistics managers, public relations/media personnel, and other employees (traveling hockey employees). During the years in issue the Bruins’ traveling hockey employees traveled to every away game.

The Bruins easily passed this first hurdle because the food was provided to all. The major issue was whether these were a de minimis fringe benefit:

Employee meals provided in a nondiscriminatory manner constitute a de minimis fringe under section 132(e) if: (1) the eating facility is owned or leased by the employer; (2) the facility is operated by the employer; (3) the facility is located on or near the business premises of the employer; (4) the meals furnished at the facility are provided during, or immediately before or after, the employee’s workday; and (5) the annual revenue derived from the facility normally equals or exceeds the direct operating costs of the facility (the revenue/operating cost test).

The Bruins lease hotel facilities; that would make it appear that they would pass the first test. “The evidence establishes that the Bruins contract with away city hotels for the right to “use and occupy” meal rooms to conduct team business, and therefore these agreements are substantively leases.” And given that they contract with the hotel to provide the food, they meet the operating test.

It appears (from the opinion) that the IRS vigorously opposed the idea that the Bruins passed the “facility is located near the business premises of the employer” test. But the Court disagreed.

First and foremost, the nature of the Bruins’ business requires the team to travel to various arenas across the United States and Canada, and it is not feasible for the Bruins to be a viable NHL franchise without participating in hockey games outside of Boston. The NHL constitution and bylaws obligate each NHL team to play both home and away games during the regular season and, if the team qualifies, postseason games. Not only does the NHL require teams to participate in away games, but it also requires visiting teams to arrive in an away city at least six hours before the away game commences. The CBA imposes an additional requirement that visiting NHL teams travel to the away city the day before game day, if travel by airplane is greater than 150 minutes. Furthermore, if an NHL team fails to participate in an away game it must forfeit the game, lose playoff points, incur financial penalties imposed by the NHL, and indemnify the home team for loss of revenue and other expenses. Therefore, an integral part of the Bruins’ professional hockey business involves traveling throughout the United States and Canada to play away games as dictated by the NHL schedule. The job of the Bruins’ team includes playing one-half of their regular season games away from their hometown arena, and the financial health of the NHL franchise–not to mention the NHL itself–would be adversely affected if teams refused to play away games.

The Court ruled that staying in away city hotels was essential for the Bruins, and it’s clear that it would be impossible for the Bruins to do all this in Boston. “The evidence at trial also establishes that the Bruins could not perform all these activities at the opponent’s arena because of limited access and insufficient space and facilities.” Thus, the Court held that the road hotels were part of the Bruins’ business premises.

The IRS disagreed:

[T]he traveling hockey employees’ activities at away city hotels are insignificant because: (1) the activities at away city hotels are qualitatively less important than playing in the actual hockey game and (2) the Bruins spend quantitatively less time at each away city hotel than they do at the team’s Boston facilities.

The Court, though, thought that the IRS was offsides on these arguments.

Without the preparatory activities that occur at away city hotels the Bruins’ performance during games would likely be adversely affected. Furthermore, respondent provides no precedent to support the argument that business premises are limited to the location where the most qualitatively significant business activity occurs…Although the Bruins do spend quantitatively less time at each individual away city hotel than they do in Boston, this goes to the unique nature of a professional hockey team that is required to play one-half of its games away from home. It is therefore illogical for respondent to ignore the nature of the Bruins’ business and the NHL and analyze the amount of time spent at each away city hotel in isolation.

The Bruins also passed the revenue/operating cost test. “Meals are excludable to recipient employees under section 119 if they are (1) furnished for the convenience of the employer and (2) furnished on the business premises of the employer.” And the Court agreed with the Bruins here:

The evidence establishes that the pregame meals at away city hotels are provided to the Bruins’ traveling hockey employees for substantial noncompensatory business reasons. The Bruins provide pregame meals to traveling hockey employees at away city hotels first and foremost for nutritional and performance reasons…Providing meals to traveling hockey employees at away city hotels enables the Bruins to effectively manage a hectic schedule by minimizing unproductive time (e.g., finding and obtaining appropriate meals from restaurants in each city) and maximizing time dedicated to activities that help achieve the organization’s goal of winning hockey games. Petitioners have provided credible evidence establishing the business reasons for furnishing pregame meals to traveling hockey employees at away city hotels, and we will not second-guess their business judgment.

The IRS conceded the last part of the test (that the meals were furnished during, before, or after the workday). Thus, it was a shutout: Bruins 2, IRS 0 (the petitioners, the owners of the Bruins, were challenging an IRS audit covering two tax years).

Other professional sports teams may be filing amended returns (if they had only been taking half of the cost of meals) because it’s hard to imagine that the requirements for, say, a traveling NFL or NBA team aren’t similar to those of an NHL team. This is a full decision of the Tax Court, so it is precedential.

Case: Jacobs v. Commissioner, 148 T.C. No. 24

2016 Tax Offender of the Year Gets 34 Months at ClubFed

Sunday, June 25th, 2017

Last April, a husband and wife from Minnesota were indicted on tax evasion charges. There wasn’t anything unusual about what they allegedly did; besides lying to their tax professional and the IRS they deducted personal expenses as business expenses. The reason Diane Kroupa won the award was her profession: She was a judge on the United States Tax Court. She knew better.

Last week Ms. Kroupa received 34 months at ClubFed; her husband received 24 months. Acting United States Attorney Gregory Brooker said,

Over a nearly ten-year period, the defendants engaged in a deliberate and brazen tax fraud scheme…Considering Ms. Kroupa’s position of public trust as a US Tax Court Judge, her crime is particularly egregious. Ms. Kroupa used her knowledge of the tax laws to further their fraud scheme, conceal their criminal conduct and maintain their acquisitive lifestyle. The sentences handed down today show that no one is above the law.

There’s not much to add to that statement.

I See $25,000 In Your Future

Thursday, June 8th, 2017

When I start reading a Tax Court decision and see the sentence, “Petitioner and her husband derived considerable income from peddling this scheme to gullible individuals,” you know it’s not going to be a good day for petitioners. But I’m getting ahead of myself.

Three years ago Ms. G had a Tax Court case on their 2004 income taxes which she lost. She appealed that decision and lost. The IRS wanted to collect the money, but the petitioner asked for a Collection Due Process (CDP) hearing with IRS Appeals. She had it, and lost that. She then appealed that result to the Tax Court. Based on income of $235,542 (of which no tax was paid), she owed $99,261 plus penalties and interest.

First, a little background on petitioner:

Petitioner and her husband are well-known tax shelter promoters with a lengthy history of litigation in this and other courts. Their speciality [sic] is the “corporation sole” tax shelter, whereby a taxpayer takes a fictitious “vow of poverty” in connection with a purported “church” and declares herself thenceforth immune from Federal income tax. Petitioner promoted this scheme by writing several books, including How to Protect Everything You Own in This Life and After and Corporation Sole vs. 501(c)(3) Corporation. Petitioner also practiced what she
preached: She and her husband established “Bethel Aram Ministries” in 1993, took fictitious “vows of poverty,” and have not filed a Federal income tax return since. [footnote omitted]

That’s not a good start. I’d like to pay no tax, but you need to be a real minister with a real vow of poverty to do so; imitations don’t work. At the CDP hearing, the IRS Appeals Officer noted that the law had been followed, and shockingly (not) that the taxpayer had still not submitted copies of 2005 to 2014 tax returns.

Well, her streak of non-filing is a bit more lengthy:

Petitioner did not request a collection alternative, and she did not supply the SO with the financial information necessary to enable him to consider one. Far from being in compliance with her ongoing tax filing obligations, she has not filed a Federal income tax return since 1993. The SO did not abuse his discretion in declining to consider a collection alternative under these circumstances…Finding no abuse of discretion in this or in any other respect, we will grant summary judgment for respondent and affirm the proposed collection action.

But the Tax Court wasn’t happy with the petitioner.

It is clear to us that petitioner has maintained this suit “primarily for delay” as part of her 25-year campaign to avoid or defer indefinitely the collection of her Federal income tax liabilities. Because our decision establishing her 2004 income tax liability became final more than three years ago, she had no plausible basis for challenging that liability through the CDP process. Her 30-page response to the motion for summary judgment includes only two paragraphs that bear any rational relationship to the issues this case presents. The vast bulk of that document is directed toward relitigation of the trial court and appellate decisions previously rendered against her. In that connection she advances numerous frivolous arguments, including assertions that the IRS “continues to lie and defame Petitioner” and that the Commissioner and the courts have conspired to deny her First Amendment rights to freedom of speech and religion.

The Tax Court assessed a Frivolous Position Penalty of $10,000.

Petitioner has wasted the resources of respondent’s counsel and this Court. We will accordingly require that she pay to the United States under section 6673(a) a penalty of $10,000. This opinion will serve as a warning that she risks a much larger penalty if she engages in similar tactics in the future.

Tax Court exists so that legitimate disputes between taxpayers and the IRS get resolved. The Tax Court has little sense of humor about frivolity. Given Ms. G’s consistent non-filing and delaying tactics, I suspect we will see her name in a future case with a section 6673(a) penalty of $25,000.

Case: Gardner v. Commissioner, T.C. Memo 2017-107

The TurboTax Defense Fails Again

Thursday, May 11th, 2017

A gentleman who is normally an expert witness in trials used TurboTax to prepare his returns. His returns ere reviewed by the IRS; the IRS claimed he took a few too many deductions. The taxpayer felt otherwise, and the dispute ended up in Tax Court. Judge Holmes wrote the opinion, so it’s very readable.

The first issue was alimony payments. Alimony is deductible for the payor but taxable to the recipient. However, one of the requirements is that there be a written order. The taxpayer and his ex-wife had an oral modification of the agreement. That may work for getting the ex-wife more money, but it fails for deducting those extra payments.

The second issue was interest. Interest that’s part of a business can be deducted, but you do have to show you made payments and those payments were interest and not principal. I’ll let Judge Holmes take this:

The evidence does show [he] made payments to his lender, but the amounts do not match those that he claimed on his tax returns, and he did not explain this discrepancy at trial. [He] also did not provide us with any business records regarding the loan, any loan statements, or any loan-repayment schedules. Without this type of documentation we are unable to tell whether these payments were made on the original 2007 loan. Remember that the note for that loan says it should have been paid in full by October 2008. We understand that it might have been his plan to pay the note with proceeds from the sale of his home, and that that sale didn’t happen. The problem is that we can’t figure out what happened to the note–was it refinanced? Was it extended? Without any paperwork (in a situation where there should have been lots of paperwork) we are left only with his testimony about the total amounts of the payments and the allocation of those payments between principal and interest. We do not find his testimony credible on this issue, and so sustain the Commissioner’s determination.

As I tell my clients, document, document, document (and save those records). A paper trail is a very good thing to have when you get to Tax Court.

The third issue was an apparent Net Operating Loss (NOL) carryforward.

A taxpayer substantiates his claim to such a deduction by filing with his return “a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the net operating loss deduction.” During trial he did turn in a tax return for a previous year (though not the one that generated the net operating loss), but even with his testimony, that is not enough to substantiate his entitlement to a loss carryforward.

The taxpayer also received an accuracy-related penalty.

The burden then swings to [him] to show that his mistakes were reasonable and in good faith. See sec. 6664(c)(1). He cannot. He admitted during trial that he deducted items he shouldn’t have, and that he overstated certain losses. He tried to blame TurboTax for his mistakes, but “[t]ax preparation software is only as good as the information one inputs into it.” [citation omitted]

If your tax return has only W-2 income and, say, mortgage interest and property tax, TurboTax will likely do an excellent job. If you have a divroce settlement with a restatement of the amount of alimony due, interest tracing, and a Net Operating Loss carryforward, it might pay to get some expert help.


Case: Bulakites v. Commissioner, T.C. Memo 2017-79

Consulting, Gambling; There’s No Difference, Right?

Monday, February 6th, 2017

The Tax Court looked at an individual (call him “Mr. A.”) who looked like a professional poker player, appeared to have an income from poker, but was described on his tax return as a “consultant.” His tax return showed less than half the income that his W-2Gs totaled. The IRS added in a negligence penalty, and the whole dispute ended up in Tax Court.

Before I get into the meat of the case, a comment about gambling and the IRS (and the Tax Court). The IRS does not have a good understanding of the mechanics of poker tournaments. The petitioner today lost some deductions because of this (and that they didn’t explain things point by point). For example, the Court stated (in footnote 4):

The parties also stipulated the authenticity of two receipts showing that Mr. A had paid buy-ins as an “alternate” to participate in “$540 No Limit Hold’em” contests at the Bellagio on July 11 and 17, 2009. As the record does not disclose whether Mr. A in fact played–and if he did not, whether his buy-in was refunded–we conclude that petitioners have not shown that Mr. A paid these buy-ins.

That’s not how alternates in a poker tournament work. Alternates are just the people who get seated when original entrants are eliminated from the tournament. I’ve never seen or heard of an alternate not being seated. But the petitioners didn’t mention this in their briefs or testimony, so the Court used what they thought the term meant, not what really happens in poker tournaments. But I digress….

The problems began with the preparing of their 2009 return.

The return was prepared by petitioners’ accountant…who has a master’s degree in accounting and had previously prepared tax returns for professional poker players. For purposes of preparing the return, Mr. A advised the preparer that his exclusive source of income in 2009 was his poker tournament winnings. He further advised the preparer that he did not have records of the expenses he incurred in order to play in poker tournaments. The preparer concluded that Mr. A was a professional poker player on the basis that poker was his exclusive source of income. Given the absence of expense records, the preparer advised petitioners to report the net income from the gambling activity on Schedule C as gross receipts but not to report any offsetting business expenses.

Let’s look at the problems here. First, the IRS computer system was almost certain to hiccup on this return. If the W-2Gs totaled $42,000 and you report $21,000, there’s a problem. I’m certain that the petitioner received an IRS automated underreporting unit notice on this issue. The second problem deals with the preparer. Tax returns have places for expenses; they aren’t supposed to be lumped with gross receipts. Additionally, there are basic standards in preparing a return. The idea of a preparer putting down, say, $10,000 for expenses when a client says he has no records of those expenses makes no sense.

The taxpayers return showed a Schedule C—the only source of income—with $20,045 of net and gross income. The Schedule C was listed Mr. A’s occupation as “Consultant.” The IRS assumed that was the case, and saw $40,395 of wagering income to be added to the return. That was the first issue. This they won:

On the basis of Mr. A’s and his accountant’s testimony and the entire record, we agree with petitioners. Other than the reference on the Schedule C to Mr. A’s business as a “consultant”, there is no evidence that Mr. A engaged in any consulting activities for compensation during 2009. He denied doing so. When called upon to explain why Mr. A’s business was described as that of a “consultant” on the Schedule C, both he and his accountant dissembled. In the circumstances, we conclude that the business was described this way in a misguided attempt to head off the closer scrutiny of the return that would likely be triggered by a description of Mr. A’s business as “poker” or “gambling”–scrutiny that would likely unearth the inadequacies in the substantiation of Mr. A’s expenses.

The Court included gambling winnings that weren’t on W-2Gs. Yes, all income is taxable no matter if you receive a piece of paper or not. The Court noted, “On this record we find that Mr. A had poker tournament winnings of $48,686 for 2009. Given our conclusion that petitioners reported $20,045 of Mr. A’s gambling income on their return, it follows that they had unreported gains from wagering transactions of $28,641 for 2009.”

The IRS contended that the petitioner wasn’t a professional gambler. Given that the only source of income for the petitioner and his wife was his gambling, the petitioner won this argument. He also was able to deduct his losing poker tournament entries (save the “alternate” entries that the court got wrong).

The taxpayer ran into trouble with his business expenses. “Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed on a return.” Mr. A. was allowed to deduct those items that he had receipts for. There were almost certainly more expenses, but a line from Tom Clancy comes to mind: If you don’t write it down it never even happened. That’s definitely the case for business expenses: Keep receipts and good records!

The IRS also asserted an accuracy-related penalty for negligence or disregarding IRS rules and regulations.

“‘[N]egligence’ includes any failure to make a reasonable attempt to comply” with the internal revenue laws. Sec. 6662(c). It connotates “a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the
circumstances…This includes “any failure by the taxpayer to keep adequate books and records or to substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax Regs. Disregard of rules or regulations includes any careless, reckless, or intentional disregard of the Internal Revenue Code, the regulations, or certain Internal Revenue Service administrative guidance.”

Respondent contends that petitioners are liable for an accuracy-related penalty on the basis of negligence. We agree. They failed to maintain records of Mr. A’s gambling activities, including the related expenses. Lacking adequate records, they filed a return that reported an estimate of their net income as if it were gross receipts. As a consequence, they significantly understated both gross receipts and net income. They also participated in a misrepresentation of Mr. A’s business as being that of a consultant rather than a professional poker player. The failure to keep records is prima facie evidence of negligence, and the misrepresentation of the nature of Mr. A’s business falls short of a reasonable effort to comply with the internal revenue laws…

Petitioners have not shown reasonable cause and good faith with regard to any portion of the underpayment. While they were advised in the preparation of their return by an accountant, the return as prepared stated a gross receipts figure that Mr. A certainly knew to be inaccurate and further identified the nature of his business in a way that both petitioners knew to be inaccurate. Petitioners have not shown that they acted with reasonable cause and in good faith with respect to any portion of the underpayment. They are liable for the negligence penalty under section 6662(a).

Some helpful hints if you want to fade into the crowd: Accurately report your gross receipts. The IRS matches things reasonably well, and if they have records that show you have $50,000 of income and your report $20,000, there’s going to be a notice sent to you. If you’re a consultant, would you note your occupation as “professional gambler?” I assume not. The converse is also true; if you’re a professional gambler, you’re not a consultant.

Second, you sign your return, and you’re expected to review it. If you’re gross income is $50,000 and you report $20,000, that you used a tax professional will not absolve you from the accuracy-related penalty.

Finally, keep good records! Every time I get a new client I emphasize with them the importance of keeping good records. An audit is an inconvenience if you have records that substantiate what’s on your tax return. If you don’t, it will be a very painful, very expensive inconvenience.

Case: Alabsi v. Commissioner, T.C. Summary Opinion 2017-5

No Gambling Log, No Problem, Right?

Tuesday, November 8th, 2016

Two married poker players worked as house players (commonly called “proposition players” or “props”) in California. They were paid wages for their work, but they had gambling winnings that they didn’t include on their tax return. They state they lost money (more than their winnings) each month with their poker playing so the winnings needn’t be included on their returns. The IRS disagreed. The dispute made its way to Tax Court.

The petitioners worked at the Hustler Casino in Gardena, California (south of downtown Los Angeles), one of the card rooms (poker clubs) in the Los Angeles metropolitan region. They were hired by the Hustler to start poker games, and fill those games until other customers came. Such house players are common, and are used at off hours or to start games.

One of the petitioners happened to be at the right place at the right time and shared in a “Bad Beat” jackpot worth $16,800 (noted on a W-2G). Because their losses exceeded their wins, the petitioners simply ignored the W-2G. Although not specified in the Tax Court’s opinion, petitioners likely received an Automated Underreporting Unit Notice (probably a CP2000) noting the missing income. Eventually a Notice of Deficiency was issued, and the case made it to Tax Court.

Petitioners didn’t note what they won or lost. From the Opinion:

Petitioners assert that initially they tried to keep track of their poker winnings and losses by writing down the amount won or lost at the end of each day, but after a while they gave up that practice because it is “bad for your psyche * * * you need to be strong mentally” when playing cards.

The Opinion goes into how gambling losses for a proposition player should be noted (whether it’s an unreimbursed employee expense or a gambling loss), but the Court first had to determine the losses.

Regardless of whether petitioners were employees or independent contractors, they were engaged in a gambling activity and are required to substantiate their reported gambling losses. Accordingly we first look to the issue of whether petitioners substantiated their reported gambling losses.

Deductions and credits are a matter of legislative grace, and taxpayers must prove entitlement to the deductions and credits claimed. Taxpayers are required to identify each deduction, show that they have met all requirements, and keep books or records to substantiate items underlying all claimed deductions. To establish entitlement to a deduction for gambling losses the taxpayer must prove the losses sustained during the taxable year. The Commissioner has suggested that gamblers regularly maintain a diary, supplemented by verifiable documentation, of gambling winnings and losses. A taxpayer’s “contention that it was too difficult for him to maintain contemporaneous records of his gambling activities is without merit.”[citations omitted]

The “bad for your psyche” defense isn’t a good one at Tax Court. The petitioners didn’t provide any evidence of their losses. They could have used a phone app to note their gambling results or pen and paper. They provided no confirmation to the Court, so the Court was left with little choice but to affirm the Notice of Deficiency.

A helpful hint for props: Keep a gambling log! It’s not hard (there are even phone apps you can use). Yes, your psyche may be damaged by a bad day at the poker table but you won’t suffer a second loss in Tax Court if you keep that log.

Case: Pham v. Commissioner, T.C. Summary 216-73