Archive for the ‘Tax Court’ Category

Voluntary Human Egg Retrieval and Damages

Thursday, January 22nd, 2015

A very interesting full decision of the Tax Court was released today in Perez v. Commissioner. The issue was whether a woman who had eggs retrieved from her body after undergoing fertility treatments in exchange for compensation could exclude the compensation because of the pain and suffering she went through in the procedure.

Today’s decision was written by Judge Mark Holmes, so it’s very readable for the layman. The petitioner, Nichelle Perez, agreed to undergo treatments so eggs could be taken from her body; in return she received compensation of $10,000. She did this twice in 2009; the egg donation agency issued her a 1099-MISC for $20,000. She didn’t include it as income because under Section 104(a)(2) income from damages from personal injuries and pain and suffering can be excluded from taxation. This is noted in Regulation Sec 1.104-1(c)(1):

Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.

The Court had to decide whether excluding her compensation qualified as damages per this regulation. The regulation notes that damages are required; this causes the Court to look at a Chevron test. Unlike Loving v IRS where the first step of the Chevron test failed, here the Court looked at the second step. I’m going to extensively quote Judge Holmes’ opinion here as there’s no need for paraphrasing:

On this step, we find a regulation invalid only if it is “‘arbitrary or capricious in substance or manifestly contrary to the statute.’” Perez argues that the definition of “damages” in the regulation is invalid because it requires prosecution (or threat of prosecution) of a legal suit as a prerequisite for a payment’s exclusion from income…[citations and footnotes omitted]

Perez very clearly has a legally recognized interest against bodily invasion. But we must hold that when she forgoes that interest–and consents to such intimate invasion for payment–any amount she receives must be included in her taxable income. Had the Donor Source or the clinic exceeded the scope of Perez’s consent, Perez may have had a claim for damages. But the injury here, as painful as it was to Perez, was exactly within the scope of the medical procedures to which she contractually consented. Twice. Her physical pain was a byproduct of performing a service contract, and we find that the payments were made not to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered…

This small change just helped tax regulation keep up with a bit of a shift in American law toward administrative or statutory remedies and away from common-law tort for some kinds of personal injuries. It is not at all arbitrary, capricious, or manifestly contrary to the Code. But it also doesn’t help Perez. We completely believe Perez’s utterly sincere and credible testimony that the series of medical procedures that culminated in the retrieval of her eggs was painful and dangerous to her present and future health. But what matters is that she voluntarily signed a contract to be paid to endure them. This means that the money she received was not “damages”.

We conclude by noting that the result we reach today by taking a close look at the language and history of section 104 is also a reasonable one. We see no limit on the mischief that ruling in Perez’s favor might cause: A professional boxer could argue that some part of the payments he received for his latest fight is excludable because they are payments for his bruises, cuts, and nosebleeds. A hockey player could argue that a portion of his million-dollar salary is allocable to the chipped teeth he invariably suffers during his career. And the same would go for the brain injuries suffered by football players and the less-noticed bodily damage daily endured by working men and women on farms and ranches, in mines, or on fishing boats. We don’t doubt that some portion of the compensation paid all these people reflects the risk that they will feel pain and suffering, but it’s a risk of pain and suffering that they agree to before they begin their work. And that makes it taxable compensation and not excludable damages.

It would be nice if tax professionals could claim part of the fees were damages from the myriad of paper cuts we get each year. Or if I could claim damages for my chipped and fake teeth (yes, I played hockey). That said, Judge Holmes’ decision, as harsh as it may be for Ms. Perez, does seem absolutely right to me. Under the US Tax Code, any accession to income is taxable (unless Congress has exempted it). Ms. Perez willingly signed a contract prior to her procedures for compensation.

Lew Tashioff has more on this.
There’s also an interesting discussion on this case from last March at the Faculty Lounge.

Case: Perez v. Commissioner, 144 T.C. No. 4

The Second Time Wasn’t the Charm

Monday, January 12th, 2015

There’s a cliche I like, “If you don’t succeed, try, try again.” In the Bozo world things work a bit differently; for them it should be, “If you don’t succeed, stop!” Today, the Tax Court looked at Joseph Banister, an individual making his second appearance at the court. The petitioner had a B.S. in accounting, a CPA license from California, and worked for the IRS as a special agent in Criminal Investigations. He also wrote a book on taxes. He must know about tax law, right?

Well, his book titled “Investigating the Federal Income Tax: A Preliminary Report” is out of print. There’s likely a good reason for that:

In the book petitioner presented a variety of arguments that he and other citizens were not obligated to pay Federal income tax for reasons including that such payment was voluntary, that the Sixteenth Amendment was not legally ratified, and that Government financing operations are unconstitutional. Petitioner began providing tax consultation services, speaking at conventions throughout the country, operating Web sites, and selling books, CDs, and DVDs setting forth his views on income tax and the Internal Revenue Code.

The petitioner was disbarred from practicing before the IRS in December 2003, largely for advising taxpayers that they weren’t liable for income taxes because the 16th Amendment wasn’t legally ratified (and some other frivolous arguments). He appealed, both administratively and via the courts, and lost the appeals.

He also lost his California CPA license “…because of the conduct that led to his disbarment from practice before the IRS.” He appealed that and also lost those appeals.

Now, let’s move to today’s decision. From 2003-2006 the petitioner made money from consultations, speeches, books, and other activities; however, he never filed returns. The IRS examined the petitioner, but the petitioner didn’t cooperate. Eventually the IRS issued Substitute for Returns with income of between $87,000 and $177,000 for each of the four years.

At trial, the petitioner didn’t deny the income.

Instead, His arguments, his motions, his attempts to conduct discovery, and his cross-examination of respondent’s witnesses at trial have been directed to his claim that the statutory notice was invalid because it was not signed by an authorized person and that, as a result, this Court lacks jurisdiction over his case. In his pretrial memorandum he also asserted that his U.S. income was not subject to tax and that he had no obligation to file tax returns, repeating or restating the arguments that had led to his disqualification to practice before the IRS and his loss of his certified public accountant’s license…

Petitioner has a history of pursuing frivolous arguments and rejecting the conclusions of every agency or court that has considered them. His argument that domestic income is not subject to Federal income tax has been restated by him in various filings, but the same conclusion has been rejected as frivolous in his administrative proceedings and in the Court of Appeals’ opinion sustaining his disbarment by the OPR. No further discussion of petitioner’s stale theories is warranted.

Petitioner was not only accused of failing to file, he was assessed the fraudulent failure to file penalty. That penalty is a whopping 75% of the tax that is due.

The additions to tax for fraud have frequently been imposed on taxpayers like petitioner “who were knowledgeable about their taxpaying responsibilities * * * [and] consciously decided to unilaterally opt out of our system of taxation…Because petitioner refused to testify, he has shown no plausible nonfraudulent explanation for his behavior.”

Ouch. But that was not all:

Petitioner was warned of the possibility of a penalty under section 6673 if he persisted in his frivolous contentions. He has presented neither evidence nor arguments showing a reasonable dispute as to the income, tax, penalties, or additions to tax determined in the statutory notice. Under these circumstances, section 6673(a)(1) provides for a penalty not in excess of $25,000 when proceedings have been instituted or maintained by the taxpayer primarily for delay or where the taxpayer’s position is frivolous or groundless. Petitioner has been undeterred despite loss of his privilege to practice before the IRS, loss of his license as a certified public accountant, and other losses in litigation. Adding a penalty to his substantial tax debt may not dissuade him. However, serious sanctions also serve to warn other taxpayers, particularly those that he purports to counsel, to avoid pursuing similar tactics.

Yes, he was assessed a $25,000 penalty for being frivolous.

I don’t know if the petitioner has any other cases floating around the IRS or the Tax Court. If he does, he might want to change his tune. I can guarantee that the third time won’t be the charm, either. He did earn one other item today: The first nomination for the 2015 Tax Offender of the Year.

Case: Banister v. Commissioner, T.C. Memo 2015-10

The Tax Court Looks for $1,410 in Dividends

Wednesday, January 7th, 2015

Today I generated my first 1099s for clients. The Tax Court looked at a case where the petitioners said they didn’t receive three $470 dividends. The issuer said they sent the checks and a Form 1099-DIV. Who was right?

In the case of information returns, the burden of proof can shift to the IRS.

If a taxpayer asserts a reasonable dispute with respect to any item of income reported on a third-party information return and the taxpayer has fully cooperated with the Secretary, the Secretary has the burden of producing reasonable and probative information concerning that deficiency in addition to such information return.

But the Court never looked at that as it based its decision on “the preponderance of the evidence.”

The only evidence that the IRS had was a letter from Computerserve (the registered agent for BNSF, the company that might or might not have issued the dividends) that said they were issued and that a 1099-DIV was sent to the petitioner.

Petitioner husband has made numerous unsuccessful attempts in recent years to contact Computershare and Wells Fargo regarding various matters relating to his BNSF stockholdings, including payment of the disputed dividends…

Petitioner husband testified that petitioners did not receive the disputed dividend payments in 2009 or a Form 1099-DIV reporting those payments and that he does not recall having negotiated any checks. His testimony included details regarding the acquisition of BNSF by Berkshire Hathaway and his persistent but unsuccessful attempts to make inquires with Computerserve and Wells Fargo about the disputed dividend payments. He called the phone number provided in the February 28, 2014, letter, but was unable to speak to anyone regarding that

Petitioner husband has devoted a substantial amount of time to contest the relatively small amount of tax liability at issue here, and he testified consistently, clearly, and with considerable conviction in explaining the negative–that he did not receive the disputed dividend payments. He has persuaded us that he did not receive the disputed dividend payments in 2009.

I suspect that the petitioner had documentation of his phone calls to Computerserve and Wells Fargo. If you do ever find yourself in such a situation, keep good records of your attempts to obtain information.

In any case, this case does show that when there’s an incorrect information return (a 1099) it is possible to dispute it and win. It would have been a lot easier for the petitioners if they could have reached someone at Computerserve or Wells Fargo and explain their situation but we have to treat life as it is, not as we want it to be.

Case: Ebert v. Commissioner, T.C. Memo 2015-5

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