Taxable Talk

Sometimes when you deal with the government you get the runaround. Agency "A" will tell you need to talk with Agency "B" while Agency "B" says only Agency "A" can handle the problem. It's enough to give you gray hair.

One enterprising (albeit Bozo) attorney had an interesting idea of how to apply this in reverse. He had just filed his mother's estate into probate in King County (Seattle), Washington. He decided to file a Tax Court case on the estate, and tell the Probate Court there was a problem resolving the Tax Court case while telling the Tax Court there was a problem resolving the Probate Court case.

He did this quite successfully for twelve years. Unfortunately, he wasn't so successful in the thirteenth year. The Tax Court caught on to his scheme and has sanctioned the attorney:

Mr. Allison’s education and legal experience, not to mention his admission to the Tax Court bar, underscore the egregiousness of his conduct. The issues in both cases before us are fairly simple and should have been resolved long ago. Instead, the cases before us have dragged on for over eight years, and the probate case has lingered for more than a decade. We therefore find that he used procedures of our Court primarily for delay, and in doing so was repeatedly dishonest. Mr. Allison’s persistence in the face of warnings from both courts thus warrants a penalty under section 6673(a)(2). That section requires a determination of the costs imposed on the Commissioner, and we will order the Commissioner to file evidence of what those costs were.

Because Mr. Allison is an attorney currently admitted to practice before the Tax Court, other sanctions may be appropriate. We will also send this opinion (and the order to show cause dated March 7, 2008) to the King County Superior Court for their consideration in In re Estate of Allison, No. 95-4-03740-0.

I guess the old saying, fool me once, shame on you, fool me twice, shame on me, needs to be lengthened.

Other Coverage: Roth Tax Updates, TaxProf Blog

Today the Tax Court looked at the case of a police officer who used an unnamed Bozo tax preparer. The officer didn't have receipts, records, or other documentation to back-up his itemized deductions, yet the tax preparer put down lots of itemized deductions: "[P]etitioner claimed deductions totaling $26,829 comprising $13,737 in unreimbursed job-related expenses, $6,545 of charitable contributions, $3,023 of medical and dental expenses, and $3,494 of State and local income taxes."

The Court did allow some of the deductions: deductions for dry cleaning of the uniform at $20/week, ammunition of $65, and state and local taxes of $3,494.

The Court did not allow deductions for black Nike boots (these could be worn while off work), private target practice (not proven to be "necessary and ordinary"), commuting (commuting is never deductible), parking (no receipts/back-up records), charitable contributions (no documentation), and medical expenses (he admitted he had no medical expenses). Given that the standard deduction of $4,750 was greater than the itemized deductions (they total $4,559), the IRS was the winner.

But that wasn't all. The IRS asked for an accuracy-related penalty of 20%. The Court noted:

Petitioner contends that he is not liable for the penalty because he relied on erroneous expert advice given by his tax preparer. However, petitioner did not take reasonable steps to report the correct tax liability. Petitioner did not provide the preparer with any documents or receipts to substantiate any of his claimed deductions, nor did he scrutinize any of the figures that the preparer reported on the return. Further, petitioner failed to question any of the inflated figures. Thus, petitioner did not exercise the due care of a reasonable and ordinarily prudent person. The understatement is due to negligence within the meaning of section 6662(c), and petitioner is liable for the accuracy-related penalty under section 6662(a).

Whether you're a policeman or an insurance agent, there's one rule to live by when figuring your itemized deductions: document, document, and document. This cop didn't, and he paid the price.

Case: Snead v. Commissioner, T.C. Summary 2008-57

We constantly hear "if you don't succeed at first, try, try again." Of course, if you're a Bozo taxpayer, that should be changed to, "If you fail once, and you fail again, you're probably going to fail a third time."

Take the case of John Green. Mr. Green is in Tax Court for the third time. Back in 1993, he attempted (without success) to escape paying taxes on money he embezzled because he's a Native American. As I've written before, illegal income is just as taxable as legal income. And Native Americans must pay taxes, too. Next, he fought a deficiency on his 2001 tax return claiming it wasn't based on his 2001 return. Well, he never filed a 2001 tax return; the deficiency and the penalties were sustained. Today he reappears: "In this case, he challenges with hydraheaded interpretations of settled law the deficiencies which the Commissioner determined for his 1997, 1999, and 2000 tax years."

I'll start with Mr. Green's arguments:

"Green now admits that his status as a tribal Potawatomi doesn’t relieve him of the obligation to pay income taxes. He does, however, argue that his “treaty-based return position disclosures” (we’ll call them the “disclosure” documents) were tax returns and so triggered the running of the statute of limitations. If that doesn’t work, he argues that the Commissioner is collaterally estopped from raising the issue of whether his disability-retirement pay is taxable. If that fails, he claims that his disability-retirement pay is nontaxable income under sections 104 and 105. If it isn’t, then he claims that the Commissioner should have included the lump-sum payments in his 1998 deficiency, not his 1997 deficiency. And, finally, he argues against the imposition of any penalties for any of the years at issue."

The first issue is whether or not Mr. Green filed returns. The IRS contended that he didn't file anything; however, Mr. Green had certified mail receipts. "Of course, this establishes only that Green filed his “disclosure” documents with the IRS Service Centers, and not that the documents were sufficient as tax returns to begin the running of the statute of limitations."

However, the Court finds that Mr. Green's documents weren't returns, that they weren't signed under the full penalty of perjury (Mr. Green modified the language), and he didn't provide enough data for the IRS to calculate his tax liability. There's a fourth test, but the Court notes, "We are leery of finding ourselves in this titanomachy. And we can scurry away from the dispute till another day. Green submitted self-made documents that did not objectively permit the assessment of his tax liability...Enough--Green wasn’t being honest or reasonable" The Court found that there is no statute of limitations because the returns weren't filed.

Next, Mr. Green uses a collateral estoppel argument. "We’re not biting--the test remains whether the issue was actually litigated and necessary to the judgment. And whether tagged “abandonment” or “concession”, the Commissioner’s decision for the 1993 tax year doesn’t estop him from contesting the exclusion of Green’s disability-retirement pay from his taxable income in this case."

Next, Mr. Green argues that his disability pay is exempt from tax. He argues that sections 104 or 105 exempt his disability pay. You'll have to read the case to see that each of his arguments is demolished by the Court—his disability income is taxable.

Finally, Mr. Green argues that the doctrine of "Constructive Receipt" means that the income is not taxable to him in the years in dispute. Mr. Green was to receive $1 of $93,905 of disability pay; the other $93,904 was sent to pay child support and back taxes. The question the Court had to decide was when does constructive receipt occur?

"That occurred no later than December 16, 1997 in the OPM records--by that time, Green had filed the required paperwork and OPM recognized him as entitled to the money and reinstated him as eligible for future payments. It was Green himself who sent the court-ordered garnishment instructions to OPM, informing the agency that it should withhold part of his retroactive disability-retirement pay to satisfy his child support obligations."

There is one last issue for the Court to decide:

"We therefore hold in this case that the Commissioner is right to allocate $93,304 to Green’s 1997 income. That leaves a bit of a puzzle as to the remaining $1...That suggests there might be another $1 check left over from the lumpsum payment. If such a check had also been sent to Green in January 1998, its taxability would be governed by the general rule that a check is treated as income when received. Kahler v. Commissioner, 18 T.C. 31, 34-35 (1952). But because we have no clear evidence as to when he received that possible $1 payment, we find that Green fails to meet his burden of proof that the $1 should be taxed in 1998, so he is taxable on $93,305 and not just $93,304, in 1997."

So the third time definitely wasn't the charm for Mr. Green. The Court ruled that he owes the taxes and penalties assessed.

Case: Green v. Commissioner, T.C. Memo 2008-130

Most individuals put their lease agreements in writing. But not everyone does that. An individual in Maryland leases a bar to a friend with a verbal agreement. He doesn't tell his accountant about the lease; the accountant believes (wrongly) that the individual is operating the bar. And the individual's name is on the legal documents as the owner of the bar because his friend had a felony conviction years ago and doesn't believe he'll qualify for a Maryland liquor license. The IRS audits the individual. The accountant realizes that there's an error, and attempts to correct it...but the IRS refuses to accept the corrections. The mess ends up in the Tax Court.

It's an excellent case to read. “Taxation * * * is eternally lively; it concerns nine-tenths of us more directly than either smallpox or golf, and has just as much drama in it; moreover, it has been mellowed andmade gay by as many gaudy, preposterous theories.” [The quote, from the decision, is actually from H.L. Mencken, “The Dismal Science,” Smart Set, June 1922, at 42.]

Verbal leases are binding. The evidence in the case shows that there truly was a lease between the landlord and the tenant. Their agreement was based on a "swinging door concept"—everything inside was the responsibility of the tenant and everything outside was the responsibility of the landlord and the evidence backed them up.

As to who owned the bar, "Even more telling, however, is that Monk’s [the landlord's] financial interest--which consisted primarily of his monthly rent payment--wasn’t tied to the profits or losses of Chuck’s Place." The IRS' view that the landlord ran the bar ran into some literal evidence, "Maney [the tenant] also testified that he (and not Monk) has the bar’s logo tattooed on his chest. Though the Court did not undertake a visual inspection, we found him credible on this point."

The Tax Court noted the reality: "In situations like this, where there is written documentation which contradicts the reality of a situation, we disregard the documents to properly tax the person actually earning the income." So today the petitioner really was the winner. He was just a landlord of a business, not the owner.

Case: Monk v. Commissioner, T.C. Memo 2008-64

Today the Tax Court looked at a case that showed what happens when you use a tax preparer who (a) doesn't understand the software, (b) has little knowledge about your primary sources of income, and (c) has little tax knowledge. As you might expect the petitioners didn't fare well.

Our petitioners had their return audited for 2002, and a deficiency resulted from disallowing "(1) $12,000 deducted as an other miscellaneous deduction for “home winterization” on Schedule A, Itemized Deductions, and (2) the following expenses claimed on Schedule E, Supplemental Income and Loss, for rental Property B (identified as an “apartment building” located at 8314 South Green Street):

• Advertising $350
  
• Auto and travel 4,500
  
• Cleaning and maintenance 3,000
  
• Repairs 12,000
  
• Supplies 900
  
• Utilities 3,000"

When the parties met for the pre-trial conference the petitioners' accountant, when informed that it was required by the Tax Court that everything not in dispute be stipulated, made a remark that set the tone for the case: "Rules are made to be broken." I'm sure the Court appreciated that.

Things didn't get much better. "During the above meeting, [petitioner's accountant] redefined the properties listed on petitioners’ Schedule E...." Why wasn't this done before the audit? But I digress. These changes, which included one rental property included on the original return which shouldn't have, and another property that wasn't included suddenly appeared, resulted in additional deficiencies and an accuracy-related penalty:

"(1) Unreported rental income; (2) disallowance of five dependency exemption deductions; (3) unreported income from a State income tax refund; (4) disallowance, in total, of itemized Schedule A deductions for (a) medical and dental expenses, (b) real estate taxes, (c) personal property taxes, (d) home mortgage interest, (e) gifts to charity, and (f) unreimbursed employee business expenses; (5) disallowance in total of all Schedule E deductions; and (6) disallowance of rental and real estate loss because of passive activity loss limitations."

As for the actual case, just a few lines from the decision note the most important point of all.

"Petitioners provided no receipts to substantiate any of the expenses claimed for either Property A or B. For example, [Petitioner] admits that they did not spend $350 to advertise either Property A or B for rent and that, in the case of Property A, no advertising of any kind was necessary since their daughter took possession of that property immediately after they moved to Property B. [Petitioner] acknowledged that $700 claimed for auto and travel expenses was arbitrarily arrived at. [Petitioner] testified that the $2,000 claimed for cleaning expenses for Property A was paid to clean out the basement of that property in anticipation of their move.

"Our examination of the record convinces us that petitioners failed to maintain any records whatsoever with respect to the items claimed on the Schedule E attached to their 2002 return. Moreover, [petitioner] and their tax preparer...admit that some of the figures claimed for deductions taken on their 2002 return, including all of their Schedule E deductions, were false and/or arbitrarily contrived."

I could go on and on, but I think you get the flavor.

There are some morals to this story. First, not all tax preparers are equal. Obviously the petitioner's tax preparer comes from the Bozo side of tax preparation. He was unlicensed, untrained, and, had little knowledge of the tax software he was using. That's a problem with software—it will put the numbers exactly where you tell it to. As the cliche goes, garbage in, garbage out.

Second, get a tax preparer who understands your major areas of tax concern. For example, I had a potential client approach me about doing his return. I sent him to another professional I know because his return had a large amount of oil, gas, and mineral rights income, and that's an area I don't know well. He's much better off going to someone who understands that well as it's a specialized area. Sure, I could learn it, but he'd have to pay me to relearn the wheel, so to speak (and I have enough areas that I specialize in already).

Third, choose your preparer wisely. You are ultimately responsible for what's on your tax return, not your accountant. As the Tax Court noted,

"We further conclude that petitioners have failed to show that their reliance on Mr. Ingram’s tax return preparation was reasonable. Mr. Ingram admitted that he was not an accountant, that he was unfamiliar with the computer software that he used to prepare petitioners’ return, that he had made many errors with respect to petitioners’ 2002 return, and that his rush to complete the return also resulted in errors. Petitioners’ reliance on Mr. Ingram as their tax return preparer was clearly unreasonable."

And finally, keep your receipts! Today's petitioners invented numbers out of thin air and got the results they deserved. If you have rental property, you're supposed to treat it as a business. You can purchase a filing cabinet for under $100.

Case: Burkley v. Commissioner, T.C. Summary 2008-20

Fresh off the Wesley Snipes case two actors are having their own tax troubles. Joe Kristan found this story about Joe Pesci. Mr. Pesci besides appearing in movies has his own production company with employees. The regulation involved states, "You must make deposits using EFTPS for all depository tax liabilities for the current year if you made more than $200,000 in aggregate deposits for all types of Federal depository taxes in the year two years before the current year or if you were required to make electronic deposits in the previous year."

Mr. Pesci's production company didn't use EFTPS, and the penalties were upheld.

Meanwhile, actor Nicolas Cage will be fighting the IRS in Tax Court. The TaxProf Blog quotes a story in Forbes:

The IRS says movie star Nicolas Cage used a company he owns to wrongly write off $3.3 million in personal expenses, including limos, meals, gifts, travel and his Gulfstream 1159A turbojet. ... The feds hit Cage both ways, denying Saturn a deduction for the disputed expenses while taxing Cage individually on the perks as salary and "constructive dividends."

Cage's business manager, Samuel J. Levin, says in an e-mail that the expenses were proper as "customary in the entertainment industry" and were partly based on the actor's "security needs."

Mr. Cage's Tax Court case will probably not be heard for many months, with a decision possible in 2009.

You have a small dispute with the IRS. The IRS alleges that you owe $554 and $1142 for the two years in question. You elect to file a Tax Court petition. When most people go to Tax Court, they work with the Court and the IRS (the respondent in a Tax Court action) so that their case can be heard and the judge can determine who is right.

However, today we look at what happens when a bozo petitioner brings a Tax Court action. Would he: (a) allege that respondent's counsel has, "engaged in serious misconduct"; (b) allege that the "presiding judge has failed and failed again to show any semblance of impartiality"; (c) refuse to accept service of court documents (sent by certified mail); (d) send the IRS an ultimatum demanding settlement on his terms and not appear in any of the pre-trial hearings/motions; or (e) all of the above.

You already know the answer—we're dealing with a bozo here. All of the above happened and is documented in this case.

The IRS moved for dismissal because of lack of prosecution (the petitioner never brought the facts out on his case), and as the Tax Court noted, dismissal was a "relatively simple matter."

The IRS also asked that the petitioner face a penalty under section 6673. The Tax Court noted that in a different case the Fifth Circuit Court of Appeals held,

"it is difficult to imagine a lesser sanction that would vindicate the integrity of the court proceedings and deter * * * [taxpayers] from similar misconduct. Wasteful and dilatory appeals unjustifiably consume the limited resources of the judicial system: “While judges, staff and support personnel have expended energy to dispose of this meritless appeal, justice has been delayed for truly deserving litigants.” Foret v. S. Farm Bureau Life Ins. Co., 918 F.2d 534, 539 (5th Cir. 1990). [Id.; fn. ref. omitted.]"

As the Court concluded, "Petitioner’s attempts to delay and his belligerence must be sanctioned to vindicate the integrity of this Court’s proceedings and to deter petitioner from similar misconduct in the future." He received $1000 sanctions for each of the two cases heard.

Cases: Mack v. Commissioner, T.C. (two cases), T.C. Memo 2008-29

There are losing streaks and then there are really long losing streaks. Larry Harvey has not had a good year battling IRS attorney Randall Preheim. Yesterday, as Joe Kristan noted, Mr. Harvey lost his 64th and 65th cases. Today, that streak reached 67.

Look, the Washington Generals did win six games. (Well, they lost 13,000 games during that same time span....) And the Cubs are celebrating the 100th anniversary of their last World Series triumph so there is hope, Mr. Harvey.

Today the Tax Court looked at the case of a "pathological gambler." This isn't a problem gambler. As the Court noted,

"A pathological gambling disorder is a type of impulse control disorder and mental illness, not an “addiction”. This disorder is accepted by the scientific community and is in a category with kleptomania (the impulse to steal stemming from emotional disturbance rather than economic need) and trichotillomania (pulling hair). Dr. Pike concluded that Mr. Gagliardi suffered “from the almost delusional belief that if he gambled long enough, he’d win everything back or break even.”"

The IRS claimed that this pathological gambler didn't have any back-up to claim his gambling losses from 1999-2001. The taxpayer disagreed. Which side did the Court believe?

The preferred method of keeping a record of gambling wins and losses is through a gambling log. The gambler in question, Mr. Gagliardi, didn't do that. He had won the lottery in the early 1990s and began, in the late 1990s, to use the proceeds to gamble on slot machines at local Indian casinos. He didn't keep a log; however, he did keep all of his W-2Gs (issued when he won a jackpot of $1200 or more) and his ATM receipts. Mr. Gagliardi testified during the trial Mr. Gagliardi opined that he “could wallpaper my
bathrooms with just the ATM receipts for millions of dollars.” His ex-girlfriend also testified to his gambling.

But this wasn't good enough for the IRS. They didn't believe Mr. Gagliardi, and believed that the only method to substantiate losses was through a gambling log. The Court noted that this isn't the case.

"At trial respondent’s counsel had great difficulty explaining exactly what a “gambling log” is and what petitioner should have recorded in a gambling log. Respondent’s counsel stated that it was not realistic for someone to keep track of every bet and that the revenue procedure does not require taxpayers to keep track of every bet (i.e., the revenue procedure does not require a taxpayer to list how much he/she bet for each slot machine “pull”). Respondent’s counsel contended that to keep a log for slot machine play, per the revenue procedure, a taxpayer must know how much was wagered and how much was lost and record it contemporaneously. But see id.

"We also note that the revenue procedure provides that “Verifiable documentation for gambling transactions includes but is not limited to” Forms W-2G, wagering tickets, canceled checks, credit records, and bank withdrawals--all of which are present here. Id. sec. 3, 1977-2 C.B. at 538. Additionally, the revenue procedure provides a method, keeping a gambling log, that the IRS will consider as acceptable evidence for substantiation of wagering winnings and losses. Id. It does not contain the exclusive method for substantiating gambling losses. Id. sec. 1, 1977-2 C.B. at 538 (“The purpose of this revenue procedure is to provide guidelines to taxpayers concerning the treatment of wagering gains and losses for Federal income tax purposes and the related responsibility for maintaining adequate records in support of winnings and losses.”)."

Mr. Gagliardi also had two expert witnesses who testified on his behalf. Dr. Suzanne Pike (noted above) testified that Mr. Gagliardi was a pathological gambler, and as the Court noted, "Dr. Pike stated that a pathological gambler, such as Mr. Gagliardi, who walks away from a casino with money will, with an extremely high probability, go back to a casino the next day with the money." In fact, the outlook for Mr. Gagliardi is bleak if he continues gambling. The Court stated in a footnote,

"We note that Dr. Pike testified that, unlike recreational and problem gamblers, pathological gamblers take the “gambler’s fallacy” to a delusional level--they believe if they gamble long enough, they will win back all their losses and even more. Dr. Pike also opined that, unless treated for his illness, Mr. Gagliardi will gamble until he dies or loses all his money."

Also testifying for Mr. Gagliardi was Mark Nicely, a casino gaming expert who currently works at International Game Technology, a leading manufacturer of slot machines. Mr. Nicely testified that at the Class 2 machines that Mr. Gagliardi gambled, his chance of breaking even was worse than one in one trillion. At the casinos Mr. Gagliardi gambled the 'payback' on slot machines is probably worse than 90 percent (likely either 83% or 70%).

The IRS had no counter to the testimony which showed fairly conclusively that Mr. Gagliardi gambled and lost. His gambling losses were upheld.

There are two other important points to this case. First, Mr. Gagliardi had to go to Tax Court, hire two attorneys, have expert testimony, and then he won his case. Had he kept a gambling log it's likely he wouldn't have needed to go through the effort. And second, the IRS has a lot of problems dealing with gamblers. Most of the personnel within the IRS doesn't have experience with gambling, and even an IRS attorney had trouble explaining an IRS-suggested procedure on gambling (a gambling log).

Case: Gagliardi v. Commissioner, T.C. Memo 2008-10

I remember the Michael Myers movie, So I Married an Axe Murderer. Today the Tax Court looked at a related issue: What happens if you marry a tax cheat but don't know about it?

The basic facts weren't in dispute. The petitioner's ex-wife was a parking lot cashier at the Philadelphia Airport in the early 1990s. She participated in a scheme to steal money from the airport. She earned about $90,000 in illegal (stolen) income. As you might expect, when the theft was discovered her employment was terminated.

There's no dispute that illegal income is taxable. There's also no argument that when a joint return is filed, both spouses are responsible for paying the tax on the income. In this case, both the IRS and the petitioner agree that about $36,000 in tax is owed.

However, there is a protection for the true innocent spouse. Section 6015(c) of the Tax Code:

"...That section limits an individual’s liability for a deficiency to the portion of the deficiency properly allocable to that individual under section 6015(d). In general, an item that gives rise to a deficiency on a joint Federal income tax return will be allocated to the individuals who file the return in the same manner as that item would have been allocated had those individuals filed separate returns."

Given that when the returns were signed the petitioner knew nothing about the ex-wife's illegal income, all of the income would be attributable to the wife.

However, the IRS disputed whether the petitioner had actual knowledge of the illegal income. If that were the case, he would not be eligible for relief by filing a Section 6015(c) election.

Luckily for the petitioner, for this section of the Tax Code the burden of proof is with the IRS (per Section 6015(c)(2)). While petitioner's ex-spouse testified that the petitioner knew about the illegal income, that was apparently the only evidence that the IRS had. The petitioner also testified that he had no knowledge of the illegal income, and "...we find petitioner’s version of the events to be the more credible. Other evidence supports our finding in this regard. "

So if you marry a tax cheat, don't despair. The Tax Code does actually offer you some protection. On the other hand, if you marry an axe murderer....

Case: Eller v. Commissioner, T.C. Summary 2007-215

A partnership changes its address. What should it do to notify the IRS? Well, that's fairly simple: Like any taxpayer it should send in Form 8822. Today, the Tax Court looked at a case where the partnership didn't follow the normal procedure.

Partnerships are required to designate a "Tax Matters Partner" (TMP). When the IRS has questions/issues/needs to send a notice, it sends the same to the TMP. In this case, the IRS sent 14 final partnership administrative adjustment (FPAA) notices to three different addresses. As the Tax Court said, "By mailing FPAAs to multiple addressees at multiple addresses, respondent made a good faith effort to notify all affected parties of the partnership adjustments, thus satisfying the notice requirement of sec. 6223(a)." And one of the addresses was the last address of the Form 1065, thus making it a correct address to mail the FPAAs.

The partnership wanted to challenge the FPAAs. (Among other issues, the IRS believes the partnership is a sham.) From this case and two related cases the Tax Court ruled on, it's unclear whether or not the partnership received the FPAAs timely. It's quite clear that they didn't respond timely (the Tax Court case was brought two years after mailing of the FPAAs). Because the IRS mailed the FPAAs to a correct address, the Tax Court dismissed the partnership's petition.

Consider what would have happened to the case had the partnership correctly filed a change of address—there's a good chance their case would be heard at the Tax Court. (Whether or not they would prevail is unknown, as the issues involved were never argued.) Certified mail costs under $5.00. I guarantee that the IRS asked the partnership for more than $5.00.

Case: Stone Canyon Partners v. Commissioner, T.C. Memo 2007-377

That's the score in the epic battle between Larry Harvey and Randall Preheim. Mr. Harvey has represented 61 taxpayers who resided in Antarctica and wanted to take the Foreign Earned Income Exclusion. Mr. Preheim represented the IRS.

Antarctica is still not a continent, and it's 61 losses and counting for Mr. Harvey. Joe Kristan likens this to the battle between the Roadrunner and Wile Coyote. I liken it to the Washington Generals, who achieved an enviable record of 6 wins to 13,000 losses.

I hear the Generals are due for a win soon....

Cases: Role v. Commissioner, McDonald v. Commissioner, and Owens v. Commissioner

Wouldn't it be nice if you could conduct an audit of that conniving guy or gal that you have to deal with? You'd make his or her life a total pain.

Well, that's just no doable. Only the IRS (and various state tax agencies) conduct audits. Today, the Tax Court turned down Creed Pearson's request to audit The Organization:

Petitioner asks that we allow him to audit the Organization, which is not a party to this case, and that he be able to pay his taxes out of the proceeds of that audit. There is no provision in the Code that gives us the authority to allow one taxpayer to audit another taxpayer in order to reduce his tax deficiency. Therefore, we deny petitioner’s request."

Joe Kristan has lots more on this case.

One of the vexing matters for tax professionals are side businesses. If they're profitable, it's usually not an issue. It's another Schedule C for the return. However, when they are unprofitable problems can arise if the IRS scrutinizes the return.

The Tax Court looked at this again on Thursday when the decided the case of a Kansas couple who had an exotic animal breeding business. The husband is a successful physician, with a medical practice that brought in $750,000 or more annually. Starting in 1989, the began to breed exotic birds. They then expanded into all sorts of exotic animals, including (but not limited to) "Watusi cattle, miniature donkeys, miniature horses, elk, reindeer, zebras, African antelope, kangaroos, Clydesdale horses, and primates."

The Kansas couple did some things right: They did keep a separate set of books and a separate bank account. But they didn't bother with sales receipts to customers. They did treat the employees of their business as employees. They withheld taxes, offered health insurance, etc.

However, they never turned a profit. And when the IRS audited the couple's tax return for 2001 and 2002, the IRS ruled that the couple could not deduct the losses at the business. The case was then appealed to the Tax Court.

The Court looked at their records, and found them deficient.

"Although we are satisfied that petitioners kept financial records of their breeding activity, we are not convinced that petitioners’ record keeping represented anything other than an effort to substantiate expenses claimed on their return...Petitioners presented no evidence that their books and records were used to review profitability or to implement cost-saving measures. While a taxpayer need not maintain a sophisticated cost accounting system, the taxpayer should keep records that enable the taxpayer to make informed business decisions...Although petitioners kept extensive financial records, they were not used to review and reduce expenses or to enhance the possibility of generating income...Petitioners did not introduce any evidence that they used their financial and breeding records to determine whether a specific breed was profitable...Because petitioners failed to use the existing books and records to minimize their expenses or otherwise foster profitability, the fact that they maintained records does not indicate that the activity was carried on with a profit motive."

And that basically was the case. Yes, the couple kept records. But the records appeared incomplete, and were apparently not utilized completely. The couple couldn't show that they expanded breeding of profitable exotic animals because they couldn't show which animals were profitable. Add to that 16 years of large losses, and the case flew the coop.

Case: Knudsen v. Commissioner, T.C. Memo 2007-340

If you ever go and see the Harlem Globetrotters, you'll be treated to a great show. And, of course, there's a basketball game, where the Globetrotters beat the Washington Generals (or today, the New York Nationals).

Meanwhile, attorney Larry D. Harvey has represented quite a few taxpayers—48 by my count—alleging that Antarctica is a separate country and that the taxpayers can exclude income earned their (using the foreign earned income exclusion). Unfortunately, he's 0 for 48. Today the Tax Court handed down the 48th defeat.

Joe Kristan compares Mr. Harvey to Wile E. Coyote and the government attorney, Randall Preheim, to the Roadrunner. No matter, use your own comparisons (for me, the Generals or the old Washington Senators come to mind). Well, there's always hope that the 49th time will be the charm....

Case: Grant v. Commissioner, T.C. Memo 2007-318

If you receive an IRS Determination Letter, and decide to file a petition in Tax Court, make sure you file by the deadline. The Tax Court won't accept your petition if you file late, as another taxpayer discovered today.

Our unlucky taxpayer moved twice between the time the IRS mailed the Notice of Deficiency and the time he received it. Normally, you have 90 days to respond; however, the taxpayer in question had only 75 days (until November 13, 2006). He sent his petition (using FedEx) on November 14th.

The IRS asked the Tax Court to dismiss the taxpayer's suit because it was filed late. The taxpayer argued that he should either get extra time because of the moves or that the IRS notice was inaccurate because of the wrong address.

I've written before that the Tax Court is a stickler for deadlines. This case was no different. The statute says that the taxpayer has 90 days from date of mailing (the taxpayer actually had 91, as the 90th day from the date of mailing was a Sunday), and the Court must obey the plain language of the statute. Additionally, the IRS correctly sent the notice to the (then) right address.

Once again, deadlines count. The taxpayer's case has been dismissed, and he must pay the deficiency. He can file a claim and pursue a case in US District Court or the US Court of Claims, but that's only after he pays the tax.

Later this week I need to bring my car in for service. The auto repair shop I use is on the up-and-up. However, not all of them are. Today, the Tax Court looked at a Colorado muffler shop which apparently decided to use the Cook/Schulz method of tax preparation. The results weren't pretty.

Colorado Mufflers Unlimited, Inc. is exactly what you'd think: a muffler shop in Colorado. Back in 2000, they decided to start paying their employees in cash. That's not necessarily a problem. But they didn't withhold anything from their employees' wages, didn't issue W-2s, didn't file Form 941 (or Form 940), and claimed that their employees weren't employees. The IRS disagreed, and audited the business, found that they were employees, and that the company owed about $100,000 in back employment taxes. The company took the case to Tax Court.

Adding to the company's problems was the fact that they requested a refund of employment taxes for early 2000 (they stopped paying them in the middle of the year) and they received an $88,000 refund in early 2001. The IRS filed a court case to get back the refund (there's nothing in the case that notes how that case went).

The company also lacked good timing; they filed court papers late, and their filings were not allowed. That was their first strike.

Second, the testimony showed that the "employees" were paid by the hour, week, or month—not by the job. In other words, they looked like employees.

Not only that but:

"Petitioner’s behavior during the audit and the pretrial preparation of this case was characterized by a consistent lack of cooperation and by considerable obfuscation designed to prevent respondent from ascertaining the facts regarding petitioner’s business, business payroll, and workers. It appears that petitioner used fictitious names and/or other companies to hide the nature and extent of its business activity from respondent during the years at issue."

That was strike two.

Then the Court looked to see whether an employer/employee relationship existed by evaluating seven factors. The Court found that all of the factors favored an employment relationship. Needless to say, the Court concluded, "After reviewing the record and weighing the factors, we conclude that petitioner has failed to prove that respondent’s determination treating the workers as petitioner’s employees was in error." That was strike three, and the case went to the IRS.

And the Court was not amused with the company's obfuscation and use of "frivolous or groundless" tactics. Even though the IRS did not ask for a penalty under §6673(a)(1), the Court imposed one of $3,000.

Case: Colorado Mufflers Unlimited, Inc. v. Commissioner, T.C. Memo 2007-222

Last week I wrote a post about a Tax Court ruling that said that for purposes of §911 of the Internal Revenue Code (the Foreign Earned Income Exclusion) that Antarctica is not a foreign country. Well, one reader wrote me back, noting:

Two separate courts (US Supreme and US District in MA) have ruled that in the case of other statutes (FTCA and FLSA), Antarctica IS a foreign country. The rulings in questions by the Tax Court, supported by the 7th Circuit of Appeals, only mean that for the purposes of the interpretation of this particular section of the Tax Code, Antarctica does not fall within the IRS's regulatory definition of the term "foreign country."

Quite true. Antarctica is definitely not part of the United States. I will point out, for the record, that I do not see a "Republic of Antarctica" among the world's countries.

The reader then goes on to note that he thinks the Kunzes may appeal the Tax Court decision to the 10th Circuit. I have no idea if they will, but I am very doubtful of them winning this battle. Section 911 of the Code is quite specific, and I think that the Courts got this issue correct. Now whether the law should be written this way is another question. Unfortunately for our reader and the Kunzes, there just aren't a lot of Americans in Antarctica, so I don't expect Congress to change the law any time soon.

Finally, it's nice to know that we have a reader on Antarctica. For those of you wondering, it's cold at the Amundsen-Scott South Pole Station. Here are the current conditions (courtesy of NOAA):

Wind from the NNE (020 degrees) at 17 MPH (15 KT)
Visibility 1 mile(s)
Sky conditions mostly cloudy
Weather: Ice crystals, Blowing snow
Temperature -79 F (-62 C)
Windchill -122 F (-86 C)
Pressure (altimeter) 28.31 in. Hg (958 hPa)

To contrast, here are the current conditions in Irvine:

Wind from the ENE (070 degrees) at 3 MPH (3 KT)
Visibility 9 mile(s)
Sky conditions overcast
Temperature 64.9 F (18.3 C)
Windchill None
Relative Humidity 75%
Pressure (altimeter) 29.96 in. Hg (1014 hPa)

So we're 144° F warmer than at the South Pole...

There are lots of foreign countries in the world, but Antarctica is not one of them. It is a continent. The question arose last year on whether you can take the Foreign Earned Income Exclusion (§911 of the Tax Code) if you happen to be working in Antarctica; today, the issue reappeared at the Tax Court.

The Foreign Earned Income Exclusion allows a taxpayer who is working abroad to exclude a portion of their earned income. But there are caveats--the income excluded must be earned, and it must be earned in a foreign country (there are other restrictions, too). Last year, in Arnett v. Commissioner (126 T.C. No. 5), the Tax Court ruled that §911 doesn't apply. Earlier this year, the 7th Circuit Court of Appeals upheld that decision. Unsurprisingly, the Tax Court tersely noted, "We follow our analysis and holding in Arnett I and the analysis and holding of the Court of Appeals in Arnett II."

Deductions and exclusions are narrowly constructed; that's a basic rule of the US Tax Code. Unfortunately, for today's petitioner, Antarctica doesn't fall within the scope of Section 911.

Case: Kunze v. Commissioner, T.C. Memo 2007-179

We're taught that if at first you don't succeed, try, try again. But sometimes it just doesn't work.

Take the example of Warren Follum. Mr. Follum had asked the Tax Court to review the IRS' decision to proceed with collecting tax from him for 1990 through 1993.

In those years the petitioner (Mr. Follum) included losses from sports-fishing. The IRS alleged that the petitioner wasn't in a business but, rather, had non-deductible hobby losses of between $12,000 and $35,000 each year.

Let's add some complicating factors. When the IRS originally sent Mr. Follum notices of deficiency to his (then) post office box, the mail was returned as undeliverable. Back in 1996, the Tax Court ruled that because Mr. Follum didn't timely respond to the notice of deficiency (and the IRS did sent the notice to the petitioner's last known address), the court didn't have jurisdiction in the case. The Second Circuit Court of Appeals upheld the Tax Court's decision.

So in 2003 the petitioner filed yet another Tax Court case. The case was remanded back to the IRS appeals office in 2005 for consideration of potentially more liability. Then Mr. Follum brought suit against the IRS in the Western District of New York, asking that their be an injunction against the collection of his taxes. He lost, as that court held that it lacked jurisdiction (it had jurisdiction for a refund claim, but not an allegation of procedural irregularities).

Petitioner then brought a suit in the Eastern District of North Carolina, claiming that the IRS had not sent the notice and demand to his last known address. He lost that suit, as it was dismissed under the doctrine of "res judicata" (when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound “not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose.”).

Eventually, the second Tax Court case made its way back to the Tax Court, and today the decision was rendered. The Court had to decide (1) whether petitioner's claim that the notice and demand were not sent to his last known address is barred by "res judicata"; (2) whether the period of limitations on assessment of the 1990 and 1991 taxes has expired; (3) whether the petitioner engaged in sports fishing for profit; and (4) whether the lien should remain in place.

First, because Mr. Follum had never been able to contest the underlying tax liability, the Court ruled it would look at the tax liability. The Court then upheld the underlying tax (a legal expert would note that "res judicata" appeared to apply; in any event, the Court found petitioner's underlying arguments about owing the tax at issue to be wrong).

The Court then reviewed whether Mr. Follum was sports-fishing in tournaments for fun or profit. Mr. Follum didn't keep separate books; he didn't earn a profit in any year. It didn't look like he had a plan to earn a profit in future years. It gave the appearance of a hobby, and that's how the Court ruled.

Finally, the Court noted, "Having reviewed the underlying liability de novo, we find no error. Additionally, we find no error or abuse of discretion by respondent in determining to uphold the filing of the lien against petitioner."

So the fourth try wasn't any more satisfying than the first for Mr. Follum. The morale of this tale is that sometimes additional bites at the apple are just as unsatisfying as the first. Also, it pays to keep your address current with the IRS.

Case: Follum v. Commissioner, T.C. Memo 2007-164