Taxable Talk

Back in the 1996 tax year, Leonard Gittinger, an attorney, didn't pay his taxes. He argued that wages weren't income. If you've been reading this blog, you know that argument is a typical tax protester argument, and is baseless. The Tax Court rejected his argument then, and the 5th Circuit also rejected his first appeal, noting it was "completely and utterly frivolous."

Well, Mr. Gittinger also didn't file tax returns for 1997 through 2001, and he filed yet another Tax Court case. Unfortunately, both Tax Court cases aren't available online. However, he also lost his second case. We do know, from reading his appeal of that decision, that he had 19 typical tax protester arguments. As the Appeals Court noted, only one of his 19 items merited comment: "“Whether the allegations in the petition and . . . instant proceeding are ‘frivolous and groundless?’” The answer is yes."

The Appeals Court noted that Mr. Gittinger should have learned his lesson the first time. As a reminder of the frivolous nature of the appeal (and, frankly, of the whole case), he was also ordered to pay a $6,000 sanction. "A
party who continues to advance long-defunct arguments invites sanctions." Tello v. Comm’r, 410 F.3d 743, 744 (5th Cir. 2005)

Case: Gittinger v. Commissioner, 04-611118 (5th Circuit)

My thanks to Decision of the Day for their link to this case.

Today the Tax Court looked at a §1031 Exchange case. The question before the court was whether a partnership (Peabody) could exchange gold mines for coal mines. The problem: the coal mines were encumbered with supply contracts that sent the coal to electric utilities. Does the encumbrances constitute "boot" that causes tax to be due?

Under a §1031 Exchange, like property is exchanged for like property. The exchanger avoids capital gains tax. Like property need not be exactly the same property. You can exchange a rental house for a rental duplex, for example. (There significant restrictions to &1031 exchanges; make sure you talk to your own tax advisor about your situation.)

When cash gets involved in the transaction, it's considered "boot." Boot is taxable. The IRS argued that the contracts weren't real property, but were the equivalent of cash or personal property received along with like-kind property. (There's no question that you can, in a § 1031 exchange, exchange one mine for another mine, even if each mines different substances, assuming the other provisions of § 1031 are followed.)

The court had to determine, (1) are supply contracts considered real property and, thus, can be part of a § 1031 exchange (the IRS argued that they are contracts to sell personal property); (2) are the servitudes created by the supply contracts real property; and (3) are the supply contracts boot or not?

The court noted that like-kind doesn't mean exactly the same kind:

In determining whether the like-kind requirement of section 1031 had been met, we found it significant in Koch v. Commissioner, 71 T.C. at 65, that section 1031(a) refers to property of a like, not an identical, kind. The required comparison of the old and new exchanged properties, we reasoned, should be directed to whether the taxpayer, in making the exchange, has used its property to acquire a new kind of asset or has merely exchanged its property for an asset of like nature or character.

The court did note that not all real property exchanges are like-kind exchanges, though.

The idea behind a § 1031 exchange is that the taxpayer is exchanging one piece of property for another, and that his original investment has not been sold or liquidated. The court noted,

It is true Peabody is obligated to mine and supply coal to meet the operating needs of power stations and that Peabody is prohibited from impairing the contracted-for supply by selling coal to other buyers. In our view those contract obligations and restrictions constitute a distinction in the grade or quality of the old and new mining properties rather than a difference in their kind or class. The new coal mine property is of a like nature or character to the gold mining property Peabody exchanged. By exchanging the gold mining property for the coal mining property subject to the supply contracts, Peabody is essentially continuing the original investment which remains fully unliquidated.

The court concluded, "In the light of that holding and because the supply contracts cannot be separated from Peabody’s ownership of the Lee Ranch mine coal reserves, it follows that those contracts are not taxable as other property or boot under section 1031(b)."

So Peabody is allowed to turn gold into coal, tax-free.

Case: Peabody Natural Resources Company v. Commissioner, 126 T.C. No. 14

Today the Tax Court looked at an ambiguous section of the Tax Code. Suppose an S Corporation is owed a refund, with interest. What interest rate should be used? The general "corporate overpayment" rate, the "large corporation" overpayment rate, or the "non-corporate" rate?

All corporations start as C Corporations. Many corporations immediately become small business corporations, or S Corporations. Sometimes a corporation will convert to being an S Corporation during its life. Today's case involves such a corporation. Corporations that convert from C to S can owe a "Built-In Gains Tax."

Garwood Irrigation Company owed such a tax, and prepaid it. In fact, they overpaid the tax and were due a refund. Last year, the Tax Court decided the amount of the refund. The IRS computed the refund using §6621 (a)(1) of the Internal Revenue Code, and assumed that Garwood was a large corporation:

Section 6621(a)(1) provides:
SEC. 6621. DETERMINATION OF RATE OF INTEREST.
(a) General Rule.--
(1) Overpayment rate.--The overpayment rate established under this section shall be the sum of–-
(A) the Federal short-term rate determined under subsection (b), plus
(B) 3 percentage points (2 percentage points in the case of a corporation).
To the extent that an overpayment of tax by a corporation for any taxable period (as defined in subsection (c)(3), applied by substituting “overpayment” for “underpayment”) exceeds $10,000, subparagraph (B) shall be applied by substituting “0.5 percentage point” for “2 percentage points”.

As the Tax Court notes, the dispute is based on what a large corporate overpayment is. Subsection (c)(3) states,

(3) Large corporate underpayment.--For purposes of this subsection--
(A) In general.--The term “large corporate underpayment” means any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000.
(B) Taxable period.--For purposes of subparagraph (A), the term “taxable period” means–
(i) in the case of any tax imposed by subtitle A, the
taxable year, or
(ii) in the case of any other tax, the period to which the underpayment relates.

Confused? Well, the Internal Revenue Code can confuse anyone, including Tax Court judges. As the Court notes, "This creates a question as to why Congress did not more artfully express the incongruity in dollar thresholds, if petitioner’s argument is assumed to be correct."

Because the statutes are ambiguous, the Court looks at the legislative history to resolve the dispute. The Court discovers that the large overpayment statute was designed for C Corporation; the petitioner, Garwood Irrigation Corporation, is not one. So that rules out the 1/2% rate of interest. However, Garwood is a corporation, so the Court throws out the 3% that Garwood wanted. Garwood will have to settle for a measly 2% above the federal short-term rate. But that is 1 1/2% more than the IRS wanted to give.

Case: Garwood Irrigation Corp. v. Commissioner