The Tax Court in Brief October 25 – October 29, 2021
Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.
Tax Litigation: The Week of October 25 – October 29, 2021
- Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
- Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
- Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121
Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122
Short Summary: In 2009, Tribune Media Co. (“Tribune”) formed Chicago Baseball Holdings, LLC (CBH) with the Ricketts family. Tribune contributed the Chicago Cubs Major League Baseball team and related assets (“Chicago Cubs”) (with a fair market value of approximately $770 million minus liabilities of approximately $35 million) and the Ricketts family contributed $150 million of cash. CBH then distributed approximately $700 million of cash to Tribune. After the transaction, the Rickett family became majority owners of CBH with Tribune holding a minority share.
To finance the large cash distribution to Tribune, CBH was funded with $425 million of senior debt from unrelated parties and approximately $250 million of debt from RAC Finance, an entity closely related to the Rickett family (“RAC”). Tribune executed two guarantees on the closing date: a senior guaranty and a sub-debt guaranty.
Tribune timely filed a 2009 Form 1120S. On its Form 1120S, Tribune reported the Chicago Cubs transaction as a disguised sale. It reported a loss of approximately $190 million and a net long-term capital gain of approximately $33 million. It also reported a net built-in gain of approximately $33 million.
CBH also timely filed a Form 1065. On its Form 1065, it reported that its partners contributed $150 million of cash and approximately $730 million of property. It also reported that it made an approximately $700 million distribution.
The IRS examined Tribune’s and CBH’s 2009 tax returns. Later, the IRS issued a notice of deficiency to Tribune, which determined an increased tax liability of approximately $180 million attributable to built-in gains under section 1374. The notice also made adjustments to items reported by CBH to Tribune—that is, it reduced Tribune’s reported capital contributions from $715 million to $20 million. It also reduced Tribune’s reported allocable share of recourse liabilities from $673,750,000 to zero and increased Tribune’s share of nonrecourse liabilities from approximately $6 million to approximately $27 million.
The IRS further issued an FPAA to Northside Entertainment Holdings, LLC (formerly RAC). Through the FPAA, the IRS determined partnership items of CBH, namely, adjustments to income, capital contributions, and disguised sale proceeds. The FPAA also set forth the IRS’ determinations regarding the nature of CBH’s liabilities. Both parties, through their authorized representatives, timely filed petitions with the Tax Court and the cases were consolidated for purposes of trial and briefing.
- Whether the $250 million from RAC Finance was bona fide debt or equity?
- Whether the $425 million of debt borrowed by CBH was bona fide debt?
- Under the factors in Dixie Dairies Corp., the RAC finance funds were equity for tax purposes. Thus, because it is equity, it cannot be allocated to Tribune as recourse debt—e., the portion of the distribution funded by the RAC Finance funds does not qualify under the debt-financed distribution exception of the disguised sales rules.
- The $425 million of debt borrowed by CBH was bona fide debt and under Tribune’s guarantee, it may offset a portion of the distribution/disguised sale as non-taxable.
Key Points of Law:
- A disguised sale occurs when a partner transfers property into a partnership and that partner receives cash or property in return in such a way to render the transaction a sale. Section 707(a)(2)(B) provides that “if: (i) there is a direct or indirect transfer of money or other property by a partner to a partnership; (ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner); and (iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property, such transfers shall be treated . . . [as between the partner acting other than in his capacity as a member of such partnership and the partnership].”
- The result of section 707(a)(2)(B) is to revoke the nonrecognition treatment for transactions between a partner and a partnership and to treat the transaction as a taxable sale of property between unrelated parties.
- The regulations promulgated under section 707(a)(2)(B) attempt to clarify when a transfer between a partnership and its partner more closely reflects a sale rather than a contribution and distribution. The regulations state that whether a transaction is treated as a disguised sale depends on whether based on all of the facts and circumstances, the transfer of money or other consideration would not have been made but for the transfer of property and in cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations. Reg. § 1.707-3(b)(1).
- There are exceptions to the disguised sale rules, including the debt-financed distribution rule. This rule permits a partner to receive a debt-financed distribution of property from a partnership as part of a disguised sale tax free up to the amount of debt allocated to that partner. Reg. § 1.707-5(b)(1). To invoke the debt-financed distribution rule, the partner must “retain substantive liability for repayment” of the debt, meaning it must be allocated the partnership liability.
- Under the debt-financed distribution rule, a partner’s allocable share of a partnership liability is its share of the liability under normal rules for allocation of partnership liabilities, multiplied by the percentage of the liability used to fund the distribution. Reg. § 1.707-5(b)(2). The allocation of partnership liabilities among partners depends on whether the liability is a recourse liability or a nonrecourse liability. Treas. Reg. § 1.707-5(a)(2).
- A recourse liability is a liability for which “any partner or related person bears the economic risk of loss. Reg. § 1.752-1(a)(1). A nonrecourse liability is one for which “no partner or related person bears the economic risk of loss.” Treas. Reg. § 1.752-1(a)(2).
- In determining whether an advance is debt or equity, the Tax Court considers 13 factors outlined in Dixie Dairies Corp.: the names given to the certificates evidencing the indebtedness; presence or absence of a fixed maturity date; source of payments; right to enforce payments; participation in management as a result of the advances; status of the advances in relation to regular corporate creditors; intent of the parties; identity of interest between creditor and stockholder; “thinness” of capital structure in relation to debt; ability of corporation to obtain credit from outside sources; use to which advances were put; failure of debtor to repay; and risk involved in making advances. Dixie Dairies Corp. v. Comm’r, 74 T.C. 476 (1980).
- Section 752 and its regulations govern the allocation of partnership liabilities. Under section 752(a), when a partner’s share of a partnership liability increases, the amount of that increase is treated as a cash contribution or increased investment in the partnership by that partner. Conversely, under section 752(b), a decrease in a partner’s share of liabilities is treated as a distribution of cash. The partner receiving an increase or decrease of partnership liabilities also decreases their basis in their partnership interest, reflecting their changing investment in the partnership.
- Which partner is allocated a liability depends on whether the partners are general or limited partners and whether the liability is recourse or nonrecourse. In a general partnership, the general partner is allocated liabilities. The Tax Court has held that although not a general partner, a partner’s “guarantee of an otherwise nonrecourse debt places each guaranteeing partner in an economic position indistinguishable from that of a general partner with liability under a recourse note—except that the guaranteeing partner’s liability is limited to the amount guaranteed.” Abramson v. Comm’r, 86 T.C. 360, 374 (1986).
- A partner bears the risk of economic loss for a partnership liability if the partner would be obligated to make payment to the creditor if the partnership were constructively liquidated. Reg. § 1.752-2(a) and (b)(1). In a constructive liquidation, all of the following events are deemed to occur simultaneously: (1) all of the partnership’s liabilities become payable in full; (2) all of the partnership’s assets (except property contributed to secure a partnership liability), including cash, become worthless; (3) the partnership disposes of all of its property in a fully taxable transaction for no consideration; (4) all items of income, gain, loss, or deduction are allocated among the partners as of the date of the constructive liquidation; and (5) the partnership liquidates. Treas. Reg. § 1.752-2(b)(1). A partner’s obligation to make a payment on the debt is based on the facts and circumstances and includes any statutory or contractual obligations. Treas. Reg. § 1.752-2(b)(3).
- Reg. § 1.752-2(j)(1) provides that the obligation of a partner may be disregarded if “facts and circumstances indicate that a principal purpose of the arrangement between the parties is to eliminate the partner’s economic risk of loss with respect to that obligation or create the appearance of the partner or related person bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.”
- The doctrine of substance over form embodies the concept that the economics of a transaction, not just the formal paper steps, should determine its tax treatment. The doctrine arose in Gregory v. Helvering where the Supreme Court considered a transaction that complied with the text of the Code, but not its intended purpose. The Tax Court uses the doctrine of substance over form to “determine the true nature of a transaction and appropriately recat it for Federal income tax purposes.” However, the court uses these principles “only when warranted and generally respect the form of a transaction.” The doctrine of substance over form is applied to prevent taxpayers from mislabeling transactions to achieve a desired tax consequence. See Benenson v. Comm’r, 910 F.3d 690, 699 (2d Cir. 2018).
Insight: Tribune shows that the IRS will, in certain cases, attempt to attack taxpayer transactions with anti-abuse regulations and substance-over-form arguments. Taxpayers who enter into transactions should involve tax counsel early on to ensure that the desired tax effects of a given transaction are respected for federal income tax purposes.
Cashaw v. Comm’r, No. 9352-16L, T.C. Memo 2021-123
Short Summary: This case involves the application of trust fund recovery penalties (“TFRP”) pursuant to I.R.C. § 6672. The primary issue is whether such penalties were properly assessed against the Petitioner.
- Whether Petitioner, as temporary chief administrator of Riverside, was individually responsible for TFRPs as a result of Riverside’s failure to remit the full amounts of employment taxes and tax withholdings.
- Whether Petitioner was a “responsible person” under I.R.C. § 6672(a).
Facts and Primary Holdings:
- Petitioner worked for Riverside General Hospital (“Riverside”) in Houston, Texas
- In October, 2012, Petitioner was appointed as temporary chief administrator.
- In the role as temporary chief administrator, Petitioner oversaw the functionality of Riverside, including the hospital’s payroll function; attended board meetings; and had check-signing authority under which she reviewed hospital expenses and signed checks on behalf of Riverside.
- Riverside suffered several financial issues during the periods at issue. Among those were a drastic cut in Medicare and Medicaid reimbursements, along with a legal proceeding involving one of Riverside’s creditors.
- As a result of these financial issues, Riverside had to make choices at times about what debts it paid.
- Riverside failed to remit to the IRS the full amounts of employment taxes and tax withholdings on its Form 941, Employer’s Quarterly Federal Tax Return.
- Based on that failure, the IRS assessed TFRPs against Petitioner individually.
- On April 7, 2015, the IRS sent Letter 1153, Trust Fund Recover Penalty Letter, by certified mail to Petitioner’s last known address, proposing to assess the TFRPs against her. The letter was returned unclaimed, and the IRS proceeded to assess the TFRPs against Petitioner.
- After Petitioner failed to pay the assessed TFRP, the IRS issued Petitioner a Final Notice of Intent to Levy and Notice of Your Right to a Hearing, for the TFRPs. Shortly thereafter, respondent also sent petitioner Letter 3172, Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320.
- In response, Petitioner timely submitted her request for a Collection Due Process (“CDP”) hearing. Subsequently, the settlement officer rejected Petitioner’s position, and the IRS issued a notice of determination sustaining the proposed collection actions.
Key Points of Law:
- Taxpayers who challenge their underlying tax liability in cases arising under section 6320 or 6330 bear the burden of proof regarding their correct tax liability. See Tax Court Rule 142(a); Thompson v. Commissioner, 140 T.C. 173, 178 (2013).
- Before TFRPs can be assessed, the IRS must generally notify the taxpayer in writing by mail to the taxpayer’s last known address advising that TFRPs will be assessed. I.R.C. § 6672(b)(1); Mason v. Commissioner, 132 T.C. 301 , 322 (2009).
- The IRS issuance of the Letter 1153 on April 7, 2015, by certified mail to Petitioner at her last known address satisfied the notice requirement of § 6672 despite its return undelivered.
- Where a taxpayer’s underlying tax liability is properly at issue before the Tax Court, the Court’s review of the IRS’s determination regarding the underlying liability is de novo. Sego v. Commissioner, 114 T.C. 604 , 610 (2000). The Tax Court reviews any other administrative determination regarding proposed collection actions for abuse of discretion. Id.; Goza v. Commissioner, 114 T.C. 176 , 182 (2000).
- R.C. § 6672 provides a collection tool allowing the IRS to impose penalties on certain persons who fail to withhold and pay over trust fund taxes. See Newsome v. United States, 431 F.2d 742 , 745 (5th Cir. 1970). The penalty under that section is equal to the total amount of the tax not paid over and is imposed on (1) any responsible person who (2) willfully fails to collect, account for, and pay over the tax. Mazo v. United States, 591 F.2d 1151, 1154 (5th Cir. 1979).
- A responsible person is any person required to collect, account for, and pay over withheld taxes. Sec. 6672(a) ; Mazo, 591 F.2d at 1154 . Whether someone is a responsible person is “a matter of status, duty and authority, not knowledge.” Mazo, 591 F.2d at 1156.
- The Fifth Circuit, the court to which an appeal of this case would lie, “generally takes a broad view” of who may be a responsible person and considers some of the following factors in making this determination:
(1) the individual’s status as an officer or member of the business’ board of directors; (2) the individual’s role in managing the day-to-day operations of the business;
(3) whether the individual made decisions as to the disbursement of funds and payment of creditors; and
(4) the individual’s authority to sign checks on behalf of the business. Barnett, 988 F.2d at 1454-1455 .
- No single factor is dispositive, with the crucial inquiry being whether the person, by virtue of the person’s position in the company, had the “effective power” to pay the taxes owed based on their actual authority or ability, or could have had “substantial input” into such decisions. Barnett v. IRS, 988 F.2d 1449, 1454-55 (5th Cir. 1993).
- As chief administrator, Petitioner was a responsible person. She managed the hospital’s operations, participated in board meetings, and had check-signing authority over Riverside’s bank accounts during the periods at issue. She reviewed hospital expenses and prioritized payments to hospital staff, vendors, and private creditors that she deemed provided essential services to Riverside and its patients.
- Section 6672 applies to “any” responsible person, not the person most responsible for the payment of the taxes.
- Moreover, the individual need not have the final word as to which creditors should be paid in order to be liable for TFRPs. Brown v. United States, 464 F.2d 590 , 591 n.1 (5th Cir. 1972). Rather, it is sufficient that the person have “effective power” or “significant input” in the decision as to whether funds are to [*5] be used to pay Federal taxes owed. See Barnett, 988 F.2d at 1454-1455; Brown, 464 F.2d at 591.
- A responsible person will be held liable for a TFRP only where the failure to pay the withholding tax was willful. 6672. “Willful” for this purpose does not mean the responsible person must have a “criminal or other bad motive * * *, but simply a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees.” Newsome, 431 F.2d at 745.
- Willfulness is typically proven by evidence that a responsible person paid other creditors when withholding taxes were due to the Federal Government. Gustin v. United States, 876 F.2d 485, 492 (5th Cir. 1989).
- Petitioner does not dispute that she knew that Riverside was not fully paying its trust fund taxes and even acknowledged prioritizing the signing of checks to vendors and creditors over the Federal Government. Generally, such actions demonstrate willfulness for purposes of §6672. See Davis v. United States, 402 F. App’x 915 , 919-920 (5th Cir. 2010); Howard v. United States, 711 F.2d 729 , 735 (5th Cir. 1983). However, Petitioner contended that she was not willful because the hospital’s available funds were encumbered by certain legal obligations that excused her failure to pay the hospital’s Federal withholding tax obligations.
- The Tax Court rejected this argument, finding that Petitioner did not show that any interest, in particular the interest of the creditor’s judgment, was legally superior to that of the Federal Government such that Riverside’s funds could be considered encumbered.
Insight: This decision makes clear that Trust Fund Recovery Penalties can and will be assessed against those responsible for their collection and remittance. In a rare expression of compassion, the Court even appeared to sympathize with the Petitioner, stating that “[t]he Court appreciates the difficult situation in which petitioner found herself during the periods at issue.” However, the Court when on to make clear that “[w]hile we may sympathize with petitioner’s dilemma, we are a court of law, not equity. Stovall v. Commissioner, 101 T.C. 140 , 149-150 (1993). Petitioner was required to collect and remit withheld funds, and she did not. Her stated justification, no matter how noble, does not make her failure to pay any less willful.” Readers should therefore be mindful that, when presented with difficult choices regarding payments, trust fund taxes must generally prevail.
Albert G. Hill, III v. Comm’r; T.C. Memo. 2021-121
Summary: Petitioner was party to a settlement agreement that he understood could generate a gift tax liability. In February 2012, the district court where that litigation was pending issued a check from its registry payable to the U.S. Treasury for $10,263,750. Also in February, petitioner wrote to the IRS, providing the litigation background and explaining that the check was remitted with respect to the potential gift tax liability, as yet undetermined. In this letter and repeatedly for most of his gift tax dispute, petitioner referred to the check as a deposit. Acknowledging the receipt, the IRS noted that there was no corresponding tax return and urged petitioner to submit a gift tax return as soon as possible. During 2014, petitioner sought return of his “deposit.” Because the check was from the district court registry, the IRS requested additional information. In 2015, the IRS commenced a gift tax examination, which was resolved by settlement in 2019. Throughout this time, petitioner repeatedly referred to the district court’s check as a “deposit.”
The tax court’s stipulated decision resolving the gift tax examination did not find an overpayment of tax for any year. IRS issued petitioner a check for $3,473,750 – the difference between petitioner’s remittance ($10,263,750) and the deficiency it determined ($6,790,000). The check included no interest.
In August 2020, petitioner filed a motion to redetermine interest pursuant to Rule 261, alleging that the $10,263,750 check was intended as a deposit pursuant to § 6603(a) and that the deposit was to be directed to potential gift tax imposed for tax year 2011. Petitioner contended that the IRS erred in failing to refund the interest that accrued pursuant to § 6603(d)(1) for the time the funds were deposited with the Treasury. Petitioner argued that the interest due on his excess deposit is $1,267,323, calculated using the interest rate payable on overpayments of tax. Under section 6621(a)(1), the “overpayment rate” for non-corporate taxpayers is the Federal short-term rate plus three percentage points.
The Court did not have jurisdiction over petitioner’s motion to redetermine interest. Section 7481(c)(2)(B) permits the tax court to reopen case if it finds the taxpayer made an overpayment. Petitioner made a deposit, rather than a payment. If petitioner had made an overpayment, the court would have had jurisdiction and petitioner may have been entitled to more than an additional $1,000,000 in interest.
Taxpayers have long made deposits with the IRS to prevent interest from accruing. IRS procedures distinguish between payments made in satisfaction of a tax liability and deposits. Initially, the IRS treated deposits as similar to a cash bond (as opposed to a tax payment) and did not pay interest on deposits subsequently returned. Congress changed this in 2004, adding section 6603 (“Deposits Made to Suspend Running of Interest on Potential Underpayments, etc.”). Section 6603(a) (“Authority to Make Deposits Other Than as Payment of Tax”) provides that a taxpayer may make a cash deposit which may be used to pay any tax which has not been assessed at the time of the deposit. Unless the Secretary determines that collection of tax is in jeopardy, he is required to return to the taxpayer any amount of the deposit (to the extent not used for a payment of tax) which the taxpayer requests in writing. Sec. 6603(c).
Section 6603(d) (“Payment of Interest”) provides that, “for purposes of section 6611 (relating to interest on overpayments), except as provided in paragraph (4), a deposit which is returned to a taxpayer shall be treated as a payment of tax for any period to the extent (and only to the extent) attributable to a disputable tax for such period.” A “disputable tax” means “the amount of tax specified at the time of the deposit as the taxpayer’s reasonable estimate of the maximum amount of any tax attributable to disputable items.”
Of central importance to this case, section 6603(d)(4) specifies that “[t]he rate of interest under this subsection shall be the Federal short-term rate determined under section 6621(b), compounded daily.” In this case, the IRS conceded that petitioner was owed interest on his deposit in the amount of $218,122, calculated using the Federal short-term rate. Petitioner claimed he was owed $1,267,323 in interest, using the short-term rate plus 3 percentage points (the rate specified for overpayments).
“A proceeding to redetermine interest … on an overpayment determined under Code section 6512(b) shall be commenced by filing a motion with the Court.” Rule 261(a)(1). The motion papers must include a statement that “the Court has determined under Code section 6512(b) that the petitioner has made an overpayment,” a “copy of the Court’s decision which determined the overpayment,” and a schedule setting forth “each payment made by the petitioner in respect of which the overpayment was determined.” Rule 261(b)(3). In order for section 7481(c)(2) to apply in a case such as this, “this Court must have determined that there is … an overpayment pursuant to section 6512(b).” Because there was no overpayment, section 7481(c)(2) and the court did not have jurisdiction.
Key Points of Law: As explained above, the Code’s distinction between deposits and overpayments carries multiple consequences, substantive and jurisdictional.
Insight: As with any litigation, it is important to consider all the ramifications of strategic decisions. In 2012, when the district court issued the $10,263,750 check from its registry to the IRS, petitioner had a choice. He could have designated that check as a payment or a deposit. He understood that the district court settlement would create a gift tax liability, but he did not know the amount or for what year, at that point. Petitioner chose to characterize that check as a deposit. As the tax court observed: “Designating this remittance as a ‘deposit’ provided petitioner with an important benefit, as his advisers surely knew: He could demand the immediate return of his deposit at any time. Had petitioner made an ‘advance payment,’ he could have secured return of the funds only by pursuing the IRS’ formal refund process, which could be lengthy.” Opinion at 9 (citations omitted). Perhaps, the petitioner could have attempted to change the designation earlier, at some point before he resolved the gift tax dispute. The Court referred to petitioner’s efforts to re-characterize that remittance as an “eleventh-hour change of strategy.” Id. Having repeatedly characterized the remittance as a deposit for years (before and throughout the gift tax dispute), petitioner’s late efforts to recharacterize it as a payment were unavailing.
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