The Tax Court in Brief November 8 – November 12, 2021

The Tax Court in Brief November 8 – November 12, 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.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of  The Freeman Law Project.

Tax Litigation: The Week of November 8 – November 12, 2021

1. Peak v. Comm’r, T.C. Memo 2021-128
2. Knox v. Comm’r, T.C. Memo. 2021-126
3. Smaldino v. Comm’r, T.C. Memo 2021-127

Tax Court Case:

Peak v. Comm’r, T.C. Memo 2021-128
November 10, 2021 | Ashford, J. | Dkt. No. 10444-20

• Opinion

Short Summary:  This case involves unreported tax stemming from a distribution from a retirement plan.  The primary issue is whether such distribution was taxable.

Key Issues:

• Whether Petitioner’s receipt of a Notice CP12, informing him of mathematical errors on his return, created an “implied settlement contract,” thereby preventing the IRS from assessing additional taxes.
• Whether Petitioner’s alleged receipt of inaccurate advice from the IRS helpline constituted a defense to failure to properly report certain income.

Primary Holdings: 

• Petitioner received four distributions from three different pension or retirement plans: (1) $699.57 and $1,399.14 from the American Student Assistance Employee Pension Plan (“ASAE Pension Plan”) administered by Vanguard; $8,394.84 from the Retirement Plan for Massachusetts Higher Education administered by Charles Schwab; and (3) $3,931.51 from the Mellon Bank Retirement Plan administered by BNY Mellon.
• Each of the plans sent to the IRS and to Petitioner Forms 1099-R indicating that the entire distribution was taxable and that the distribution was a “normal distribution.”
• Petitioner prepared and timely filed his 2017 Form 1040A, in which he properly reported the total amount of distributions received as $14,425. However, he reported $1,698 as the “Taxable amount” of those distributions.
• In a Notice CP12, the IRS advised Petitioner that there were miscalculations on the 2017 return and that the overpayment amount he reported on the 2017 return had changed. Specifically, the IRS advised the petitioner that there were miscalculations affecting two areas of the 2017 return, (1) “Tax on Social Security Benefits” and (2) “Tax Computation”, and that as a result, he was due a refund of $182 (rather than a refund of $1,869 as reported on the 2017 return). The IRS also advised the petitioner that no action was required on his part if he agreed with the recalculations and that he would receive the $182 refund within four to six weeks “as long as you don’t owe other tax or debts we’re required to collect.” Petitioner did not respond to this notice, thereby agreeing to the recalculations.
• Subsequently, relying on the Forms 1099-R from Vanguard, Charles Schwab, and BNY Mellon, the IRS sent the petitioner a notice of deficiency dated January 6, 2020, determining that the full amounts of the four distributions were taxable. Petitioner timely petitioned for a redetermination.
• Petitioner alleged two bases for his petition: (1) that he called the IRS helpline for assistance in preparing the 2017 return and specifically followed the advice of the IRS representative on the IRS helpline with respect to the reporting of the four distributions; and (2) June 4, 2018, Notice CP12 confirms that he is entitled to an “Adjusted Refund” of $182 and constituted a contract between the IRS and Petitioner.

Key Points of Law:

• Gross income is defined to include “all income from whatever source derived. R.C. § 61(a)
• Gross income includes income from pensions. 61(a)(10)
• Gross income also includes a distribution from an individual retirement account (with exceptions not applicable in this case). 408(d)(1).
• A Notice CP12 is not a settlement agreement and therefore does not in any way limit the IRS from assessing additional tax found to be due.
• “[A]lthough it is unfortunate that * * * [a taxpayer] may have received incorrect legal advice from an IRS employee, that advice does not have the force of law and cannot bind * * * [the IRS] or this Court.” Richmond v. Commissioner, T.C. Memo. 2009-207 , slip op. at 7. “It is the statute which governs the determination of * * * [a taxpayer’s] substantive tax liability, and the statements of IRS representatives, while understandably nettlesome to * * * [a taxpayer], do not alter this rule.” Atkin v. Commissioner, T.C. Memo. 2008-93 , slip op. at 6-7.

Insight:  This case reflects the well-established principle that the IRS has the right, within applicable statutes of limitations, to assess additional tax where it is found to be owed.  And unfortunately, advice from an IRS agent does not rise to the level of the law that can be relied upon in excluding taxable income.

Tax Court Case:

Knox v. Comm’r, T.C. Memo. 2021-126
November 9, 2021 | Jones, J. | Dkt. No. 14687-17

• Opinion

Short Summary:

For 2015, the Knoxes reported $59,228 in Social Security Benefits, of which $16,829 and $14,523 were attributable to lump-sum payments relating to 2013 and 2014, respectively. In 2015, they received a benefit of $7,332 in advance premium tax credit (APTC) payments. In 2015, they did not file the required Form 8962, used for reconciling APTC (received in advance, throughout the tax year) with their eligible premium tax credit (PTC) at the end of the year. (As the court explained, if someone cannot afford monthly health insurance premiums during the year, providing the credits after the end of the year is of little use. Accordingly, APTCs are paid directly to an insurance provider during the year, and taxpayers are required to reconcile any APTCs received with the eligible credit amount on Form 8962.)

By notice of deficiency, the Commissioner determined a deficiency of $7,332 in the Federal income tax of petitioners, Ronald E. Knox and Joan S. Knox, for the 2015 taxable year, and an accuracy-related penalty under section 6662 of $1,466. The parties submitted this case for decision without trial under Rule 122. The court considered whether the Knoxes were entitled to a premium tax credit and, if they are not, whether they are required to repay advance premium tax credit (APTC) payments of the PTC. The court determined that they were not entitled to a PTC and confirmed the Commissioner’s deficiency determination.

Key Issues: 

• Taxpayers with income greater than 400% of the Federal poverty line are generally not eligible for PTC. The issue here is one the court previously decided in Johnson v. Commissioner, 152 T.C. 121, 124 (2019): taxpayers are required to include in their modified adjusted gross income (MAGI) all social security benefits received in the tax year, including lump-sum amounts relating to the prior year which the taxpayer elected to exclude from gross income, for purposes of determining eligibility for a premium tax credit (PTC). In their 2015 tax filings, the Knoxes reported adjusted gross income of less than 400% of the poverty line because they treated $53,813 in Social Security benefits as nontaxable.

Primary Holdings:

The court applied its holding in Johnson and, therefore, the Knoxes’ MAGI for PTC eligibility included the lump sum payments they received in 2015, which brought their income above 400% of the poverty line and made them ineligible for PTC.

Key Points of Law:

• If the taxpayer receives a lump-sum Social Security benefit attributable to a prior year, the taxpayer may make an election under section 86(e) to limit the amount of the benefit that is included in gross income for the year of receipt. Sec. 86(e)(1); see Johnson v. Commissioner, 152 T.C. at 126.
• Section 36B and its accompanying regulations are silent regarding the potential impact of a section 86(e) election on the calculation of MAGI. See Johnson v. Commissioner, 152 T.C. at 127. However, section 36B and the underlying regulations provide that a taxpayer’s MAGI must be increased by Social Security benefits received in a taxable year that were “not included in gross income under section 86 for the taxable year.” Sec. 36B(d)(2)(B)(iii); see 1.36B-1(e)(2), Income Tax Regs.
• The court observed that “many petitioners” have been “caught in this unfortunate circumstance,” but concluded: “While we are sympathetic to their plight, we cannot ignore the law to achieve an equitable end. See Commissioner v. McCoy, 484 U.S. 3, 7 (1987); Johnson v. Commissioner, 152 T.C. at 128-129; McGuire v. Commissioner, 149 T.C. at 262. Mr. and Mrs. Knox received an advance of credit to which they were not entitled and are liable for the $7,332 deficiency. Accordingly, we sustain respondent’s determination.”

Insight: There is no real insight here, other than, perhaps, to observe that the Knoxes proceeded pro see.

Tax Court Case:

Smaldino v. Comm’r, T.C. Memo 2021-127

November 10, 2021 | Thornton, J. | Dkt. No. 5437-18

• Opinion

Short Summary:  The taxpayer owned and operated numerous rental properties.  He placed 10 of these properties in Smaldino Investments, LLC (SI, LLC), which he owned through a revocable trust.  Later, the taxpayer transferred approximately 8% of the SI, LLC class B member interests to the Smaldino 2012 Dynasty Trust (Dynasty Trust), an irrevocable trust that he had created for the benefit of his children and grandchildren.  Around the same time, the taxpayer also transferred approximately 41% of the SI, LLC class B member interests to his wife, who transferred them to the Dynasty Trust the next day.

The taxpayer filed a gift tax return and reported as a taxable gift the 8% SI, LLC class B member interests he had transferred to the Dynasty Trust.  The IRS determined that the taxpayer had made a taxable gift to the Dynasty Trust of approximately 49% of the class B member interests, i.e., the IRS determined that the taxpayer had made a taxable gift of the 41% interest transferred from his wife and later to the Dynasty Trust.  On the basis of these determinations, the IRS asserted that the taxpayer had a $1,154,000 gift tax deficiency for 2013.

Key Issues:

• What is the proper characterization for gift tax purposes of the taxpayer’s transfer of the SI, LLC class B member interests to his wife followed by her transfer of the same interests to the Dynasty Trust.
• What is the fair market value of the SI, LLC class B member interests that the taxpayer transferred to the Dynasty Trust.

Primary Holdings: 

• The taxpayer never effectively transferred any membership interests in SI, LLC to his wife; accordingly, the taxpayer is treated as having transferred such interests to the Dynasty Trust for federal gift tax purposes.
• The value of the taxpayer’s gift to the Dynasty Trust is $7,820,008.

Key Points of Law:  

• Section 2501 imposes a tax for each calendar year “on the transfer of property by gift” by any taxpayer. Section 2511(a) provides that this gift tax “shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.”
• If a donor transfers an interest in property to his or her spouse as a gift, the value of the property interest is generally allowable as a deduction in computing the donor’s taxable gifts for the year. 2523(a).
• Pursuant to Rule 41(b), a party’s failure to formally amend his pleadings to assert an increased deficiency is not necessarily fatal if the issue giving rise to an increased deficiency was tried with the other party’s express or implied consent.
• It is well established that the substance of a transaction, rather than the form in which it is cast, determines the tax consequences unless it appears from an examination of the statute and its purpose that form was intended to govern. Comm’r v. P.G. Lake, Inc., 356 U.S. 260 (1958); Comm’r v. Court Holding Co., 324 U.S. 331 (1945).  Section 2511(a) implicitly embodies principles of substance over form by including “indirect” transfers in the definition of a taxable gift.  Sather v. Comm’r, 251 F.3d 1168 (8^th 2001).  Heightened scrutiny is appropriate in cases, such as this one, where all the parties to the transactions in question are related.  Brown v. U.S., 329 F.3d 664 (9^th Cir. 2003).
• A gift of property is valued as of the date of the transfer. 2512(a).  If property is transferred for less than adequate and full consideration, then the excess of the value of the property transferred over the consideration received is generally deemed a gift.  Sec. 2512(b).  A gift is measured by the value of the property passing from the donor, rather than by the property received by the done or upon the measure of enrichment to the donee.  See Treas. Reg. § 25.2511-2(a).  Typically, the court considers information available on or close to the valuation date and facts that were reasonably known on the valuation date.  Estate of Gilford v. Comm’r, 88 T.C. 38 (1987).
• For gift tax purposes, the value of the transferred property is generally the “price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” S. v. Cartwright, 411 U.S. 546 (1973).  The determination of property value for gift tax purposes is an issue of fact, and all relevant factors must be considered.  See Anderson v. Comm’r, 250 F.2d 242 (5^th Cir. 1957).
• For gift tax purposes, transfers of interests in a single-member LLC are valued as transfers of interests in the LLC rather than as transfers of proportionate shares of the underlying assets. See Pierre v. Comm’r, 133 T.C. 24 (2009).
• The Tax Court evaluates expert opinions in the light of all the evidence in the record and may accept or reject the expert testimony, in whole or in part, according to its own judgment. See Helvering v. Nat’l Grocery Co., 304 U.S. 282 (1938).  “The persuasiveness of an expert’s opinion depends largely upon the disclosed facts on which it is based.”  Estate of Davis v. Comm’r, 110 T.C. 530 (1998).

Insight:  The Smaldino case shows the potential dangers of filing a petition with the United States Tax Court.  Specifically, in this case, after the petition was filed, the IRS asserted additional gift tax deficiencies than originally asserted in the notice of deficiency.  As a result, the taxpayer actually owed more gift tax than if he had simply accepted the IRS’s determinations in the notice of deficiency.

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