The Tax Court in Brief May 25 – 29, 2020

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The Tax Court in Brief May 25 – 29, 2020

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.

The Week of May 25 – 29, 2020

Gluck v. Comm’r, T.C. Memo. 2020-66

May 19, 2020 | Lauber, J. | Dkt. No. 2020-66

Short SummaryThe IRS determined that the petitioners were not permitted to defer capital gain as part of a like-kind exchange and asserted a tax deficiency and penalties, prompting the taxpayers to file a petition with the Tax Court.  The IRS moved to dismiss the case for lack of jurisdiction with respect to the tax deficiency.  The taxpayers, in turn, moved for summary judgment, arguing that they were substantively entitled to like-kind exchange treatment under section 1031.

On June 30, 2012, the taxpayer sold a condominium unit for $10,214,000.  He deposited the proceeds from the sale of the condominium unit into a “qualified escrow account.”  See sec. 1.1031(k)-1(g)(3).  The taxpayer designated as the “replacement property” a purported 25% interest in an apartment building. The IRS, however, determined that the replacement property that the taxpayer acquired was in fact an interest in a partnership, rather than a direct interest in the real estate.  The partnership was subject to the unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA). See secs. 6221- 6234 (as in effect for years before 2018).

The taxpayer did not report the property in a manner consistent with the reporting that the IRS received from the partnership, Greenberg & Portnoy (G&P).  G&P’s returns reported that it owned the Property and that Gluck LLC (an entity established by the taxpayer) in 2012 acquired a partnership interest in G&P, as opposed to a direct ownership interest in the apartment building.

Although the taxpayer acknowledged receipt of a Schedule K-1 reporting as such, he did not report the distributive share of G&P’s income on their 2012 Form 1040. Nor did he file with the IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR). (Taxpayers are instructed to file Form 8082 if they “believe an item was not properly reported on the Schedule K-1 you received from the partnership.” IRS, Instructions for Form 8082, at 1 (rev. Dec. 2011).)

The IRS argued that its adjustment disallowing like-kind exchange treatment was necessary to conform the taxpayer’s tax treatment to the treatment shown on the partnership’s return and was thus a “computational adjustment” within the meaning of section 6231(a)(6).

Key Issue:  Whether the Tax Court has jurisdiction to address the deficiency resulting from the IRS’s adjustments, denying section 1031 treatment on the ground that the taxpayer did not comply with section 1031 because the taxpayer’s “replacement property” was actually an interest in a partnership, which is not “like-kind” property.

Primary Holdings

Key Points of Law:

InsightGood riddance to TEFRA.  So much judicial ink has been spilled fleshing out the sometimes-metaphysical nuances of this procedural regime that has been on the books since 1982.  With the enactment of the Bipartisan Budget Act of 2015, a new regime (the “BBA”) governing partnership audits and litigation generally went into effect in 2018.  While we will continue to see TEFRA litigation making its way through the system for the better part of a decade, partnership tax disputes will now be subject to a new regime.

Amanda Iris Gluck Irrevocable Trust v. Comm’r, T.C. Memo. 154 T.C. No. 11 

May 26, 2020 | Lauber, J. | Dkt. No. 5760-19L

Short Summary:   The case involved a collection due process (CDP) proceeding under which the taxpayer sought review pursuant to section 6330(d)(1) of a determination by the Internal Revenue Service (IRS or respondent) to sustain collection action for tax years 2013, 2014, and 2015.

The taxpayer was a direct and indirect partner in partnerships subject to the unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility Act of 1982. See I.R.C. secs. 6221-6234 (as in effect for years before 2018). In 2012 one of the partnerships in which the taxpayer held an indirect interest sold property and realized a large capital gain.  The taxpayer allegedly failed to report its entire distributive share of that gain.

For 2012, the taxpayer filed a return on Form 1041, U.S. Income Tax Return for Estates and Trusts. On this return it allegedly failed to report its distributive share of the gain that had been allocated to a partnership holding.

The IRS adjusted the taxpayer’s 2012-2015 returns via “computational adjustments.” See I.R.C. sec. 6231(a)(6). These adjustments eliminated the net operating loss (NOL) it had claimed for 2012 and disallowed the NOL carryforward deductions the taxpayer had claimed for 2013-2015, creating balances due for those years. The IRS immediately assessed the resulting tax. See I.R.C. secs. 6222(c), 6230(a)(1).

On June 15, 2017, the IRS sent the taxpayer two Letters 4735, Notice of Computational Adjustment. In the first letter the IRS adjusted upward, by $6,543,748, the taxpayer’s distributive share of the partnership’s capital gain for 2012, eliminating the NOL that the taxpayer had reported for that year. In the second letter the IRS disallowed the NOL carryforwards from 2012 that the taxpayer had claimed as deductions for 2013, 2014, and 2015, creating a balance due for each year. Each Letter 4735 explained that “[t]he adjustment is due to your inconsistent treatment of a partnership item related to the section 1231 gain reported by a partnership in which you have an indirect ownership.”

Subsequently, the IRS mailed a levy notice in an effort to collect the taxpayers 2013-2015 tax, and the taxpayer timely requested a collection due process (CDP) hearing. The settlement officer sustained the levy notice. The taxpayer timely petitioned for review, seeking to challenge its underlying liabilities for 2012-2015. The IRS moved to dismiss as to 2012 and 2013, noting that the 2012 tax year was never before the Court and that the taxpayer’s 2013 liability had been fully satisfied by application of credits from other years. The IRS moved for summary judgment as to 2014 and 2015.

The IRS thereafter assessed petitioner’s liabilities for 2013-2015. When the taxpayer did not pay these liabilities upon notice and demand, the IRS issued, on January 11, 2018, a Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing (levy notice). As of the date of the levy notice, the taxpayer’s outstanding liabilities for 2013-2015 exceeded $180,000.

Key Issue:  Whether the Tax Court had jurisdiction to review the taxpayer’s tax liability through a CDP challenge.

Primary Holdings

Key Points of Law:

Insight:  Where deficiencies result from a partnership proceeding or adjustment, an affected taxpayer needs to carefully vet their procedural avenues where that partnership is subject to the TEFRA statutory regime.  A taxpayer should also take precautions to preserve challenges to substantive tax liabilities in CDP hearings in order to utilize a more favorable standard of review on petition to the Tax Court.

Thoma v. Comm’r, T.C. Memo. 2020-67 

May 27, 2020 | Morrison, J. | Dkt. No. 21922-15

Short SummaryOn October 1, 1976, Mr. Thoma purchased a partial ownership interest in an accounting firm for $40,000. He worked as an accountant at the accounting firm. At some point after that, but before August 2005, Mr. Thoma became the sole owner of the accounting firm, and he began operating the firm as a sole proprietorship under the name “Thoma & Associates, CPAs”.

Around January 1, 2006, Mr. Thoma went into business with Eric Hjerpe, another accountant. Their accounting business appears to have absorbed Mr. Thoma’s sole proprietorship. Their business also appears to have initially operated under the name of Mr. Thoma’s former sole proprietorship, Thoma & Associates, CPAs, but by 2007, it was operating under the name Thoma & Hjerpe, CPAs.  During the period at issue, it was disputed whether the taxpayer (Mr. Thoma) was a partner of the firm or an employee.

Around November 3, 2011, the U.S. Department of Justice sent a letter to Thoma & Hjerpe. At trial Mr. Thoma described the letter as a civil investigative demand, issued personally to him, that requested the records of one or more of his clients. Mr. Thoma responded to the letter but never informed Mr. Hjerpe about it. Mr. Hjerpe eventually learned about the letter. A few weeks later, on November 20, 2011, Mr. Thoma arrived at the offices of Thoma & Hjerpe and found that the locks had been changed. He also discovered he no longer had access to the network, client files, and email accounts. That same day Mr. Thoma received a letter from Mr. Hjerpe informing him that he was being placed on administrative leave for his “gross mishandling” of the U.S. Department of Justice letter and asking him to “refrain from contacting any of our clients” until Mr. Hjerpe had “a better handle on what is going on”. Mr. Thoma did not provide any accounting services to his clients at Thoma & Hjerpe after receiving Mr. Hjerpe’s letter. His professional and business association with Thoma & Hjerpe ended on November 20, 2011, the day Mr. Hjerpe placed him on administrative leave.

On their tax returns for 2010 and 2011 Mr. and Ms. Thoma took the position that Mr. Thoma was self-employed and that the biweekly payments constituted self-employment income for each year, such that Mr. Thoma was liable for self-employment tax. They also claimed an income-tax deduction for one-half of the self-employment tax they reported for Mr. Thoma for each year. The IRS’s notice of deficiency determined that Mr. Thoma was not self employed, but rather an employee. The notice of deficiency recharacterized the reported self-employment income as wages.

Self-employed business-expense deductions. On their tax returns for 2010 and 2011 Mr. and Ms. Thoma claimed deductions of $7,396 and $20,867, respectively, for business expenses Mr. Thoma paid in rendering accounting services for Thoma & Hjerpe. They reported these deductions as affecting adjusted gross income (“AGI”), which is consistent with the deductions being categorized under section 62(a)(1) as attributable to a taxpayer’s business other than the business of providing services as an employee. The notice of deficiency determined that Mr. Thoma was an employee of Thoma & Hjerpe in 2010 and 2011, such that the expenses were not governed by section 62(a)(1) and not deductible in arriving at AGI. The notice of deficiency determined that Mr. Thoma’s expenses of working for Thoma & Hjerpe were deductible only as unreimbursed-employee-business expenses under section 67(b). That deduction is a subset of the miscellaneous itemized deductions allowed under section 67(b). Under section 67(a), total miscellaneous itemized deductions are allowed only to the extent they exceed 2% of AGI.

Self-employed health insurance expense deductions. On their tax returns for 2010 and 2011 Mr. and Ms. Thoma claimed self-employed health insurance expense deductions under section 162(l). Section 162(l) allows self-employed taxpayers a deduction for the cost of “insurance which constitutes medical care”, i.e., the cost of health insurance. Mr. and Ms. Thoma reported that Mr. Thoma paid health insurance expenses of $4,648 for 2010 and $5,580 for 2011. The notice of deficiency determined that Mr. Thoma was an employee of Thoma & Hjerpe and that the health insurance expenses were not properly deductible under section 162(l), but only as deductions for medical expenses under section 213(a). Section 213(a) allows a deduction for medical expenses, including health insurance expenses, but subject to a 7.5% of AGI floor.

Self-employed SIMPLE IRA contribution deductions. Mr. Thoma directly contributed $15,711 to his SIMPLE IRA in 2010 and $14,000 in 2011. Mr. and Ms. Thoma claimed deductions for those contributions. The notice of deficiency determined that the contributions were not deductible because Mr. Thoma was an employee of Thoma & Hjerpe.

Recovery of basis and character of 2011 installment sale payments. In 2008 Mr. Thoma sold his interest in Thoma & Hjerpe to Mr. Hjerpe. In 2011 he received installment sale payments from Mr. Hjerpe totaling $160,000. On their 2011 tax return Mr. and Ms. Thoma reported that the $160,000 installment sale payments were composed of $131,637 in long-term capital gain, $3,921 in taxable interest, and $24,442 in tax-free recovery of basis. The notice of deficiency determined that the installment sale payments were instead composed of $134,001 in long-term capital gain, $19,700 in taxable interest, and $6,299 in tax-free recovery of basis.

Accuracy-related penalties. The notice of deficiency determined that Mr. and Ms. Thoma were liable for accuracy-related penalties under section 6662(a) for 2010 and 2011.

Key Issue:  Whether the taxpayer was an employee or self-employed.

Primary Holdings

Key Points of Law:

InsightThe case was a complete loss for the taxpayers.  In 104 pages of IRS-deferential findings, the court sifted through a convoluted business relationship and unique factual setting to determine whether the taxpayer was a partner or an employee of the business.  The case demonstrates the multi-factor test for determining partnership status, and underscores that such an analysis is a matter of federal law (insofar as the question is, as here, whether a partnership exists for federal tax purposes).

Novoselsky v. Comm’r, T.C. Memo. 2020-68 

May 28, 2020 | Lauber, J. | Dkt. No. 22400-13

Short Summary: During 2009 through 2011, Mr. Novoselsky, an attorney, practiced law with a focus on class action litigation.  In those years, he executed “litigation support agreements” with various individuals and entities.  Under those agreements, the individuals and entities made upfront payments to support the costs of litigation.  If the litigation was successful, Mr. Novoselsky was obligated to pay the counter-party, from his award of attorney’s fees and costs, the initial payment advanced to Mr. Novoselsky plus a premium.  However, if the litigation was not successful, Mr. Novoselsky had no obligation to return any funds to the counter-party.

Mr. Novoselsky and his wife filed joint returns with a Schedule C, Profit or Loss From Business, to report the business activities of Mr. Novoselsky’s law firm.  On the Schedule C, Mr. Novoselsky did not report any of the funds advanced to him pursuant to the litigation support agreements in which he had no obligation to repay the counter-party.  The IRS examined the returns and issued a notice of deficiency to Mr. and Mrs. Novoselsky.  In the notice of deficiency, the IRS determined that the advanced funds for which there was no repayment obligation should be reported as gross income to Mr. Novoselsky.  In addition, the IRS asserted accuracy-related penalties with respect to these items.

Key Issue:  Whether the funds advanced to Mr. Novoselsky constitute a loan or gross income and whether Mr. and Mrs. Novoselsky are liable for accuracy-related penalties.

Primary Holdings:

Key Points of Law:

Insight:  The Novoselsky decision shows the breadth of I.R.C. § 61 and its statutory language that gross income includes all income from whatever source derived.  Because the taxpayer received advances from third parties in which there was no obligation to repay, the Tax Court determined the payments represented gross income.  Notably, if Mr. Novoselsky used the payments for deductible business expenses, he would be entitled to a deduction to offset the gross income, but the decision does not address this issue.

Engle v. Comm’r, T.C. Memo. 2020-69 

May 28, 2020 | Cohen, J. | Dkt. No. 15791-17L

Short Summary:  In 2004, the U.S. Attorney’s Office (USAO) filed an information in federal court charging Mr. Engle with a single count of violation I.R.C. § 7201 by attempting to evade or defeat tax for 1998.  Mr. Engle pled guilty to the information in 2004.

Later, the federal court sentenced Mr. Engle to four years of probation including 18 months of home detention.  The district court did not make a finding of the exact amount of the tax loss involved in the case and did not order full restitution in that amount.  Rather, the federal court ordered that the exact amount of restitution would be determined by the IRS.  Moreover, the federal court directed Mr. Engle pay $25,000 immediately to the IRS and $100,000 within 90 days of the sentence hearing.  On April 4, 2008, the federal court issued a written judgment that stated the exact amount of restitution would “be determined by the IRS.”

The USAO appealed the federal court’s decision, and on January 13, 2010, the Fourth Circuit Court of Appeals vacated the federal court’s decision and remanded the case for resentencing.  Specifically, the Fourth Circuit indicated that it was unable to determine whether Mr. Engle’s sentence was reasonable, particularly where the federal sentencing guidelines recommended a term of imprisonment.  In addition, the Fourth Circuit provided that the federal court was required to reconsider its refusal to order full restitution, particularly because of the significant benefits the Government would have with regard to collection and enforcement.

The federal court resentenced Mr. Engle to 60 months of incarceration and 14 months of supervised release.  The court also ordered him to make restitution to the IRS of $620,549.

On May 26, 2014, the IRS made restitution-based assessments against Mr. Engle for 1984, 1986-1993, and 1995-2001, which totaled the restitution ordered by the federal court in its 2011 amended judgment.  That same day, the IRS mailed Mr. Engle a notice and demand for payment and thereafter issued a notice of federal tax lien.  Mr. Engle filed for a Collection Due Process (CDP) hearing challenging the amount of the restitution-based assessments.  The IRS issued a Notice of Determination to sustain the notice of tax lien filing, concluding:  (1) a taxpayer cannot challenge the amount of court-ordered restitution in a CDP hearing; (2) because the Court of Appeals vacated the federal court’s sentencing order the 2008 restitution order was rendered void, meaning the ultimate restitution order was the amended 2011 judgment; (3) interest was properly assessed on the restitution-based assessments; (4) a lien withdrawal was not appropriate; and (5) the proper legal and procedural requirements had been met in the assessment and collection of the restitution.

Key Issue:  Whether the IRS Settlement Officer abused his discretion in sustaining the notice of federal tax lien filing.

Primary Holdings

Key Points of Law:

Insight:  The Engle decision stands for the proposition that criminal restitution orders may be difficult for taxpayers to challenge in CDP hearings and that such taxpayers should consider arguing more towards a collection alternative.

Larkin v. Comm’r, T.C. Memo. 2020-70 

May 28, 2020 | Gustafson, J. | Dkt. No. 6345-14

Short SummaryMr. and Mrs. Larkin were U.S. nonresident citizens for 2008 through 2010.  Mr. Larkin is an attorney, and Mrs. Larkin is a homemaker.  They owned interests in various entities and real properties in the United States and Europe and claimed deductions on Schedule A and Schedule E related to these activities.  They also claimed foreign tax credits.

The IRS examined the Larkins’ 2008 through 2010 returns and disallowed many of the Schedule A and Schedule E expenses, as well as the foreign tax credits.  Moreover, the IRS issued a notice of deficiency on these issues and also asserted the Larkins were liable for accuracy-related penalties and additions-to-tax for late filing of the returns.

At the Tax Court, the Larkins failed to properly address certain issues and failed to raise those issues in their post-trial briefings.

Key Issue:  Whether the Larkins are entitled to deductions for Schedule A and Schedule E expenses, self-employed health insurance deductions, foreign tax credits, and whether the Larkins are liable for additions-to-tax for late filings and accuracy-related penalties.

Primary Holdings:

Key Points of Law:

InsightThe Larkin decision shows the dangers of not complying with the Tax Court’s Rules of Practice and Procedure.  Taxpayers should bear in mind that every assignment of error should be identified in the petition and should be addressed throughout the trial and post-trial briefing period.  In the event the taxpayer fails to do so, the Tax Court may consider the issues waived.

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