The Tax Court in Brief June 8 – 12, 2020

Share this Article
Facebook Icon LinkedIn Icon Twitter Icon

Freeman Law is a tax, white-collar, and litigation boutique law firm. We offer unique and valued counsel, insight, and experience. Our firm is where clients turn when the stakes are high and the issues are complex.

The Tax Court in Brief June 8 – 12, 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 June 8 – 12, 2020


Howe v. Comm’r, T.C. Memo. 2020-78 

June 8, 2020 | Kerrigan, K. | Dkt. No. 29743-14

Short SummaryPetitioners’ 2008 Form 1040 was audited which resulted in a notice of proposed adjustments.  During the appeal, the IRS and the Petitioners’ agreed to sign a Form 870-AD which reduced the Petitioners’ deficiency and accuracy-related penalty.  Later the IRS determined that it had signed the Form 870-AD based on misrepresentations of material facts from Petitioners’ representative and rescinded the Form 870-AD.  The IRS then reopened the audit and issued a notice of deficiency to Petitioners.  At trial, Petitioners challenged the validity of the notice of deficiency and claimed that Form 870-AD was presumptively valid and that the IRS was equitably estopped from voiding it.  The Tax Court ruled in favor of the IRS.

Key Issue:  Whether the IRS’ conduct and actions in rescinding an executed settlement agreement can be classified as affirmative misconduct for the purposes of an equitable estoppel argument.

Primary Holding

Key Points of Law:

InsightThe Howe case shows the importance that a taxpayer or his representative provide accurate and consistent statements and information at both the audit and appeal level.  Further, it demonstrates the ability of the IRS to void a Form 870-AD and reopen an audit.  The case also illustrates the considerable burden of proof a taxpayer will have to successfully claim equitable estoppel in such a situation.

Johnson v. Comm’r, T.C. Memo. 2020-79

June 8, 2020 | Pugh C. | Dkt. No. 30283-15

Short SummaryPetitioner sought review of the IRS determination that (1) deductions for travel and car and truck expenses were not properly supported pursuant to sections 162, 179, and 274; and (2) the Petitioner’s valuation of his charitable contribution deductions, which was based on the granting of an easement to a non-profit conservation group, was incorrect.

Key Issue:  Whether the taxpayer could support his deduction of travel expenses related through his own testimony and calendar showing his dates of travel and (2) whether the taxpayer properly valued the conservation easement, and thereby the value of the resulting charitable deductions, that the taxpayer granted to a non-profit conservation group.

Primary Holdings

Key Points of Law:

InsightThe Johnson case illustrates the heightened substantiation standard for travel and car and truck expenses.  Specifically, the case demonstrates the importance of maintaining travel logs and mileage logs as needed.  Further, this case illustrates that the value of a charitable contribution deduction, which relates to the grant of a “charitable” easement, can be determined by the Tax Court’s own review of evidence in the record—rather than fully accepting an expert witnesses’ valuation.

Flume v. Comm’r, T.C. Memo. 2020-80 

June 9, 2020 | Ashford, J. | Dkt. No. 31162-14

Short SummaryThe IRS issued notices of deficiency to the taxpayers for tax years 2006, 2007, and 2008 related to income associated with foreign entities.  The underlying case ultimately arose, in part, out of an audit prompted by the IRS’s receipt of records from Union Bank of Switzerland (UBS) pertaining to a UBS account held by a Bahamian entity owned by the taxpayers.  That information was provided to the IRS in response to a request for treaty information.

This case, which will become known as “Flume II,” also arose in connection with a prior Tax Court case in which the taxpayer-petitioners were involved.  In Flume v. Commissioner (Flume I), T.C. Memo. 2017-21, a collection due process case, the issue for decision was whether Mr. Flume was liable for assessed civil penalties under sections 6038 and 6679 for his failure to declare (via Forms 5471) his ownership interest in Wilshire for the 2001-09 taxable years (and his ownership interest in FFM for the 2001 and 2002 taxable years). In deciding the issue, the Court had to determine whether Wilshire was a CFC for years that included the years at issue in the instant case. The Court determined that petitioners each held 50% ownership interests in Wilshire throughout a period that included the subject years.  Those determinations became important with respect to Flume II under issue preclusion principles.

During the years at issue and when the petition was filed petitioners were U.S. citizens residing in Mexico

Franchise Food Services de Mexico S.A. de C.V. (FFM) is a Mexican sociedad anonima, which is a limited liability stock corporation that adopted the form of a variable capital company. FFM was incorporated in Guadalajara, Jalisco, Mexico, in 1995 to operate two fast food franchises that Mr. Flume owned.

Initially there were two 50% shareholders of FFM, Mr. Flume and Norwick Adams. Mr. Flume was FFM’s president, and Mr. Adams was FFM’s secretary and treasurer. The fast food franchises were sold in 1998, but FFM remained intact, having at least one U.S. bank account.

On February 8, 2002, Mr. Flume transferred 41% of his 50% ownership interest in FFM to Victor Mendez Tornell.

During the years at issue FFM was an active corporation. On January 15, 2007, petitioners entered into a consulting and personal services contract with FFM, and FFM made payments to them for their services.

In addition, the petitioners incorporated Wilshire Holdings, Inc. (Wilshire), in the Bahamas, with each holding one bearer share of Wilshire capital stock.

During Wilshire’s February 23, 2000, organizational meeting Mr. Flume was named as Wilshire’s director and secretary. The following year petitioners changed the domicile of Wilshire, reincorporating it in Belize. At a time not established by the record petitioners amended Wilshire’s original Belizean articles of association. These amended articles of association were backdated to April 12, 2001, to reflect the date of original incorporation in Belize. As stated in these amended articles of association petitioners’ bearer shares in Wilshire were eliminated and they and their daughter each held a 9% ownership interest, and Mr. Tornell held the remaining 73% ownership interest in Wilshire. During at least the years at issue Mr. Flume was the president and a director of Wilshire, and Mrs. Flume was the vice president and a director of Wilshire.

Petitioners opened bank or brokerage accounts in Wilshire’s name with Laredo National Bank (now BBVA Compass Bank) in 2000 (BBVA Compass Bank account), United Bank of Switzerland (UBS) in 2005 (UBS account), and Fidelity Investments at a time not established by the record (Fidelity account). They had sole signature authority over each of these accounts. The BBVA Compass Bank account was opened in the United States using a U.S. identification number petitioners obtained for Wilshire. The UBS account was opened outside the United States, and in doing so petitioners provided UBS with (among other documents) Wilshire’s original memorandum and articles of association and a certificate of incumbency for Wilshire from the Corporate Services Division of the Belize Bank Limited in Belize City, Belize. The certificate of incumbency identified Mr. Flume as Wilshire’s sole director and Wilshire’s shareholders as two “[b]earers” holding one share each of its capital stock. UBS’ due diligence documents identified petitioners as the beneficial owners of the UBS account, Mr. Flume as Wilshire’s “only shareholder and owner”, and the account’s purpose as “[w]ealth [m]anagement of retirement funds; probably [a] loan for [a] flat in Paris.” It is unknown how the Fidelity account was opened.

Wilshire did not compensate petitioners by check or direct deposit for the years at issue; instead, it would transfer funds from its BBVA Compass Bank, UBS, and Fidelity accounts to petitioners’ personal accounts or directly pay some of their personal expenses. Payments made by Wilshire of petitioners’ personal expenses during the years at issue include payments of their personal credit card charges, travel expenses, household furnishings, automatic teller machine withdrawal service charges, tuition, gifts to relatives, and rent for an apartment in San Francisco, California. In addition Wilshire would transfer funds from its BBVA Compass Bank account to FFM “in lieu of salary” to petitioners.

SMA Property Development

On January 15, 2007, FFM and Wilshire entered into a five-year joint venture agreement to acquire, develop, and sell residential real property in Mexico. This joint venture of FFM and Wilshire operated under the name SMA Property Development (SMA). Petitioners managed the affairs and funds of SMA, and more specifically, Mr. Flume served as SMA’s managing partner. On January 15, 2007, petitioners were also given powers of attorney to act jointly and independently as the attorneys-in-fact of SMA. As SMA’s attorneys-in-fact they were authorized to retain any assets owned by SMA and reinvest those assets, co-own assets and commingle their funds with the funds of SMA, and personally gain from any transaction they completed on SMA’s behalf.

The IRS determined that Wilshire was a controlled foreign corporation (CFC) that was 100% owned by petitioners for the years at issue, that the investment income from Wilshire’s UBS and Fidelity accounts was foreign personal holding company income (FPHCI) under subpart F of the Code, and that as a result petitioners were required to report their pro rata share (100%) of that FPHCI as subpart F income (and taxable as additional ordinary dividend income).

In the alternative, the IRS determined that petitioners were required to report as ordinary income: (1) interest income attributable to Wilshire’s UBS and Fidelity accounts; (2) ordinary dividend income attributable to Wilshire’s UBS and Fidelity accounts ; and (3) capital gains attributable to Wilshire’s UBS and Fidelity accounts.

Key Issues:

The case involved three substantive issues: whether petitioners (1) had additional wage income, (2) had reportable subpart F income, and (3) are liable for accuracy-related penalties

A subsidiary issue bearing on whether the taxpayers had additional subpart F income was whether Wilshire was a CFC on any day during each of the years at issue with the result that if Wilshire was such a CFC then petitioners have reportable subpart F income for those years.

Primary Holdings

Key Points of Law:

Insight: Taxpayers with interests in foreign entities are often subject to complex reporting regimes, such as the CFC reporting regime, which taxes a U.S. shareholder’s allocable share of “subpart F” income earned by a CFC, whether or not the CFC actually repatriates/distributes that income to the U.S. shareholder.  The case is also yet another reminder of the significant increase in the IRS’s focus on international tax reporting deficiencies, and its continuing ability to obtain information from foreign jurisdictions and sources.

Nelson v. Comm’r, T.C. Memo. 2020-81

June 10, 2020 | Pugh, J. | Dkt. Nos. 27313-13, 27321-13

Short SummaryMrs. Nelson’s father cofounded Compressor Systems, Inc. (CSI).  CSI sells and rents gas compression equipment to the oil and gas industry and provides financing and maintenance services in connection with that equipment.  Mrs. Nelson’s father continued to expand his family businesses throughout his life, operating in Texas as a Caterpillar-approved dealer in certain territories.

As part of this expansion, Mrs. Nelson’s father organized Warren Equipment Co. (WEC), which was a holding company that owned 100% of seven other operating subsidiaries, including CSI.  After his death, Mrs. Nelson indirectly through Longspar held most of the common and preferred stock in WEC.  Longspar was formed as a Texas limited partnership to:  (1) consolidate and protect assets; (2) establish a mechanism to make gifts without fractionalizing interests; and (3) to ensure that WEC remained in business and under family control.

On December 23, 2008, the taxpayers (Mr. and Mrs. Nelson) formed the Nelson 2008 Descendants Trust (Trust).  Mr. Nelson is a beneficiary of the Trust, along with their four daughters.  Thereafter, Mrs. Nelson made two transfers of limited partnership interests in Longspar to the Trust.  The first transfer occurred on December 31, 2008, and was done via a Memorandum of Gift and Assignment of Limited Partner Interest for $2,096,000 “as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.”  The second transfer occurred on January 2, 2009, and was done via a Memorandum of Sale and Assignment of Limited Partner Interest for $20,000,000 “as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment.”  In connection with the second assignment, the Trust executed a promissory note for $20 million.

After the assignments, the taxpayers hired an appraiser to value the limited partnership interests in Longspar.  The appraiser concluded that, as of the valuation date, the fair market value of a 1% limited partnership interest in Longspar was $341,000.  In arriving at this conclusion, the appraiser relied on a fair market valuation of WEC’s common stock completed by Ernst & Young.  Thus, on the basis of his valuation, the appraiser determined that Mrs. Nelson’s December 31, 2008, and January 2, 2009, transfers equated to the rounded amounts of 6.14% and 58.65% limited partnership interests in Longspar, respectively.

The taxpayers filed separate Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Returns for 2008 and 2009.  On their 2008 Forms 709 they each reported the gift to the Trust “having a fair market value of $2,096,000 as determined by independent appraisal to be 6.1466275% limited partner interest” in Longspar.  They did not report the January 2, 2009, transfer.

The 2008 and 2009 gift tax years were audited by the IRS.  Later, the IRS issued notices of deficiency determining that the taxpayers had undervalued the December 31, 2008, gift and that their halves of the gift were each worth $1,761,009 rather than $1,048,00 as of the valuation date.  The IRS also determined that the taxpayers had undervalued the January 2, 2009, transfer by $13,607,038 and therefore concluded that each had made a split gift in 2009 of $6,803,519.

Key IssueWhether the interests in Longspar Partners, Ltd. (Longspar), transferred on December 31, 2008, and January 2, 2009, were fixed dollar amounts or percentage interests; and (2) the fair market value of those interests.

Primary Holdings:

Key Points of Law

InsightAs with many valuation issues in tax litigation, the Nelson case involved a battle of expert opinions.  When large gifts are made, taxpayers are well-advised to seek qualified appraisals of any gift transfers and document the transfers accordingly.


Tax Litigation Attorneys

Need assistance in managing the Tax Compliance process? With our unique substantive and procedural knowledge, we can provide a comprehensive approach to the tax dispute resolution process, often collaborating with clients’ existing tax professionals to formulate creative solutions to the most complex tax problems. Freeman Law offers value-driven legal services and provides practical solutions to complex tax issues. Schedule a consultation now or call (214) 984-3410 to discuss your tax concerns and questions!