The Tax Court in Brief June 15 – 19, 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 15 – 19, 2020
- Schwager v. Comm’r, T.C. Memo. 2020-83 | June 15, 2020 | Urda, J. | Dkt. No. 17954-18L
- Sellers v. Comm’r, T.C. Memo. 2020-84 | June 15, 2020 | Buch, J. | Dkt. No. 5742-18
- Bidzimou v. Comm’r, T.C. Memo. 2020-85 | June 15, 2020 | Paris, J. | Dkt. Nos. 16250-17, 10104-18
- Moukhitdinov v. Comm’r, T.C. Memo. 2020-86 | June 16, 2020 | Colvin, J. | Dkt. No. 20240-18
- Santos v. Comm’r, T.C. Memo. 2020-88 | June 17, 2020 | Ashford, T. | Dkt. No. 27693-14
- Abrego v. Comm’r, T.C. Memo. 2020-87 | June 16, 2020 | Copeland, J. | Dkt. No. 23713-17
- Hewitt v. Comm’r, T.C. Memo. 2020-63 | June 17, 2020 | Goeke, J. | Dkt. No. 11728-17
- Cosio v. Comm’r, T.C. Memo. 2020-90 | June 18, 2020 | Vasquez J. | Dkt. No. 23623-17L
- Rogers, et. al. v. Comm’r, T.C. Memo. 2020-91 | June 18, 2020 | Goeke J. | Dkt. No. 29356-14, 15112-16, 2564-18.
Schwager v. Comm’r, T.C. Memo. 2020-83
Short Summary: In response to a proposed levy, Mr. Schwager filed a request for a Collection Due Process (CDP) hearing. In his CDP hearing request, he raised tax protestor arguments, including the ultra vires doctrine, delegation of authority, and the Paperwork Reduction Act. Later, during the hearing, Mr. Schwager insisted that he was not a “taxable person” under the Code, that the Office of Appeals had no jurisdiction over him, and that he could support these positions with discovery and reference to “Positive Laws.” The Settlement Officer closed Mr. Schwager’s case and issued a Notice of Determination concluding the proposed levy action was appropriate. After Mr. Schwager filed his petition with the Tax Court, IRS Chief Counsel moved for summary judgment.
Key Issue: Whether the Settlement Officer abused her discretion in concluding that the proposed levy action was appropriate.
- Because Mr. Schwager’s arguments are frivolous, and because the IRS Office of Appeals did not abuse its discretion, summary judgment is appropriate. In addition, Mr. Schwager is warned that continuing to make such arguments may result in a penalty under Section 6673.
Key Points of Law:
- The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials. Peach Corp. v. Comm’r, 90 T.C. 678, 681 (1988). Under Rule 121(b), the Tax Court may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Sundstrand Corp. v. Comm’r, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994).
- The Tax Court may impose a penalty not in excess of $25,000 whenever it appears to the Tax Court that a taxpayer has instituted or maintained a proceeding “primarily for delay” or has taken a position that is “frivolous or groundless.” See Section 6673.
Insight: Regrettably, there are still a few taxpayers that continue to make frivolous arguments similar to Mr. Schwager’s. The Schwager decision stands for the position that the Tax Court will swiftly dispose of such arguments via summary judgment procedures and may, in certain instances, impose a civil penalty.
Sellers v. Comm’r, T.C. Memo. 2020-84
Short Summary: For the years at issue, Mr. Sellers, a CPA, filed individual and business tax returns with the IRS. On his individual returns and on the returns of one of his corporations, Mr. Sellers deducted nonpassive losses attributable to two passthrough entities: King’s Dominion Investments, LLC (King’s Dominion), a partnership, and SS Marine, LLC, also a partnership. After auditing the returns, the IRS recharacterized the losses as passive and disallowed many of his deductions, including a self-employed health insurance expense deduction. The IRS also asserted accuracy-related penalties.
Key Issue: Whether: (1) Mr. Sellers and his corporation had sufficient bases in the passthrough entities to deduct the reported losses; (2) Mr. Sellers materially participated in SS Marine; and (3) Mr. Sellers may deduct his self-employed health insurance expenses. In addition, whether Mr. Sellers is liable for the accuracy-related penalty under Section 6662.
- Sellers failed to provide sufficient evidence to show his bases in the relevant passthrough entities; Mr. Sellers failed to show that he materially participated in SS Marine; and Mr. Sellers failed to substantiate he was entitled to a deduction for self-employed health insurance expenses. Moreover, the accuracy-related penalty is proper because he did not maintain sufficient records to substantiate items underlying his deductions and nonpassive losses, and he lacked reasonable cause because he has expertise in tax, business formations, and the necessity of maintaining records.
Key Points of Law:
- A partner may not deduct partnership losses in excess of the partner’s adjusted basis in the partnership. 704(d). And losses attributed to a partner cannot reduce that partner’s basis below zero. Sec. 705(a)(2).
- A partner’s outside basis is increased in part by the partner’s distributive share of income and the partner’s contributions to the partnership. 705(a)(1), Sec. 722. Any increase in a partner’s share of liabilities or assumption of partnership liabilities also increases the partner’s outside basis. Sec. 752(a). A partner’s basis is decreased by the partner’s distributive share of partnership losses, nondeductible expenses, and distributions. Sec. 705(a)(2).
- When he bears the burden of proof on a matter of substantiation, the Commissioner will fail to meet that burden if the taxpayer provides additional information regarding substantiation records. Storey v. Comm’r, T.C. Memo. 2012-115.
- It is well established that the Tax Court may draw an adverse inference from a party’s failure to introduce evidence available to the party. Abramson v. Comm’r, T.C. Memo. 1987-276.
- Section 469 generally prohibits deducting passive losses from unrelated income and allows them to offset only other passive income. Disallowed passive losses do not disappear; they are suspended and may be used to offset passive income in a later year. 469(b). A passive activity is a trade or business in which the taxpayer does not materially participate. Sec. 469(c)(1). A taxpayer materially participates in an activity when he or she is involved on a regular, continuous, and substantial basis. Sec. 469(h)(1). When determining material participation, the activity of a spouse is taken into account. Sec. 469(h)(5). The regulations identify safe harbors that satisfy material participation, including a safe harbor in which the taxpayer participates in the activity for more than 500 hours during the year. Temp. Reg. § 1.469-5T(a).
- A taxpayer may establish participation “by any reasonable means.” Reg. § 1.469-5T(f)(4). “Reasonable means * * * may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.” Id. Although “reasonable means” may be interpreted broadly, “a post-event ballpark guestimate” will not suffice. Goshorn v. Comm’r, T.C. Memo. 1993-578. In addition, the Tax Court is not “bound to accept the unverified, undocumented testimony of taxpayers.” Bartlett v. Comm’r, T.C. Memo. 2013-182.
- Credible testimony from multiple witnesses can strengthen a taxpayer’s testimony. Lamas v. Comm’r, T.C. Memo. 2015-59.
- Section 162(l)(1) allows a self-employed individual to deduct medical insurance costs for the tax year.
- Section 6662(a) and (b)(1), (2), and (3) imposes a penalty on “any portion of an underpayment of tax required to be shown on a return” if the underpayment is due to, among other reasons, negligence, a substantial understatement of income tax, or a substantial valuation misstatement. An understatement of income tax is “substantial” if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. 6662(d)(1)(A).
- “Negligence” includes any “failure to make a reasonable attempt to comply with the provisions of this title.” 6662(c). Negligence has been further defined as a “lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances.” Neely v. Comm’r, 85 T.C. 934, 947 (1985). Additionally, a taxpayer is negligent if he fails to maintain sufficient records to substantiate the items in question. Higbee v. Comm’r, 116 T.C. 438, 449 (2001).
Insight: The Sellers decision shows the importance of taxpayers maintaining sufficient books and records to substantiate items claimed on their return. This is particularly so where a taxpayer does not engage in a business full-time and may need to show material participation in the activity.
Bidzimou v. Comm’r, T.C. Memo. 2020-85
Short Summary: Mr. Bidzimou (the taxpayer) and Ms. Bidzimou were married and had one child, BB. However, they divorced in 2013, and pursuant to those divorce proceedings, Ms. Bidzimou was made the custodial parent with Mr. Bidzimou retaining certain “parenting time.” The divorce court also ordered Mr. Bidzimou to pay child support and health insurance for BB, and gave him the “right to claim the child on all income tax filings.”
In addition, Mr. Bidzimou attended Butler County Community College (BCCC) at least half time and had expenses related to tuition and other education expenses. Part of Mr. Bidzimou’s tuition and education expenses were paid pursuant to Federal Pell Grants and Federal direct student loans.
For 2015 and 2016, Mr. Bidzimou timely filed federal income tax returns. On both returns, he claimed a dependency exemption deduction with respect to BB, head of household filing status, an additional child tax credit, and an earned income tax credit. In addition, for 2015, he claimed the American opportunity credit and for 2016, he claimed the child tax credit. However, he did not file with either return a Form 8832, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or equivalent declaration signed by the custodial parent.
Key Issue: Whether Mr. Bidzimou is entitled to: (1) dependency exemption deductions under Section 151(a) and (c) for 2015 and 2016; (2) head of household filing status under Section 1(b) and 2(b) for 2015 and 2016; (3) a child tax credit or an additional child tax credit under Section 24(a) and (d), respectively, for 2015 and 2016; and (4) earned income tax credits under Section 32(a) for 2015 and 2016. In addition, whether Mr. Bidzimou paid qualifying tuition and related expenses over and above a Federal Pell grant award, and if so, in what year he paid those expenses.
- Bidzimou is not entitled to a dependency exemption deduction for BB because: (1) the evidence does not show that BB stayed more than one-half of the nights with Mr. Bidzimou in 2015 and 2016; (2) BB was the qualifying child of his mother, the custodial parent, for those years; and (3) Mr. Bidzimou did not attach a Form 8332 (or equivalent declaration) to either the 2015 or 2016 tax return.
- Bidzimou is not entitled to claim head of houseld because BB is not his qualifying child under Section 152(c) for 2015 or 2016, nor is Mr. Bidzimou entitled to a dependency exemption deduction for BB under Section 151 for 2015 or 2016.
- Because BB is not Mr. Bidzimou’s qualifying child under Section 152(c) for 2015 or 2016, he is not entitled to either a child tax credit or an additional child tax credit for 2015 or 2016.
- Bidzimou is not entitled to the earned income tax credit for 2015 or 2016 because BB was not his qualifying child and because Mr. Bidzimou’s adjusted gross income exceeded the threshold for a single person for those years.
- Bidzimou is entitled to an education credit for 2016 for the portion of his qualified tuition and related expenss not paid with Federal Pell grant proceeds but paid with proceeds from Federal direct student loan proceeds.
Key Points of Law:
- Generally, the Commissioner’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving error in the determinations. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions and credits are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction or credit claimed on a return. INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
- Section 151(a) and (c) allows taxpayers an annual exemption deduction for each “dependent” as defined in Section 152. A dependent is either a qualifying child or a qualifying relative. 152(a). The requirement is disjunctive; an individual satisfying either the qualifying child requirement or the qualifying relative requirement may be claimed as a dependent. Skitzki v. Comm’r, T.C. Memo. 2019-106.
- A qualifying child must meet five requirements for the taxpayer to qualify for the deduction. 152(c). To be a taxpayer’s qualifying child under section 152(c)(1), an individual must: (A) bear a specified relationship to the taxpayer; (B) have the same principal place of abode as the taxpayer for more than one-half of the taxable year; (C) meet certain age requirements; (D) have not provided over one-half of his or her own support for the year; and (E) not have filed a joint return with his or her spouse for the taxable year.
- Tax Court precedent has counted a child’s nights spent with a parent in determining whether the child has the same principal place of abode as that parent for more than one-half of the tax year. Skitzki, supra.
- Pursuant to Section 152(e), a child will be treated as a qualifying child of the noncustodial parent rather than of the custodial parent when the following requirements are met: (1) the custodial parent signs a written declaration, in the manner and form prescribed by Regulations, stating that she will not claim the child as a dependent for each year at issue; and (2) the noncustodial parent attaches the declaration to his return for each year. The written declaration must be an “unconditional release” of the custodial parent’s claim to the child as a dependent. Treas. Reg. § 1.152-4(e)(1)(i). The written declaration must be made either on a completed Form 8332 or on a statement conforming to the substance of Form 8332. Miller v. Comm’r, 114 T.C. 184, 189 (2000). Court orders, decrees, and separation agreements executed in a taxable year beginning after July 2, 2008, do not qualify. Reg. § 1.152-4(e)(1)(ii). Indeed, it is the Code and not State court orders that determines one’s eligibility for a deduction for federal income tax purposes. Shenk v. Comm’r, 140 T.C. 200, 206 (2013).
- Section 1(b) provides a special tax rate for an individual who qualifies as a head of household. Section 2(b) defines head of household, as relevant here, as an individual who: (1) is unmarried as of the close of the tax year and is not a surviving spouse and (2) maintains as his home a household that constitutes for more than one-half of the tax year the principal place of abode, as a member of such household, of either a qualifying child of the individual or any other person who is a dependent of the taxpayer, provided the taxpayer is entitled to a deduction for the tax year for that person under Section 151. Rowe v. Comm’r, 128 T.C. 13, 16-17 (2007).
- A taxpayer may claim a child tax credit for an individual who is his “qualifying child” as defined in Section 152(c) and has not attained age 17 during the tax year. 24(a), (c). Under Section 24(d), a portion of that credit – commonly referred to as the additional child tax credit – is refundable.
- Section 32(a)(1) allows an eligible individual an earned income tax credit to offset that individual’s tax liability, subject to a phaseout explained in Section 32(a)(2). The amount of the credit to which an eligible individual is entitled increases if the individual has a qualifying child. 32(b), (c)(3). A qualifying child for purposes of Section 32 is generally defined as an individual who is the taxpayer’s “qualifying child” as defined in Section 152(c). Sec. 32(c)(3)(A). In addition, a taxpayer without any qualifying children may be eligible for the earned income tax credit for 2015 or 2016, but only if his adjusted gross income did not exceed $14,820 for 2015 and $14,880 for 2016 if he was not filing a joint return. See Rev. Proc. 2014-61, sec. 3.06(1); Rev. Proc. 2015-53, sec. 3.06(1).
- The Code permits an education credit, referred to as the American Opportunity Credit. See Section 25A(i). A taxpayer may claim a credit for qualified tuition and related expenses paid with proceeds from a student loan, even if those proceeds are paid by the lender directly to the educational institution on the student’s behalf. See Reg. § 1.25A-5(b)(1); Terrell v. Comm’r, T.C. Memo. 2016-85. Loan proceeds disbursed directly to an education institution are treated as being paid by the student on the date the institution credits the proceeds to the student’s account. See Treas. Reg. § 1.25A-5(e)(3); Terrell, supra.
Insight: The Tax Cuts and Jobs Act suspended the deduction for personal and dependency exemptions for tax years 2018 through 2025. However, the ability to claim a dependent for these years may still permit a taxpayer to be eligible for other tax benefits, such as the child tax credit, additional child tax credit, earned income credit, and head of household filing status. As shown in Bidzimou, the taxpayer may be required to meet certain requirements and jump through certain hoops to qualify.
Moukhitdinov v. Comm’r, T.C. Memo. 2020-86
Short Summary: The taxpayers are married and filed a joint income tax return for 2013. The IRS issued a notice of deficiency but inadvertently added “946” to the end of the taxpayers’ proper zip code: 10017-3522. Later, when the taxpayers failed to respond, the IRS issued a collection notice with the same erroneous zip code. However, the taxpayers responded to the collection notice. Almost 20 months after the notice of deficiency deadline, the taxpayers petitioned the Tax Court.
Key Issue: Whether the Tax Court has jurisdiction over the petition filed by the taxpayers.
- Under Second Circuit precedent, the Tax Court lacks jurisdiction over the late-filed petition because the record shows a proper notice of deficiency and Forms 3877 with inconsequential errors. Accordingly, the IRS’ burden has been met, and the notice was sent to the taxpayers’ last known address.
Key Points of Law:
- To be valid, a notice of deficiency must be sent to a taxpayer’s “last known address.” 6212(b); King v. Comm’r, 88 T.C. 1042, 1050 (1987), aff’d, 857 F.2d 676 (9th Cir. 1988). Generally, a taxpayer’s last known address is the address that appears on the taxpayer’s most recently fled and processed federal tax return. Treas. Reg. § 301.6212-2(a). A notice of deficiency is valid even if the taxpayer’s address includes an inconsequential error. Yusko v. Comm’r, 89 T.C. 806, 810 (1987). The Tax Court has previously said an error in a zip code was inconsequential. See, e.g, Lee v. Comm’r, T.C. Memo. 2011-129; Sebastian v. Comm’r, T.C. Memo. 2007-138; Pickering v. Comm’r, T.C. Memo. 1998-142.
- In O’Rourke v. U.S., 587 F.3d 537, 540 (2d Cir. 2009) (to which this case is appealable absent a stipulation to the contrary) held that the Commissioner met the burden of proving proper mailing of a notice of deficiency by providing: (1) a proper notice of deficiency; and (2) an incomplete Form 3877. To be valid, a notice of deficiency must “identify the taxpayer, indicate that the Commissioner has made a determination of deficiency, and specify the taxable year and amount of the deficiency.” Andrew Crispo Gallery, Inc. v. Comm’r, 16 F.3d 1336, 1340 (2d Cir. 1994).
- Where the existence of the notice of deficiency is not disputed, a properly completed Form 3877 by itself is sufficient, absent evidence to the contrary, to establish that the notice was properly mailed to a taxpayer. Coleman v. Comm’r, 94 T.C. 82, 91 (1990). A defective Form 3877 corroborated with other evidence also can be sufficient to prove mailing.
Insight: Forms 3877, Firm Mailing Book for Accountable Mail, are used by the U.S. Postal Service to internally track mail. In this case, the IRS introduced into evidence two Forms 3877, dated November 1, 2016, which included a list of items being sent by the “IRS Detroit Computing Center.” Generally, the IRS will use these forms and testimony of a U.S. Postal employee to try to prove that a notice of deficiency was mailed on a certain date if the taxpayer disagrees.
Abrego v. Comm’r, T.C. Memo. 2020-87
Short Summary: During 2015, Mr. Abrego was a driver and, in his spare time, ran a small business preparing tax returns, mostly for friends and family members. Mrs. Abrego was a housekeeper. Although Mr. Abrego was eligible for Medicare during 2015, the Abregos nevertheless purchased private health insurance because they expected to receive the premium assistance tax credit (PTC) under the Patient Protection and Affordable Care Act (ACA). The health plan the Abregos enrolled in required them to pay monthly premiums of $1,029.01.
Under the ACA, the U.S. Department of Treasury offset the cost of the Abregos’ plan premiums by making monthly advance PTC payments to the plan on the Abregos’ behalf. Thus, Treasury paid the plan 10 monthly installments of $921 for a total of $9,210 during 2015. During those 10 months, the Abregos paid the difference, or $108.01 per month.
The Abregos filed their 2015 tax return on January 24, 2017. They did not request an extension of time to file because they expected to receive a refund. On their return, the Abregos left blank Line 69, Net Premium Tax Credit. The Abregos also failed to attach to their return Form 8962, Premium Tax Credit, which is used to reconcile the amount of the advanced PTC a taxpayer receives with the amount of the PTC to which the taxpayer is ultimately entitled.
The IRS issued the Abregos a notice of deficiency determining that the Abregos: (1) received advanced PTC payments of $9,210, but (2) were not entitled to any PTC for 2015, and (3) were responsible for repaying the excess of advanced PTC paid on their behalf for 2015, $9,210, over the PTC to which they were entitled, zero. Moreover, the IRS determined that the Abregos were ineligible for the PTC because their income exceeded 400% of the federal poverty line for a family of two in California, where they resided.
Key Issue: Whether the Abregos: (1) received excess advance payments of the premium assistance tax credit (commonly known as the premium tax credit or PTC) allowed under section 1412 of the ACA, which in turn increased their tax due by the amount of the excess, subject to the limitations set forth in Section 36B(f)(2)(B); and (2) are liable for the addition to tax under Section 6651(a)(1) for filing their 2015 tax return late.
- The Abregos are liable: (1) for repayment of $2,500 of the advanced PTC; (2) for the addition to tax under Section 6651(a)(1) for filing their 2015 return late.
Key Points of Law:
- Generally, the Commissioner’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
- The ACA, section 1401, created Section 36B, which provides that taxpayers meeting certain requirements are eligible for the PTC, which subsidizes the cost of their health insurance purchased through a health insurance exchange. Reg. § 1.36B-2(a). A recipient can elect to receive PTC payments in advance on the basis of an estimate of the amount of PTC for which the recipient will be eligible and whereupon monthly payments are made throughout the year directly from Treasury to the recipient’s insurer. ACA, sec. 1412.
- Taxpayers are generally eligible for the PTC if their HHI is at least 100% but not more than 400% of the amount equal to the FPL for the applicable year. 36B(c)(1)(A). HHI is specifically defined for this purpose. Sec. 36B(d)(2)(A); see also Treas. Reg. § 1.36B-1(e)(1). Eligibility is also contingent on enrollment in a qualified health plan. Sec. 36B(b)(2)(A).
- HHI means the sum of the taxpayer’s modified adjusted gross income (MAGI) plus the MAGI of family members: (1) for whom the taxpayer properly claims deductions for personal exemptions; and (2) who are required to file a federal income tax return under Section 1. 36B(d)(2)(A). An individual’s MAGI is his or her AGI increased by: (1) amounts related to foreign earned income and housing costs which were excluded from gross income under Section 911; (2) tax-exempt interest; and (3) the amount of any Social Security benefits which were not included in gross income under Section 86. Sec. 36B(d)(2)(B).
- Section 162(l) permits self-employed taxpayers to deduct all or a portion of their health insurance premiums paid during the tax year for the taxpayer and certain members of the taxpayer’s family. The deduction is limited to the taxpayer’s earned income from a trade or business with respect to which the health insurance plan is established. 162(l)(2)(A).
- The amount of PTC a taxpayer is entitled to is calculated by comparing the premium for the plan the taxpayer selected to a PTC amount calculated against a benchmark plan premium. If the actual plan premium is less than the calculated PTC amount, then the PTC will cover the entire plan premium. If the plan premium is more than the calculated PTC amount, then the PTC will cover only the calculated PTC amount
- At the end of the year a taxpayer who received an advanced PTC is instructed by the IRS to use Form 8962 to reconcile: (1) the amount of the advanced PTC (which was based on the estimated eligibility) the taxpayer received during the year with (2) the amount of PTC to which the taxpayer is actually entitled (which is based on HHI when the taxpayer files his or her annual income tax return). See Section 36B(f)(2). If the amount of the advanced PTC is more than the amount of PTC to which the recipient is ultimately entitled, the taxpayer owes the excess credit back to the Government, which is reflected as an increase in tax. 36B(f)(2)(A); Keel v. Comm’r, T.C. Memo. 2018-5.
- However, the increase in tax for excess advanced PTC is limited to a maximum of $2,500 if the taxpayer’s HHI is at least 300% but less than 400% of the FPL. 36B(f)(2)(B)(i). If a recipient is wholly ineligible for the PTC because the recipient’s HHI was more than 400% of the FPL, then the entire amount of already paid advanced PTC must be included as a tax liability on the recipient taxpayer’s tax return. Sec. 36B(c)(1)(A), (f)(2)(B).
- Section 6651(a)(1) imposes an addition to tax for the late filing of a return absent a showing by the taxpayers of reasonable cause and lack of willful neglect. The penalty is calculated as 5% of the amount required to be shown as tax on the return for each month, not to exceed 25% in the aggregate. 6651(a)(1). Reasonable cause exists if the taxpayer exercised ordinary business care and prudence but nevertheless could not file or pay the tax when due. U.S. v. Boyle, 469 U.S. 241, 245 (1985). Circumstances that may constitute “reasonable cause” include (among other things) unavoidable postal delays, the timely filing of a return with the wrong IRS office, the death or serious illness of a taxpayer or a member of his immediate family, a taxpayer’s unavoidable absence from the United States, or reliance on erroneous advice from a competent tax advisor or IRS officer. Marrin v. Comm’r, 147 F.3d 147, 152 (2d Cir. 1998), aff’g, T.C. Memo. 1997-24; McMahan v. Comm’r, 114 F.3d 366, 369 (2d Cir. 1997), aff’g T.C. Memo. 1995-547. However, there is no legal basis for a position that filing late is excusable because a refund is expected.
Insight: The Abregos case shows the difficulty of determining with specificity, at least in some cases, whether a taxpayer qualifies for the advanced PTC and PTC. In addition, it stands for the position that it may difficult to support a reasonable cause defense for abatement or waiver of penalties where the taxpayer anticipated a refund but that belief later turns out to be untrue.
Santos v. Comm’r, T.C. Memo. 2020-88
Short Summary: Petitioner challenged the IRS’ determination that Petitioner had misclassified her workers as independent contractors when they should have been classified as employees. Because of the misclassification by Petitioner, the IRS determined that Petitioner was liable for unpaid federal employment taxes. The Tax Court ruled in favor of the Petitioner.
Key Issue: The sole issue at trial was whether Petitioner’s workers should be classified as employees or independent contractors.
- The totality of the circumstances and facts will need to be considered when determining whether a worker is to classified as an employee or an independent contractor.
Key Points of Law:
- Whether an individual is an employee or an independent contractor is a factual question to which common law principles apply. Weber v. Commissioner,103 T.C. 378, 386 (1994), aff’d per curiam, 60 F.3d 1104 (4th Cir. 1995); see also IRC §3121(d)(2) (defining an employee as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee”).
- Relevant factors the Tax Court will consider in determining whether a worker is a common law employee or an independent contractor: (1) the degree of control exercised by the principal over the worker;(2) which party invests in the work facilities used by the worker; (3) the worker’s opportunity for profit or loss; (4) whether the principal can discharge the worker;(5) whether the work is part of the principal’s regular business; (6) the permanency of the relationship; and(7) the relationship the parties believed they were creating. Ewens & Miller, Inc. v. Commissioner, 117T.C. at 270 (citing Weber v. Commissioner, 103T.C. at 387). No single factor is determinative. Id.
- The extent to which the principal has the right to exercise control over the worker is the “crucial test” in determining the nature of a working relationship. Weber v. Commissioner, 103 T.C. at 387; see also Casey v. Dep’t of Health & Human Servs., 807 F.3d 395, 405 (1st Cir. 2015).
- An employer-employee relationship exists when the principal retains the right to direct the manner in which the work is to be done, controls the methods to be used in doing the work, and controls the details and means by which the desired result is to be accomplished. Coast Masonry, Inc. v. Commissioner, T.C. Memo. 2012-233, at*15 (citing Ellison v. Commissioner, 55 T.C. 142, 152-153 (1970)).
- The fact that the Petitioner issued 1099-MISC to her workers, and not W-2s, Forms 940 or Forms 941, showed evidence that the Petitioner thought she was creating independent contractors not employees. See Kurek v. Commissioner, at *14; John Keller, Action Auto Body v. Commissioner, slip op. at13-14.
Insight: The Santos case demonstrates the need for employers to correctly classify the workers that it has. Further, it illustrates the need to issue 1099-MISC to workers who have been classified as independent contractors.
Hewitt v. Comm’r, T.C. Memo. 2020-63
Short Summary: Petitioners claimed a charitable contribution for an easement donation on their 2012 Form 1040 and carried over portions of the contribution for 2013 and 2014. The IRS did not challenge the deduction for 2012 but disallowed the deduction for 2013 and 2014. The IRS determined IRC § 6662(e) and (h) 40% accuracy-related penalties for gross valuation misstatements and IRC § 6662(a) and (b)(1) and (2) 20% accuracy-related penalties. The Tax Court found that the Petitioners were not entitled to carryover the charitable deduction for the donation of the conservation easement, but Petitioner was not liable for the assessed penalties.
Key Issue: Whether the deed of conservation easement granted by the Petitioners protects the conservation purposes of the contribution in perpetuity as required by IRC §170(h)(5)?
- Petitioner’s deed of conservation easement does not meet the perpetuity requirement of by IRC §170(h)(5) as the deed does not allocate to the donee a share of the proceeds in the event the property is sold following a judicial extinguishment of the easement in violation of 26 CFR §1.170A-14(g)(6)(ii).
- Petitioner did not overstate the fair market value of the easement by 200% or more and therefore is not liable for 40% accuracy-related penalties for gross valuation misstatements. Further, Petitioner is not liable for 20% accuracy-related penalties as Petitioners reasonably relied on professional advice.
Key Points of Law:
- IRC §170(a)(1) allows taxpayers to deduct charitable contributions made within the taxable year. If the taxpayer makes a charitable contribution of property other than money, the amount of the contribution is generally equal to the donated property’s fair market value at the time of the donation. 26 CFR §170A-1(c)(1).
- Generally, a taxpayer is not entitled to deduct the donation of “an interest in property which consists of less than the taxpayer’s entire interest in such property”. IRC §170(f)(3)(A).
- An exception is made for a contribution of a partial interest in property that constitutes a “qualified conservation contribution”. IRC §170(f)(3)(B)(iii). The exception applies where:(1) the taxpayer donates a “qualified real property interest”, (2) the donee is “a qualified organization”, and (3) the contribution is “exclusively for conservation purposes.” IRC §170((h)(1). The donation must satisfy all three requirements. Irby v. Commissioner, 139T.C. 371, 379 (2012).
- A contribution is exclusively for conservation purposes if its conservation purpose is protected in perpetuity. IRC §170(h)(5)(A).
- If an unexpected change subsequent to the granting of the conservation easement makes it impossible or impractical to use the property for conservation purposes, the perpetuity requirement may be deemed satisfied if the restrictions are extinguished by judicial proceeding and the donee uses the all the donee’s proceeds from a subsequent sale or exchange of the property in a manner consistent with the conservation purposes of the original contribution. 26 CFR §1.170A-14(g)(6)(i).
- The proceeds that a donee receives from a subsequent sale, exchange, or involuntary conversion of the property must take into account the value of any posteasement improvements to the property. 26 CFR §1.170A-14(g)(6)(ii).
- The IRS has the burden of production with respect to penalties. RERI Holdings I, LLC v. Commissioner, 149 T.C. 1, 37 (2017), aff’d sub nom. Blau v. Commissioner, 924 F.3d 1261 (D.C. Cir. 2019).
- A gross valuation misstatement occurs when a taxpayer reports a value for the donated property that is 200% or more of the correct amount. IRC §6662(h)(2).
- When experts offer competing estimates of fair market value, the Tax Court will decide how to weigh those estimates by examining the factors the experts considered in reaching their conclusions. Casey v. Commissioner, 38 T.C. 357, 381 (1962).
- IRC §6662(a) accuracy-related penalties do not apply where the taxpayers establish that they acted with reasonable cause and in good faith. IRC §6664(c)(1); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299F.3d 221 (3d Cir. 2002).
- The Tax Court will determine reasonable cause and good faith on a case-by-case basis taking into account all pertinent fact sand circumstances. The most important factor is the extent of the taxpayer’s effort to assess his proper tax liability. The taxpayer’s education and business experience are also relevant. 26 CFR §1.6664-4(b)(1), and (c)(1).
- Reliance on professional advice may constitute reasonable cause and good faith if the reliance was reasonable. Freytag v. Commissioner, 89 T.C. 849, 888(1987), aff’d on another issue, 904 F.2d 1011 (5th Cir. 1990), aff’d, 501 U.S. 868(1991); 26 CFR §1.6664-4(b)(1), (c)(1).
- Reliance on professional advice is reasonable if (1) the professional was independent and had the expertise to justify reliance, (2) the taxpayers provided necessary and accurate information to the adviser, and (3) the taxpayers actually relied in good faith on the advice. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), aff’d,3d 221 (3d Cir. 2002).
Insight: The Hewitt case illustrates the importance of strict adherence to the to the Tax Code when drafting deeds for conservation easements. Further, it reinforces the need for taxpayers to properly assess their tax liability and employ competent professional tax advisors if a taxpayer is unsure.
Cosio v. Comm’r, T.C. Memo. 2020-90
Short Summary: Petitioner sought review, pursuant to I.R.C. § 6330(d)(1), of the IRS determination to proceed with collection of his unpaid Federal income tax liabilities for 2012 and 2015. The IRS filed a motion for summary judgment alleging that the Appeals Officer did not abuse her discretion because she provided the petitioner with a reasonable opportunity to present evidence with respect to tax year 2015. The Tax Court held that a genuine question of material fact existed, and the motion for summary judgment was denied.
Key Issue: Whether an issue of fact existed as to the Appeals Officer abusing her discretion by failing to provide petitioner a reasonable opportunity to present evidence with respect to tax year 2015.
- A genuine issue of material fact existed so as to preclude summary judgment in favor of the IRS. Specifically, the notice of determination contained inaccurate discussions of the case’s activity, which created a material issue of fact.
Key Points of Law:
- With respect to proceedings in tax court regarding a Collection Due Process hearing, the court’s jurisdiction depends on the issuance of a notice of determination following a timely request for a CDP hearing and the filing of a timely petition for review in Tax Court.
- In a Tax Court case, the Court may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. See Rule 121(b).
- In deciding whether to grant summary judgment, the court will construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994).
- If a taxpayer requests a hearing in response to a notice of levy pursuant to section 6330, a hearing shall be held before an impartial officer or employee of Appeals before a levy can be made. R.C. § 6330(b)(1), (3).
- At the hearing the taxpayer may raise any relevant issue relating to the unpaid tax or the proposed levy, including appropriate spousal defenses, challenges to the appropriateness of the collection action, and collection alternatives. I.R.C. § 6330(c)(2)(A).
- A taxpayer is precluded from contesting the existence or amount of the underlying liability unless the taxpayer did not receive a notice of deficiency for the liability in question or did not otherwise have an opportunity to dispute the liability. I.R.C. § 6330(c)(2)(B).
- Following a hearing Appeals must determine whether proceeding with the proposed levy action is appropriate. In making that determination Appeals is required to take into consideration: (1) verification presented by the Secretary during the hearing process that the requirements of applicable law and administrative procedure have been met, (2) relevant issues raised by the taxpayer, and (3) whether the proposed levy action appropriately balances the need for the efficient collection of taxes with the taxpayer’s concerns regarding the intrusiveness of the proposed collection action. I.R.C. § 6330(c)(3).
- Section 6330(d)(1) grants this Court jurisdiction to review Appeals’ determination in connection with a collection hearing. Where the validity of the underlying tax liability is properly at issue, the Tax Court will review the taxpayer’s liability de novo. Where the underlying tax liability is not properly at issue, the Tax Court will review the determination for abuse of discretion.
- To preserve a challenge to the underlying tax liability in a CDP hearing, the taxpayer “must also present Appeals with ‘evidence with respect to that issue after being given a reasonable opportunity’ to do so.” Treas. Reg. § 301.6330-1(f)(2).
Insight: The Cosio case illustrates the use of § 6330 and any subsequent review of an Appeals Officer’s notice of determination with respect to an IRS collection action. The case provides an overview for the process, but it also demonstrates the importance of ensuring, as a practitioner, that all facts that may bear on the Appeals Officer’s determination or discretion are entered into the Appeals Officer’s record in order to challenge a notice of determination in Tax Court. This includes keeping highly specific records of any correspondence with the Appeals Officer.
Rogers, et. al. v. Comm’r, T.C. Memo. 2020-91
Short Summary: Petitioner sought review of an IRS determination that she was not entitled to Innocent Spouse Relief.
Key Issue: Whether the taxpayer was entitled to innocent spouse relief pursuant to I.R.C. 6015(b), (f) where the petitioner was an attorney and her husband was a tax attorney with a history of aggressive tax positions.
- The taxpayer was not entitled innocent spouse relief.
Key Points of Law:
- Section 6015 provides a regime for a joint filer to seek relief from that joint and several liability. Under Section 6015(b)(1), a taxpayer is entitled to relief to the extent such tax liability is attributable to such understatement if:
- (A)a joint return has been made for a taxable year;
- (B)on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return;
- (C)the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;
- (D)taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement; and
- (E)the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election.
- In determining relief pursuant to Section 6015(f), the Tax Court uses IRS guidance. Specifically, Rev. Proc. 2013-34 sets forth a three-part procedure for evaluating requests for innocent spouse relief:
- (1) section 4.01 lists seven threshold conditions that a requesting spouse must satisfy to be eligible for relief;
- (2) section 4.02 sets out a three-part test for a streamlined determination to grant relief; and
- (3) if the taxpayer is not entitled to a streamlined determination, section 4.03 sets out a nonexclusive list of factors that the IRS will consider in determining whether it would be inequitable to hold the spouse jointly and severally liable.
- The seven threshold conditions under Rev. Proc. 2013-34 are as follows:
- (1) the requesting spouse filed a joint return for the taxable year for which she seeks relief;
- (2) relief is not available to the requesting spouse under section 6015(b) or (c);
- (3) the claim for relief is timely filed;
- (4) no assets were transferred between the spouses as part of a fraudulent scheme by the spouses;
- (5) the nonrequesting spouse did not transfer disqualified assets to the requesting spouse;
- (6) the requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and
- (7) with enumerated exceptions, the income tax liability from which the requesting spouse seeks relief is attributable (in full or in part) to an item of the nonrequesting spouse.
- If the taxpayer is not entitled to a streamlined determination, the Tax Court will look at the following factors:
- (1) marital status;
- (2) economic hardship;
- (3) knowledge or reason to know;
- (4) legal obligation by either the requesting spouse or the nonrequesting spouse to pay the Federal income tax liability;
- (5) significant benefit;
- (6) compliance with Federal income tax laws; and
- (7) mental or physical health issues.
- No single factor is determinative, and all factors shall be considered and weighted appropriately.
- But the Tax Court may choose to assign varying weight to each factor or to include other factors depending on the specific facts and circumstances of each case. And the Tax Court may assign particular weight to the requesting spouse’s knowledge of the erroneous items on the joint income tax returns.
Insight: The Rogers case illustrates how the Tax Court analyzes claims for innocent spouse relief pursuant to Section 6015. But of particular note, the Tax Court can place a heavy emphasis on the requesting spouse’s “knowledge of the erroneous items on the joint income tax returns” in making a determination—particularly where the taxpayer is sophisticated in his or her own right.
Need assistance in managing the audit process? Freeman Law’s team of attorneys and dual-credentialed attorney-CPAs regularly represents taxpayers before the IRS and Texas Comptroller. Our team also provides tax return-related representations and helps taxpayers navigate state tax laws. Our Firm offers value-driven services and provides practical solutions to complex issues. Schedule a consultation or call (214) 984-3410 to discuss our tax representation services.