The Tax Court in Brief August 29 – September 4, 2020

The Tax Court in Brief August 29 – September 4, 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.

Tax Litigation: The Week of August 29 – September 4, 2020

• Savedoff v. Comm’r, T.C. Memo. 2020-125
• Daichman v. Comm’r, T.C. Memo. 2020-126
• Douglas M. Thompson and Lisa Mae Thompson v. Comm’r, 155 T.C. No. 5
• Dickinson v. Commissioner, T.C. Memo. 2020-128
• Franklin v. Commissioner, T.C. Memo. 2020-127

Savedoff v. Comm’r, T.C. Memo. 2020-125

August 31, 2020 | Urda P. | Dkt. No. 4346-18L

• Opinion

 Short Summary:  In a collection due process case, the Petitioner seek review of the IRS’s Office of Appeal’s decision to uphold the filing of a notice of federal tax lien (“NFTL”) with respect to unpaid federal income tax liabilities for years 2013 and 2014, as well as associated interest and additions to tax.  Petitioner contends that she did not receive proper service of the NFTL and the Office of Appeals abused its discretion in its determination.  The IRS moved for summary judgment and the Tax Court granted the motion.

Key Issue:  Was the NFTL properly served on the Petitioner and did the Office of Appeals abuse it discretion by not withdrawing the NFTL once Petitioner had entered into an installment agreement.

Primary Holdings: 

• A taxpayer’s last known address is the address that appears on the taxpayer’s most recently filed and properly processed Federal tax return, unless the IRS is given clear and concise notification of a different address.
• The IRS may withdraw a NFTL when a taxpayer enters an installment agreement however the IRS is not required to do so.

Key Points of Law:

• Under 26 USC App. 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. In deciding whether to grant summary judgment, the Tax Court will construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party.  The nonmoving party, however, may not rest upon the mere allegations or denials in its pleadings but instead must set forth specific facts showing that there is a genuine dispute for trial.  See 26 USC App. Rule 121(b); See also Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986).
• Pursuant to IRC §§ 6320(c) and 6330(d)(1) the Tax Court has jurisdiction to review Office of Appeals’ determinations. When the underlying tax liabilities are not at issue, the Tax Court will review the determination of the Office of Appeals for abuse of discretion. See Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176, 182 (2000).
• In reviewing for abuse of discretion, the Tax Court must uphold the Office of Appeals’ determination unless it is arbitrary, capricious, or without sound basis in fact or law. See, e.g., Murphy v. Commissioner, 125 T.C. 301, 320 (2005), aff’d, 469 F.3d 27 (1st Cir. 2006); Taylor v. Commissioner, T.C. Memo.  2009-27, 97 T.C.M. (CCH) 1109, 1116 (2009).
• To determine whether the Office of Appeals abused its discretion, the Tax Court will review whether the settlement officer met the three requirements of IRC § 66330(c)(3): (a) properly verify that the requirements of any applicable law or administrative procedure have been met; (b) consider any relevant issues raised by the taxpayer; and (c) consider whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.
• IRC § 6320(a)(2)(C) provides that an NFTL shall be sent to the taxpayer’s last known address. See also 26 CFR § 1301.6320-1(a)(1).  A taxpayer’s last known address is the address that appears on the taxpayer’s most recently filed and properly processed Federal tax return, unless the IRS is given clear and concise notification of a different address.  See26 CFR § 301.6212-2(a).  This definition applies to lien notices.  See id.  (c).
• A taxpayer may submit a change of address by indicating a new address on her most recently filed tax return, by properly filing a written or electronic notice of change of address with the IRS, or by providing an updated address to the U.S. Postal Service for inclusion in its National Change of Address database. See Chapman v. Commissioner, T.C. Memo. 2019-110, at *15; see also 26 CFR § 301.6212-2(a) and (b; Rev. Proc. 2010-16, sec. 5.04, 2010-19 I.R.B. 664, 667.
• IRC § 6323(j) permits the IRS to withdraw an NFTL in certain enumerated circumstances, including where a taxpayer enters into an installment agreement. IRC § 6323(j) “is permissive, and nothing in it requires respondent to withdraw the NFTL because of * * * [an] installment agreement.”  See Berkery v. Commissioner, T.C. Memo. 2011-57, 101 T.C.M. (CCH) 1258, 1260 (2011); see also 26 CFR § 301.6323(j)-1(c). (“If the Commissioner determines conditions for withdrawal [of an NFTL] are present, the Commissioner may (but is not required to) authorize the withdrawal.”). The existence of the installment agreement by itself thus did not render the NFTL unnecessary or require its withdrawal.
• As a general matter, the Internal Revenue Manual (IRM) provides that an NFTL should be withdrawn where, inter alia, a taxpayer has entered into a direct debit installment agreement and his aggregate unpaid balance of assessments on the installment agreement is $25,000 or less at the time of the request. See IRM pt. 5.12.9.3.2.1(3) and (4) (Oct. 14, 2013).

Insight:  This case highlights the need for taxpayers to provide the IRS with their current address, especially in instances where the taxpayer is involved in settlement negotiations with the IRS.  The case also illustrates that the IRS is not required to withdraw a NFTL in every instance where it enters into a settlement agreement with a taxpayer.

Daichman v. Comm’r, T.C. Memo. 2020-126 

August 31, 2020 | Paris, J. | Dkt. No. 14368-15

• Opinion

Short Summary:  During 2009, the taxpayers transferred personal assets of cash and marketable securities to a wholly owned S corporation, which in turn immediately transferred those assets to a family limited partnership.  Weeks later, the taxpayers dissolved the S corporation and received the partnership interest as a liquidating distribution.  Due to the liquidation, the taxpayers claimed a nonpassive loss deduction on Schedule E, Supplemental Income and Loss.

Key Issues:  Whether the taxpayers are entitled to a short-term capital loss deduction of $2,099,090 in connection with the dissolution of the S corporation, and whether the taxpayers are liable for an accuracy-related penalty.

Primary Holdings: 

• Because the transactions generating the reported loss on Schedule E for the dissolution of the S corporation lack economic substance, the reported loss is disallowed. Moreover, the taxpayers are liable for the accuracy-related penalty on the grounds of a substantial understatement of income tax.

Key Points of Law:

• A taxpayer is generally free to structure his business transactions as he wishes, even if motivated in party be a desire to reduce taxes. Gregory v. Helvering, 293 U.S. 465, 469 (1935); see also Smith v. Comm’r, T.C. Memo. 2017-218.  Transactions which do not vary control or change the flow of economic benefits, however, are to be dismissed from consideration.  See Higgins v. Smith, 308 U.S. 473, 476 (1940).  The economic substance doctrine allows courts to enforce the legislative purpose of the Code by preventing taxpayers from reaping tax benefits from transactions lacking economic reality.  Klamath Strategic Inv. Fund v. U.S., 568 F.3d 537, 543 (5^th 2009).
• A court may disregard a transaction for Federal income tax purposes, even one that formally complies with the Code, if the transaction has no effect other than generating an income tax loss. See Knetsch v. U.S., 364 U.S. 361 (1960); Smith v. Comm’r, T.C. Memo. 2017-218.  Whether a transaction has economic substance is a factual determination for which the taxpayer bears the burden of proof.  S. v. Cumberland Pub. Serv. Co., 338 U.S. 451, 456 (1950); Smith v. Comm’r, T.C. Memo. 2017-218.
• Under the Golsen rule, because an appeal in this case would lie with the U.S. Court of Appeals for the Fifth Circuit, see Section 7482(b)(1)(A), the Court follows the law of that circuit with respect to its interpretation of the economic substance doctrine. See Golsen v. Comm’r, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10^th 1971).
• The Court of Appeals for the Fifth Circuit has interpreted the economic substance doctrine as a conjunctive multifactor test. Klamath Strategic Inv. Fund, 568 F.3d at 544.  Within the Fifth Circuit, a transaction will be respected for tax purposes only if:  (1) it has economic substance compelled by business or regulatory realities; (2) it is imbued with tax-independent considerations; and (3) it is not shaped totally by tax avoidance features.  ; see also Frank Lyon Co. v. U.S., 435 U.S. 561, 583-84 (1978).  The transaction must therefore exhibit an objective economic reality, a subjectively genuine business purpose, and some motivation other than tax avoidance.  Southgate Master Fund, LLC v. U.S., 659 F.3d 466, 480 (5^th Cir. 2011); Smith v. Commissioner, T.C. Memo. 2017-218.  The Court of Appeals has recognized, however, that there is “near-total overlap between the latter two factors,” reasoning that “[t]o say that a transaction is shaped totally by tax-avoidance features is, in essence, to say that the transaction is imbued solely with tax-dependent considerations.”  Southgate Master Fund, LLC, 659 F.3d at 480 n.40.
• The first prong of the economic substance inquiry requires that the transaction have economic substance compelled by business or regulatory realities, often referred to as “objective economic reality.” A transaction lacks economic substance if it does not “vary control or change the flow of economic benefit[s]”.  Klamath Strategic Inv. Fund, 568 F.3d at 543 (quoting Higgins v. Smith, 308 U.S. at 476).  Under the objective economic inquiry, the Court examines whether the transaction affected the taxpayer’s financial position in any way, such as whether the transaction “either caused real dollars to meaningfully change hands or created a realistic possibility that they would do so.”  Southgate Master Fund, LLC, 659 F.3d at 481.  A circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes.  Merryman v. Comm’r, 873 F.2d 879, 882 (5^th 1989), aff’g T.C. Memo. 1988-72.
• The second and third prongs of the economic substance doctrine overlap and derive from an inquiry into the taxpayer’s purpose, e., whether the taxpayer had a subjectively genuine business purpose or some motivation other than tax avoidance. See Southgate Master Fund, 659 F.3d at 481.  Taxpayers are not prohibited from seeking tax benefits in conjunction with seeking profits for their business, and a taxpayer who acts with mixed motives of profit and tax benefits may nonetheless satisfy the subjective test.  Id. at 481-82.  Tax-avoidance considerations may not be the taxpayer’s sole purpose for entering into a transaction, however.  Salty Brine I, Ltd. v. U.S., 761 F.3d 484, 495 (5^th Cir. 2014).  The fact that a taxpayer enters into a transaction primarily to obtain tax benefits does not necessarily invalidate the transaction under the subjective purpose inquiry.  Compaq Comput. Corp. & Subs. v. Comm’r, 277 F.3d 778, 786 (5^th Cir. 2001), rev’g 113 T.C. 214 (1999).
• Section 6662(a) and (b)(1) and (2) imposes an accuracy-related penalty equal to 20% of the portion of an underpayment of tax required to be shown on a tax return that is attributable to “negligence or disregard of rules or regulations” or a “substantial understatement of income tax.” Negligence includes “any failure to make a reasonable attempt to comply with the provisions of this title.”  6662(c).  An understatement of income tax is a “substantial understatement” if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000.  Sec. 6662(d)(1)(A).
• The Commissioner bears the burden of production with respect to an individual taxpayer’s liability for any penalty, addition to tax, or additional amount, requiring the Commissioner to come forward with sufficient evidence indicating that imposition of the penalty is appropriate. 7491(c); Higbee v. Comm’r, 116 T.C. 438, 446-47 (2001).  The Court has previously held that, as part of that burden, the Commissioner must produce evidence that he complied with the procedural requirements of Section 6751(b)(1).  See Graev v. Comm’r, 149 T.C. 485, 492-93 (2017).  Section 6751(b) requires the initial determination of certain penalties to be “personally approved (in writing) by the immediate supervisor of the individual making such determination”.  See Graev v. Comm’r, 149 T.C. at 492-93; see also Clay v. Comm’r, 152 T.C. 223, 248 (2019).
• Where the taxpayer has challenged the Commissioner’s penalty determination, the Commissioner must come forward with evidence of proper penalty approval as part of his initial burden of production under section 7491(c). Frost v. Comm’r, 154 T.C. ___, ___ (slip op. at 20) (Jan. 7, 2020).  Once the Commissioner makes that showing, the taxpayer must come forward with contrary evidence.     The Court has previously concluded that the supervisory approval must be secured no later than (1) the date on which the IRS issues the notice of deficiency or (2) the date, if earlier, on which the IRS formally communicates to the taxpayer the Exam Division’s determination to assert a penalty and notifies the taxpayer of his right to appeal that determination.  Clay v. Comm’r, 152 T.C. at 249.
• Section 6664(c)(1) provides an exception to the Section 6662(a) penalty with respect to any portion of an underpayment if the taxpayer acted with reasonable cause and in good faith. The Court determines whether a taxpayer acted with reasonable cause and in good faith on a case-by-case basis, taking into account all pertinent facts and circumstances, including the taxpayer’s efforts to assess the proper tax liability, the knowledge and experience of the taxpayer, and the reliance on the advice of a professional tax adviser.  Reg. § 1.6664-4(b)(1); see also U.S. v. Boyle, 469 U.S. 241, 250 (1985).
• To show reliance on an adviser, a taxpayer must show that (1) the adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer gave the adviser the necessary and accurate information; and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 98-99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also Prudhomme v. Comm’r, 345 F. App’x 6, 10-11 (5^th 2009), aff’g  T.C. Memo. 2008-83.  The advice must be based on all the pertinent facts and circumstances, taking into account the taxpayer’s purposes for entering into a transaction and for structuring a transaction in a particular manner.  Treas. Reg. § 1.6664-4(c)(1)(i).  Moreover, the advice “must not be based on unreasonable factual or legal assumptions . . . and must not unreasonably rely on the representations, statements, findings, or agreements of the taxpayer or any other person.”  Treas. Reg. § 1.6664-4(c)(1)(ii); see also Brinkley v. Comm’r, 808 F.3d 657, 669 (5^th Cir. 2015), aff’g T.C. Memo. 2014-227.  A taxpayer’s education and business experience are relevant to the determination of whether the taxpayer acted with reasonable reliance on an adviser and in good faith.  Prudhomme v. Comm’r, 345 F.App’x at 11.   Due care does not require that the taxpayer challenge his or her attorney’s advice or independently investigate its propriety.  Streber v. Comm’r, 138 F.3d 216, 219 (5^th Cir. 1998).

Insight:  The Daichman decision shows that although taxpayers may comply with a strict interpretation of the Internal Revenue Code and its rules and regulations, tax benefits may nevertheless be denied under the economic substance doctrine.

Douglas M. Thompson and Lisa Mae Thompson v. Comm’r, 155 T.C. No. 5.

August 31, 2020 | Greaves, J. | Dkt. No. 6613-13

• Opinion

Short Summary:  The case involves the analysis of two of the requirements provided by section 6751(b): first, the concept of “initial determination”, secondly, the “supervisory approval” requirement provided by section 6751(b)(1). Finally, the Court analyzes whether the rule of lenity applies because of the ambiguity of the statute as for the timing of the supervisory approval.

Mr. Thompson and Mrs. Thompson (the “taxpayers”) were engaged in a Distressed Asset Trust (DAT) transaction in 2005. The IRS assigned a Revenue Agent (the “agent”) to examine the respective tax returns of the taxpayers for several years, including 2005.

In 2007, the agent sent a first letter to the taxpayers offering them the opportunity to resolve their tax liabilities in accordance with the terms of Announcement 2005-80 (an IRS program aimed to offer settlements to taxpayers engaged in listed transactions with accuracy-penalties below the statutory rates). Such letter did not identify a specific tax year nor provided an underpayment amount. The taxpayers declined the offer.

In 2009, the agent mailed a second letter to the taxpayers, offering them the opportunity to settle the DAT transaction. This letter specified that the taxpayers would have to pay accuracy-related penalties in an amount of the underpayment attributable to the DAT transaction. However, the letter did not identify the tax period, nor provided an underpayment amount, and only stated that if not accepted, the IRS would complete the examination. The taxpayers declined this second offer.

Later in 2009, the agent concluded the examination and determined that the taxpayers owed tax and penalties for tax years 2003-2007. On December of that year, the agent’s immediate supervisor signed the penalty memorandum, approving the agent’s determinations. The notice of deficiency was sent to the taxpayers on 2012.

The taxpayers filed a petition in Tax Court and argued that: (i) the penalty approval requirement of section 6751(b)(1) was not met here, (ii) that there was not a meaningful review by the acting immediate supervisor and (iii) given the ambiguity of section 6751(b)(1) as for when the statutory approval was required the Court should apply the rule of lenity and consequently, interpret the rule in the taxpayer’s favor.

The Tax Court rejected the taxpayers’ arguments and concluded that the approval requirement was met here because the offers made by the agent in 2007 and 2009 do not constitute an “initial determination” within the meaning of section 6751(b). Additionally, the Court concluded that the signature of the immediate supervisor meets the approval requirement. Finally, the Court determined that the rule of lenity does not apply here.

Key Issues:  Under section 6751(b), do the offers made by the agent in 2007 and 2009 constitute an initial determination? The approval requirement as provided by 6751(b)(1) is satisfied by the supervisor’s signature or requires a depth analysis? Is the rule of lenity applicable when interpreting section 6751(b)?

Primary Holdings: An initial determination within the context of 6751(b) is one that determines that a taxpayer is liable for penalties for a specific amount, and that is subject to review by Appeals or the Tax Court. Letters that do not meet these characteristics do not fall within the spectrum of section 6751(b). The approval requirement as provided by the section in analysis, is met by the signature of the immediate supervisor, and no meaningful review is required. Finally, the rule of lenity is not triggered when determining the timing of the supervisory approval requirement.

Key Points of Law:

• Section 6751(b) provides that no penalty shall be assessed unless the “initial determination” of the penalty is personally approved by the immediate supervisor of the individual making the determination (in this case the agent). Under previous decisions, the concept of “initial determination” has been defined as a “document that formally notifies the taxpayer, in writing, that it has completed its work and made and unequivocal decision to assert penalties”. See Belair Woods, LLC v. Commissioner.
• Considering such definition, the supervisory approval is required by the date the IRS issues the notice of deficiency or if earlier, the date the IRS formally communicates to the taxpayer the determination to assert a penalty and right to appeal the determination.
• The Court reasoned that the offers made by the agent in 2007 and 2009 were only “offering” to settle penalties and did not “determined” that the taxpayers were liable for specific amounts. Consequently, such letters did not require supervisory approval because they were only preliminary proposals.
• As for the argument concerning the “meaningful review” by the supervisor of the agent, the Court stated that the only requirement established by section 6751(b)(1) is to obtain the “approval of the immediate supervisor”. Such requirement is satisfied by the signature of the immediate supervisor.
• Finally, the Court analyzed whether the rule of lenity is triggered by the ambiguity of section 6751(b), as for the timing of when the approval is required. Based on decisions of the Supreme Court, the Tax Court concluded that the “simple existence of some statutory ambiguity” does not trigger the application of the rule of lenity. Moreover, the Court ruled that the significant caselaw on this section, supports the conclusion that section 6751(b) does not cover settlement offers like the ones in the instant case.

Insight:  Section 6751(b) is one of the most used procedural defenses in the tax controversy area. However, the construction of such section by the Courts have greatly reduced its possible application and unless the IRS flagrantly omits this statutory requirement in examinations, this defense may be not applicable. This case continues the line of cases that have narrowed the application of this section and provides insight on the relative low standard that section 6751(b) imposes on the IRS.

Dickinson v. Commissioner, T.C. Memo. 2020-128

September 3, 2020 | Greaves, T. | Docket No. 9526-19

• Opinion

Short Summary:  Petitioners sought a determination from the Tax Court that their donation of company shares to Fidelity Investments Charitable Gift Fund (a 501(c)(3)) were deductible charitable donations.

Key Issue:  Whether a taxpayer’s donation of company shares, where he served as an officer, to a 501(c)(3) that then redeemed such shares for cash is a deductible charitable donation?

Primary Holdings: 

• The taxpayers made an absolute gift of the company shares in each taxable year before the stock gave rise to income by way of a sale, and such donations were, thus, deductible, and no income was owed on the transfer of the stock.

Key Points of Law:

• A taxpayer may deduct the fair market value of appreciated property donated to a qualified charitable organization. SeeR.C. § 170; Treas. Reg. § 1.170A-1(c)(1).
• Donating appreciated property to a charity allows the taxpayer to avoid paying tax that would arise if the taxpayer instead sold the property and donated the cash proceeds. SeeR.C. § sec. 61(a)(3)
• Pursuant to the holding in Humacid Co. v. Commissioner, 42 T.C. 894, 913 (1964), the Tax Court will uphold the transfer as a charitable deduction under § 170 if “the donor (1) gives the property away absolutely and parts with title thereto (2) before the property gives rise to income by way of a sale.”
• To defeat a Motion for Summary Judgment by the taxpayer in this context, “respondent must set forth specific facts showing that there is a genuine dispute for trial as to whether a taxpayer made an absolutely perfected gift of the stock before the redemption.”
• Where a donee redeems shares shortly after a donation, the assignment of income doctrine applies only if the redemption was practically certain to occur at the time of the gift, and would have occurred whether the shareholder made the gift or not.
• “We respect the form of the transaction because petitioner [] did not avoid receipt of redemption proceeds by donating the [company] shares.”
• The Tax Court has not adopted Rev. Rul. 78-197, 1978-1 C.B. 83 as the test for resolving anticipatory assignment of income issues. The ultimate question is whether the redemption and the shareholder’s corresponding right to income had already crystallized at the time of the gift.

Insight:  The Dickinson case illustrates how the Tax Court analyzes charitable deductions based on the donation of company stock.  Specifically, the case demonstrates application of the Humacid Co. two-prong test to determine the substance of the transaction.

Franklin v. Commissioner, T.C. Memo. 2020-127

September 3, 2020 | Nega, J. | Docket No. 3855-18

• Opinion

Short Summary:  Petitioner sought a determination from the Tax Court that his deductions for meal, entertainment, and travel expenses; his deduction for business losses relating to certain loans and business properties was proper; and that he was not liable for the accuracy-related filing and late-filing addition to tax.

Key Issues:  (1) Whether meal and entertainment expenses and travel expenses are deductible as claimed on petitioner’s Form 1040, U.S. Individual Income Tax Return, and Schedule C, Profit or Loss From Business; (2) whether petitioner is entitled to deduct business losses relating to certain loans and business properties; and (3) whether petitioner is liable for the accuracy-related penalty and the late-filing addition to tax.

Primary Holdings: 

• The taxpayer could not deduct the meal, entertainment, or travel expenses, and could not deduct the business losses, as he did not demonstrate that such expenses were incurred in the operation of a trade or business, and he failed to provide credible evidence regarding his basis in property. Further, the Tax Court held that the taxpayer was liable for the late-filing addition to tax and accuracy-related penalty.

Key Points of Law:

• Section 162(a) allows as a deduction “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”
• An expense is ordinary if it is normal, usual, or customary in the taxpayer’s trade or business, and it is necessary if appropriate or helpful for such a business
• Section 274(d) imposes strict substantiation requirements for deductions claimed for travel, meals, entertainment, and vehicle expenses. No such deduction is allowed unless the taxpayer substantiates, by adequate records or by sufficient evidence corroborating his own statements, the amount, time and place, and business purpose for each expenditure.
• In order to be adequate, records must be prepared or maintained in such a manner that each recording of an element or expenditure is made at or near the time of the expenditure or use.
• While a contemporaneous log is not required to substantiate the deduction, a taxpayer’s subsequent reconstruction of his or her expenses does require corroborative evidence with a high degree of probative value to support such a reconstruction, in order to elevate that reconstruction to the same level of credibility as a contemporaneous record.
• If travel is for both business and personal purposes, the taxpayer has the burden to prove the primary purpose of the travel.
• Section 166(a)(1) provides that, for any business or nonbusiness debt, “[t]here shall be allowed as a deduction any debt which becomes [wholly] worthless within the taxable year.” To give rise to a deduction under section 166(a)(1), a debt must have become wholly worthless during the tax year at issue. Worthlessness is a question of fact based on all the relevant circumstances, which considers, among other things, the debtor’s financial condition and the value of any security.  A debt is not worthless to the extent the collateral securing the debt has value.
• Losses sustained during the tax year that are not compensated by insurance or otherwise are deductible subject to applicable limitations. The allowance of losses for the permanent withdrawal of depreciable property from use in a trade or business or in the production of income are governed by regulations covering the applicable depreciation method.
• Where an asset is permanently retired from use in the trade or business or in the production of income but is not disposed of by the taxpayer or physically abandoned, recognized loss will be measured by the excess of the adjusted basis of the asset at the time of retirement over the estimated salvage value or over the fair market value of the property at retirement.
• An ordinary loss deduction for the loss of usefulness or obsolescence of non-depreciable property is allowed for the year the loss is actually sustained if (1) the loss is incurred in a business or a transaction entered for profit; (2) the loss arises from the sudden termination of usefulness in the business or transaction; and (3) the property is permanently discarded from use, or the business or transaction is discontinued.
• Where a depreciable asset used in a trade or business or held for the production of income is retired by actual physical abandonment, a loss will be recognized if the taxpayer intends to discard the asset irrevocably so that it will neither be used again by the taxpayer nor retrieved by the taxpayer for sale, exchange, or other disposition.
• Section 6651(a)(1) authorizes the imposition of an addition to tax for failure to file a return timely unless it is shown that such failure was due to reasonable cause and not due to willful neglect. A failure to file a Federal income tax return timely is due to reasonable cause if the taxpayer exercised ordinary business care and prudence but nevertheless was unable to file the return within the prescribed time, typically for reasons outside the taxpayer’s control.
• To assert an accuracy-related penalty, the IRS carries the burden of demonstrating that his representatives complied with section 6751(b)(1). But Section 6664(c)(1) also provides an exception to the section 6662(a) penalty if it is shown that there was reasonable cause for any portion of the underpayment and the taxpayer acted in good faith.  Such determination is made on a case-by-case basis.

Insight:  The Franklin case illustrates the importance of keeping extensive records of meals, entertainment, and travel expenses—particularly records demonstrating the business purpose of such expenses.  It further demonstrates how the Tax Court analyzes business loss deductions and reasonable cause penalty abatement requests.

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