The Tax Court in Brief – January 25 – 29, 2021

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The Tax Court in Brief January 25 – 29, 2021

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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

The Week of January 25 – January 29, 2021

Costello v. Comm’r, T.C. Memo. 2021-9

January 25, 2021 | Halpern, J. | Dkt. No. 1350-17

Short SummaryTaxpayer-wife was involved in a farming activity (raising chickens, growing vegetables, and raising cattle) from which she incurred seven years of losses.  She also engaged in rental real estate activities.  The IRS examined the taxpayers’ 2012 and 2013 tax returns and disallowed the farming losses on the grounds the taxpayers were not engaged in an active trade or business.  Moreover, the IRS disallowed the rental real estate activity losses on the basis that the property had been flooded, was in no condition to rent, and had not been advertised for rent.  Finally, the IRS disallowed the operating loss deductions for other rental properties as passive losses and asserted failure-to-file and accuracy-related penalties.

Key Issues: Whether the taxpayers are:  (1) entitled to claim losses from their farming activities; (2) entitled to claim losses from their rental property activities; (3) liable for penalties under I.R.C. § 6651(a)(1) and I.R.C. § 6662.

Primary Holdings: The taxpayers are:  (1) not entitled to deduct losses from their farming activities because the losses were startup expenses under I.R.C. § 195(a); (2) not entitled to deduct operating losses related to one rental property because the property was not held for rental; (3) entitled to a loss deduction for certain other rental activities because the IRS erred in determining the losses were passive losses; (4) liable for I.R.C. § 6651(a)(1) and I.R.C. § 6662 penalties.

Key Points of Law:

Insight: Section 195 can act as a trap for the unwary in that it can suspend the immediate deduction of certain losses until later years.  The Costello case therefore stands as a reminder that tax planning can be significant, particularly when a taxpayer begins a new business venture.

Grajales v. Comm’r, 156 T.C. No. 3

  January 25, 2021 | Thornton, J. | Dkt. No. 21119-17

Short SummaryWhen the taxpayer was 42, she took loans in connection with her New York State pension plan.  The pension plan sent her a Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reporting the gross distribution.  The taxpayer timely filed her tax return for the tax year at issue but did not report any retirement plan distributions as income.  The IRS issued a notice of deficiency determining the retirement plan distributions reported on Form 1099-R should have been included in income and were subject to a 10% additional tax on early distributions under Section 72(t).

Key Issues: Whether the requirements under Section 6751(b) apply to the Section 72(t) exaction on early distributions from qualified retirement plans?

Primary Holdings: The Section 72(t) exaction is a “tax” rather than a “penalty,” “addition to tax,” or “additional amount” and is not subject to the written supervisory approval requirement of Section 6751(b).

Key Points of Law:

InsightThe Grajales decision is one of a long-line of Tax Court decisions holding that the Section 72(t)(1) exaction is a tax rather than a penalty.  However, taxpayers should continue to make good faith efforts with respect to other provisions in the Code that can be construed as a penalty subject to the written managerial approval requirements of Section 6751(b).

Reynolds v. Comm’r, T.C. Memo. 2021-10

  January 26, 2021 | Thornton, J. | Dkt. No. 9864-18L

Short SummaryThe taxpayer developed strategies to use corporations to conceal assets and evade income tax.  He marketed these strategies to others and even used them for himself with respect to his own personal finances.  On October 18, 2010, he pleaded guilty to two counts of subscribing false federal income tax returns under Section 7206(1) for tax years 2002 and 2003.  On October 20, 2010, the United States district court entered its judgment and sentenced him to 18 months in prison for each of the two counts on which he was convicted.  Pursuant to 18 U.S.C. § 3663(a)(3), the judgment required the taxpayer to pay the United States restitution of $193,812 with respect to his 2000, 2001, 2002, and 2003 tax years.

On August 26, 2013, the IRS assessed restitution against the taxpayer under Section 6201(a)(4) for the 2000, 2001, 2002, and 2003 tax years, which matched the restitution order by the United States district court.  Later, the IRS audited the taxpayer’s 2002 and 2003 tax returns and issued a notice of deficiency to the taxpayer.  In the notice of deficiency, the IRS determined that the taxpayer was liable for civil fraud penalties under Section 6663(a) for tax years 2002 and 2003.  The Tax Court later entered a stipulated decision that the taxpayer was liable for deficiencies for both years and for civil fraud penalties under Section 6663(a).

The IRS issued the taxpayer a Final Notice of Intent to Levy and Notice of Your Right to a Hearing to the taxpayer.  The IRS also issued a Notice of Federal Tax Lien Filing and Your Right to a Hearing Under IRC 6320.  The taxpayer filed Forms 12153 in response to both the proposed levy and the notice of federal tax lien filing.  The taxpayer indicated he “cannot pay balance”.

The IRS requested Forms 433-A and 433-B—however, the taxpayer refused to provide them.  The taxpayer subsequently hired legal counsel to represent him during the Appeals hearing.  However, the proposed levy and notice of federal tax lien were sustained, and the taxpayer filed a timely petition with the Tax Court.

Key Issues: Whether the IRS Appeals office abused its discretion in sustaining the proposed levy and the filing of the notice of federal tax lien?

Primary Holdings:  The IRS Appeals office did not abuse its discretion in sustaining the proposed levy and the filing of the notice of federal tax lien.

Key Points of Law:

InsightThe Reynolds decision shows how difficult it can be for a taxpayer to settle with the IRS after a court-ordered restitution payment has been made for criminal tax evasion.

Whatley v. Comm’r, T.C. Memo. 2021-11

  January 28, 2021 | Holmes, J. | Dkt. No. 6838-12

Short SummaryThe taxpayer was a successful entrepreneur and banker who purchased real estate in Alabama.  He later added two dozen more acres of real property an formed an LLC to report his use of the property on his returns from 2004 to 2008.  He recorded large losses for farm activities.  The IRS disallowed the losses, and the taxpayer petitioned the Tax Court for a redetermination.

Key Issues: Whether the taxpayer is entitled to claim losses related to his LLC for the tax years 2004 to 2008?

Primary Holdings:  The taxpayer is not entitled to claim the losses related to the farming activities because the taxpayer was not engaged in such activities for profit.  See Sec. 183.

Key Points of Law:

InsightThe Whatley decision shows the challenges a taxpayer may face when the taxpayer is engaged in other activities outside of their regular work.

Sells v. Comm’r, T.C. Memo. 2021-12

January 28, 2021 | Holmes, J. | Dkt. Nos. 6267-12, 6801-12, 6835-12, 6836-12, 6837-12, 6838-12, 19246-12, 13553-13

Short SummaryIn August 2002, Burnish Bush Farms, LLC was formed with eight members—each a 12.5% owner.  Later, Mr. and Mrs. Moses sold mountainous land to Burnish Bush for $1.4 million.  In 2003, Burnish Bush deeded a conservation easement on the acres that it owned to Chattoawah Open Land Trust, Inc.  The conservation deed contained various provisions, including an extinguishment-proceeds clause.

Burnish Bush filed a Form 1065, U.S. Return of Partnership Income.  Attached to the Form 1065 was Form 8283, Noncash Charitable Contributions.  On page 2 of this form Burnish Bush reported the donation of the conservation easement to COLT as a noncash charitable contribution with a value of less than $5.4 million.  Burnish Bush attached a “qualified appraisal” to the return.  The IRS audited the return, disallowed the charitable contribution, and proposed penalties.

Key Issues: Whether the taxpayers are entitled to a charitable conservation easement deduction and whether they are liable for penalties?

Primary Holdings:  The taxpayers are not entitled to the charitable conservation easement deductions.  Moreover, with respect to some taxpayers, the IRS failed to comply with Section 6751(b) with respect to certain proposed penalties—accordingly, those penalties are waived.  Moreover, some taxpayers are not liable for penalties due to reasonable cause.

Key Points of Law:

InsightThe decision in Sells shows that the IRS will continue to aggressively go after perceived, abusive conservation easement deductions.  It also shows the potential use of Section 6751(b) as a defense against proposed penalties.


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