The Tax Court in Brief February 8 – February 12, 2021

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The Tax Court in Brief February 8 – February 12, 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 February 8 – February 12, 2021

BM Construction v. Comm’r, T.C. Memo. 2021-13

February 8, 2021 | Urda, J. | Dkt. No. 24352-17L

Short Summary: The IRS initiated an examination of the tax liabilities associated with Mr. Bernotas and his sole proprietorship, BM Construction. After issuing an initial report on May 7, 2014, the examination officer issued two Letters 950-D: (1) to Mr. Bernotas with respect to his income taxes on June 6, 2014; and (2) to BM Construction with respect to backup withholding tax liabilities on June 13, 2014. The examination officer detailed these actions in the file’s activity log and noted that neither of the mailed letters were returned. At more than one subsequent in-person meeting, Mr. Bernotas was notified of his appeal rights—particularly that he had 30 days from the date of Letter 950-D.

Mr. Bernotas did not file an official protest, and the examination officer closed BM Construction’s tax file. The IRS then assessed withholding taxes, penalties, and interest and issued a Notice of Intent to Levy and Notice of Your Right to a Hearing to BM Construction. Mr. Bernotas requested a Collection Due Process Hearing, and a CDP Hearing was held between a settlement officer and Mr. Bernotas’ CPA. The CPA attempted to dispute the underlying liability. The settlement officer noted that BM Construction was precluded from challenging the underlying liability and ultimately sustained the levy notice. BM Construction petitioned the Tax Court for review.

Key Issues:

Primary Holdings:

Key Points of Law:

Insight: Notices and letters issued by the IRS are presumed to reach their ultimate destination unless credible evidence can rebut the presumption. BM Construction highlights the fact that self-serving statements from the taxpayer are not enough to overcome this presumption. Additionally, taxpayers should dispute a proposed tax liability during the examination process. Waiting to challenge the tax liability at issue until the taxpayer’s case is turned over to IRS collections will likely prove to be a problem.

Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14 

February 10, 2021 | Halpern, J. | Dkt. Nos. 13368-15 and 19898-17

Short Summary: Taxpayer-corporation (Corp.) acquired the assets of a business from a third-party partnership (P’ship).  In exchange for the transferred assets, Corp. issued approximately 5 million shares of common stock.  Immediately thereafter, Corp. redeemed 1.875 million of the common shares held by P’ship in exchange for $2.7 million in cash and Corp’s obligation to make an additional payment of $300,000 a year later.  P’ship paid the cash and assigned its right to the additional payment to one of its partners in redemption of that partner’s interest in P’ship.  Corp. claimed an increased basis of $3 million in intangible assets it acquired from P’ship and amortized that additional basis under I.R.C. § 197(a). The IRS disallowed the deductions under I.R.C. § 197(a).

Key Issues:  Whether Corp. is entitled to the amortization deductions under I.R.C. § 197(a)?

Primary HoldingsYes, in part, because:  (1) Corp’s issuance and immediate redemption of 1,875,000 common shares had no economic substance and should be disregarded under the step transaction doctrine, with the cash and the deferred payment right treated as additional consideration for the assets Corp. acquired from P’ship; (2) the parties agree that I.R.C. § 351 governs the tax consequences of the transactions at issue and accordingly, P’ship recognized gain in the transaction to the extent of the $2.7 million cash it received and the fair market value of its right to the additional $300,000 payment; this increases the basis of the assets transferred to Corp.; and (3) when assets transferred in an I.R.C. § 351 exchange with taxable boot constitute a trade or business, the residual method of allocation prescribed by I.R.C. § 1060 can appropriately be used to allocate the boot among the transferred assets; consequently, P’ship’s gain in amortizable I.R.C. 197 intangibles, and the corresponding increase in asset bases allowed to Corp., is determined by subtracting from the agreed total asset value the estimated values of those assets other than amortizable I.R.C. § 197 intangibles.

Key Points of Law:

Insight: Complex Media is a 103 page reminder of the potential federal income tax complexities inherent in certain taxable or tax-free transactions.  As discussed in the opinion, in many cases, taxpayers are bound to the transactional form they choose, even to their peril.  This can lead to surprising tax results, particularly if not vetted by tax counsel.

Little Sandy Coal Company, Inc. v. Comm’r, T.C. Memo. 2021-15 

February 11, 2021 | Halpern, J. | Dkt. No. 17431-17

Short Summary: Little Sandy Coal Company, Inc. (the “Petitioner”) owns a shipbuilding subsidiary, Corn Island Shipyard, Inc. (“CIS”). In the course of developing 11 separate vessels, Petitioner claimed a research credit under Sections 38 and 41(a) for its taxable year ended June 30, 2014. CIS’s projects included, in part: Project 720 (building a tank barge under contract with Apex Oil, Inc.); Project 730 (building a dry dock for Detyens Shipyard); and Projects 749 and 750 with Tell City Boat Works.

The Internal Revenue Service disallowed the research tax credit noted above related to CIS’s developing the 11 vessels. As a result, the Internal Revenue Service determined a deficiency in federal income taxes and also assessed an accuracy-related penalty under Section 6662 for the same year.

The Petitioner ultimately petitioned the Tax Court. The Petitioner argued, in part, that substantially all of the activities of its subsidiary’s research in developing the vessels constituted elements of a process of experimentation for purposes of I.R.C. § 41(d)(1)(C) and Treas. Reg. § 1.41-4(a)(6) because more than 80 percent of the elements of each vessel differed from those of vessels CIS had previously developed.

Prior to trial, both the Petitioner and the Internal Revenue Service agreed to treat two of the vessels—Projects 720 and 730—as representative of the others in regard to the common issues. For purposes of this opinion, the Tax Court only addressed the specific issues below related to the four projects outlined above.

Key Issues:

Primary Holdings:

Key Points of Law:

Insight: The Little Sandy case emphasizes the importance of the fourth requirement of Section 41(d)(1) with respect to qualified research. The fourth requirement focuses on a taxpayer’s activities, not the physical components, supplies, or supervisors related to the research. Further, it appears that the taxpayer ultimately hampered its own case here where it agreed to treat two of its projects (vessels) as representative of the others. This foreclosed the Tax Court’s ability to separately evaluate the taxpayer’s other projects, such as the TCBW issues.


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