The Tax Court in Brief May 10 – May 14, 2021

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The Tax Court in Brief May 10 – May 14, 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.

Tax Litigation: The Week of May 10 – May 14, 2021

Tax Court Case: Jenkins v. Commissioner, T.C. Memo. 2021-54

May 10, 2021 | Holmes, J. | Dkt. Nos. 27139-11, 28712-11

Tax Dispute Short Summary:

Mr. Ira Gentry (Gentry) owned Universal Dynamics, a company that primarily produced a software program called Northstar. In the late-1990s, a reverse merger occurred between Universal Dynamics (a private corporation) and UniDyn Corp. (a public corporation). UniDyn acquired many of Universal Dynamics’ assets in exchange for 180,000 shares of stock. Following the merger, Gentry became president, CEO, and director of UniDyn. Universal Dynamics became the owner of more than 70% of UniDyn’s outstanding stock.

During this time, Gentry became acquainted with Mr. Randy Jenkins (Jenkins). Jenkins set up overseas entities related to UniDyn. He also helped implement an employee-leasing scheme that UniDyn used to save on employment tax.

As the controlling shareholder of a publicly traded corporation, Gentry wanted to raise money to pursue two developmental avenues. The first involved the purchase of Derritron to become a single source for quality-assurance shaker systems. This was disclosed in SEC filings. The second involved the creation of a new product, the Sterling. This product would be a revolutionary technological development.

In promoting the Sterling, Gentry wooed a variety of groups. A UPS employee, under the allure of Gentry’s pitch, helped raise $470,000 to produce the Sterling. In 1998, UniDyn stated in SEC filings that it was patenting the Sterling. It also disclosed that a large Japanese company made a commitment to buy 20 units. Later, Gentry identified the company as TechNet, Inc. and suggested that the contract totaled $3.8 million. UniDyn also disclosed that it completed stock acquisition of Avalon Manufacturing Co. to begin the manufacture. This series of announcements built significant momentum for the business. It culminated with a press release that the company secured a $250 million contract with TechNet, signed by Hiroshi Tsuriya. As a result of these efforts, the UniDyn stock price soared.

The problem addressed by the case is simple: these claims were all lies. The press release failed to disclose that Avalon was actually a subsidiary of UniDyn. IBM never tested the product. Contrary to the 1998 disclosure, Gentry had not begun the patenting process. The TechNet contracts were made up. Hiroshi Tsuriya denied signing the contract. The court notes that the Tsuriya signature may have been pasted or traced on the TechNet contract. The Board determined that Gentry never wrote the thesis that provided the basis for the Sterling, and beyond that, the Board concluded that the actual author concluded that this project was not feasible. Following the revelations, the stock of UniDyn plummeted.

In 2006, the Federal Government executed a search warrant on Mr. Gentry’s office. Gentry and Jenkins were arrested, and the Government concluded that Gentry and Jenkins conducted a “pump-and-dump scheme.”  Neither paid taxes on their gains. Both were convicted for a variety of felony counts. The court entered judgments against both men at the end of the criminal case.

Later, the Commissioner pursued a civil case against both Gentry and Jenkins. The Commissioner controlled that Gentry controlled four corporations—Marriott Investment, Universal Dynamics Prime Security, and Mearns Acceptance—that saw significant gains when they dumped their UniDyn stock in 2000. The Commissioner argued that Gentry used these entities as alter egos to avoid reporting the financial gains and is liable for the tax on the $7.8 million gains.

Tax Litigation Key Issue(s):

Primary Holding(s):

Key Points of Law:

Adler v. Commissioner, T.C. Memo. 2021-56 

May 10, 2021 | Kerrigan, J. | Dkt. No. 13564-19

Tax Dispute Short Summary:

Petitioner owned a sales and consulting business called Grupo Fortuna, LLC. In 2016, Petitioner filed a Schedule C, reporting expenses totaling $105, 227, including $16,535 for travel expenses.

In 2016, MediaNaviCo—a digital entertainment company—hired Petitioner as a consultant. This position required travel to and attendance at both conferences and trade shows. When traveling, Petitioner was initially responsible for paying the expenses and would deliver them to MediaNaviCo’s CFO for reimbursement. Later, NBCUniversal Media, LLC purchased MediaNaviCo.

Two specific instances raised issues here. First, during this time, Petitioner traveled to Blackfoot, Idaho, to look at land inherited from his father. Second, Petitioner reported $44,586 for contract labor expenses on his 2016 Schedule C. The contract labor expenses arose because, during this time, Petitioner performed construction work. Despite this work, Petitioner did not issue any W-2 Forms to employees or Forms 1099-MISC to contract laborers.

In 2017, Petitioner and his wife filed Form 1040, reporting expenses of $57,397 on his Schedule C.

On May 1, 2019, respondent issued: (1) a notice of deficiency for 2016, disallowing expense deductions for travel and contract labor; and (2) a notice of deficiency for 2017, disallowing deductions for $53,098 of the expenses.

Tax Litigation Key Issue(s):

Whether Petitioner is entitled to deduct business expenses for 2016 and 2017?

Primary Holding(s): For both 2016 and 2017, Respondent’s disallowance is sustained because the Petitioner failed to provide evidence to support the expenses.

Key Points of Law:

Bailey v. Commissioner, T.C. Memo. 2021-55

May 10, 2021, | Pugh, J. | Dkt. No. 5477-14

Tax Dispute Short Summary

Mr. Bailey working as an unenrolled tax return preparer assisted clients (Uwe Zink and Gary Skuro) in creating a new entity, Interradiology, Inc. (Interradiology) organized under the laws of Arizona and elected to be treated as an S corporation for Federal tax purposes in 2017. Therefore, Mr. Bailey prepared and filed Forms 1120S, U.S. Income Tax Return for an S Corporation, for Interradiology for tax years 2007 through 2012. Also, he held 10% of the shares of Interradiology during the tax year 2008 and 20% during tax years 2009 through 2012.

Mr. Bailey prepared and filed petitioners’ Forms 1040, U.S. Individual Income Tax Return, for the years in issue. He timely filed their 2008 and 2012 Forms 1040, but he untimely filed their 2009, 2010, and 2011 Forms 1040 on March 9, 2011, November 29, 2011, and February 19, 2013, respectively. The 2010 and 2011 returns both reported tax due, which the IRS assessed before the issuance of the notices of deficiency for those years.

Regarding petitioners’ Forms 1040, Mr. Bailey reported gross income by adding together any wages, Schedule C business income, capital gain, and taxable Social Security benefits, plus the distributive shares of Interradiology’s income petitioners received during each year. Mr. Bailey offset this income in part with the standard deduction in 2010 and Schedule A itemized deductions in 2008, 2009, 2011, and 2012. In respect to petitioner’s Schedules C, Mr. Bailey reported gross profits and offset those profits in part with business expense deductions, including rent he paid for the Broadway office.

The IRS audited petitioners’ Forms 1040 and Interradiology’s Forms 1120S for the years in issue, resulting in the issuance of notices of deficiency to petitioners for tax years 2008 to 2013, adjusting the petitioners’ distributive shares of Interradiology’s income upward, and reducing the Schedule C deductions. Some of the adjustments included reclassifying petitioners’ mortgage interest expense deductions as home mortgage interest expense deductions, so the respondent also adjusted the corresponding Schedule A deductions.

Petitioners timely filed petitions with the United States Tax Court challenging the proposed adjustments. The respondent sent to the petitioners a proposed stipulation of settled issues. Both parties signed the document which was filed on November 21, 2019. The proposed stipulation stated: (i) that two of the substantive issues were resolved; (ii) that the remaining issues involve primarily substantiation of business expenses and itemized deductions, additions to tax, and penalties; (iii) that petitioners had raised new issues requesting additional deductions not originally claimed; (iv) agreements regarding Interradiology’s income, deductions and the amounts of Mr. Bailey’s distributive share of Interradiology’s income; (v) that petitioners did not receive the capital gain relating to Interradiology that had been reported on their Forms 1040 for 2010 and 2012.

After the document was submitted, the respondent filed a motion for leave to file the first amendment to answer under I.R.C. §6651(a)(2). The motion requests additions to tax for failure to timely pay tax shown on petitioners’ Forms 1040 for 2010 and 2011 which continue to accrue since the issue of notices of deficiency. At trial, the parties filed their first stipulation of facts showing the parties’ agreement outlined in detail the time and manner of determination of the I.R.C. §6662 penalties for each year, and the parties’ agreement that respondent had satisfied the requirements of section 6751(b) for each penalty determined in the statutory notices.

Tax Litigation Key Issue:

Primary Holdings

Key Points of Law:  

Tax Litigation Insight: The Bailey decision shows that taxpayers have the burden of proof of their entitlement to deductions. Accordingly, they have to keep request books and records in order to prove their request.

Battat v. Commissioner, T.C. Memo. 2021-57 

May 11, 2021 | Colvin, J. | Dkt. No. 17784-12

Tax Dispute Short Summary

The IRS examining agent sent taxpayers a revenue agent report (RAR) attached to a Letter 4121 that (1) corrected the tax due and (2) notified of liability for penalty under section 6662.  At the time of issuance, the IRS examining agent failed to receive immediate supervisor approval in writing for the RAR, the Letter 4121, or the penalty liability.  Two weeks after the postage of the RAR with Letter 4121, the examining agent issued a Form 4549-A attached to a Letter 950, 30-day letter. Also on that day, the examining agent received written supervisory approval for the section 6662 penalty.  Tax Court considered when the penalty liability was imposed and whether such liability was properly imposed.  The Tax Court determined the “initial determination” occurred at the time of issuance of the RAR and that it failed to have the requisite approval of an immediate supervisor.

Key Issue:

Primary Holdings

Key Points of Law:

Tax litigation InsightThe Tax Court’s determination reaffirms the statutory requirement of supervisory approval, in writing, for a penalty liability assessed by an examining agent.  The employees of the IRS must follow proper procedure, or, else, risk failing to adequately impose tax and penalty liabilities.  This can be a procedural pitfall for the IRS.  It represents a small comfort to the taxpayer that everyone must play by the same rules, even the IRS.


May 13, 2021 | Geoke, J. | Docket No. 4415-14 

Tax Dispute Short Summary:

Decedent Clara M. Morrissette established a perpetual dynasty trust (the “CMM trust”) for the benefit of her three sons. On October 31, 2006, the CMM trust entered into two split-dollar agreements with each dynasty trust. Mrs. Morrissette reported the payment of the premiums as gifts to her sons for gift tax purposes to the extent required by the economic benefit regime of Treas. Reg. § 1.61-22, which treats the premiums as annual gifts equal to the annual cost of current protection. The IRS argued that IRC § 2036 and IRC § 2038 should be applied to the transfer of the premiums that the CMM trust made as part of the split-dollar agreements and argued that the values of the split-dollar rights should be included in the gross estate, at least in the amount of the transferred premiums or the cash surrender values of the underlying policies. In practice, however, the real issue of the case concerned the actual valuation of the split-dollar rights included in Mrs. Morrissette’s gross estate.

Tax Litigation Key Issues:

The primary issues presented in Estate of Morrissette are (1) whether section 2036 or 2038 applies to recapture inter vivos transfers made as part of the split-dollar agreements, and; (2) if not, how to determine the fair market values of the split-dollar rights, including whether the special valuation rule of section 2703 applies to require that the valuation disregard a provision in the split-dollar agreements that restricts the parties’ right to unilaterally terminate the agreements, and; (3) is the estate liable for a 40% penalty for a gross valuation misstatement?

Primary Holdings:

Key Points of Law:

Insight: The Estate of Morrisette decision demonstrates the critical quality of ‘in good faith’ metrics, especially with competing valuations in play. Morrisette highlights that taxpayers are not entitled to rely upon facially unreasonable appraisals (here, a $30 million payout turned into $7.5 million for estate tax reporting purposes) and then later claim to have done so in good faith, even when dealing with the complicated valuations of split-dollar rights.


Tax Court Litigation Attorneys

Need assistance litigating in the U.S. Tax Court? Freeman Law’s tax attorneys are experienced litigators with trial-tested litigation skills and in-depth substantive tax knowledge, having collectively litigated hundreds of cases before the U.S. Tax Court. Our tax controversy lawyers have extensive experience in Tax Court matters involving partnership audits and litigation under both the TEFRA and BBA regimes, international tax penalties, foreign trusts, valuation, reasonable compensation disputes, unreported income, fraud penalties, other tax penalties, any many other matters. We draw on our experience and wealth of tax knowledge to advise and guide clients through the entire tax controversy process, building the right strategy to resolve tax controversies from day one. Schedule a consultation or call (214) 984-3000 to discuss your Tax Court concerns or questions.