The Tax Court in Brief June 21 – June 25, 2021
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 June 21 – June 25, 2021
Tax Court Case: Ervin v. Commissioner, T.C. Memo. 2021-75
Tax Dispute Short Summary:
For nearly a decade, the taxpayer and his wife failed to file Federal income tax returns and made no payments. The couple were indicted and convicted for tax evasion for a three-year period of the near-decade non-payment. The following year, the taxpayer was ordered to pay restitution for the entire period of non-filing and non-payment.
After remanded to custody, the IRS completed a civil examination for the taxpayer’s individual income tax liabilities for a six-year period, which included years subject to the criminal court’s order for restitution. IRS prepared and certified a substitute for return for the relevant years. IRS, then, sent taxpayer two notices of deficiency for two three-year periods, providing for penalties.
The taxpayer, from prison, submitted a tax court petition, but failed to allege errors in the IRS’ determinations. In the time between the petition being filed and the opinion, the U.S. Department of Justice auctioned off the taxpayer’s gold coins and certified that the taxpayer’s restitution was paid, in full. In response to requests for admissions, the taxpayer admitted to failing to file, failing to make timely income tax payments, failing to make timely estimated tax payments, and he lacked reasonable cause to abate the penalties. The Commissioner moved for summary judgment. The taxpayer argues that liability should not exist by virtue of the restitution obligation.
Tax Litigation Key Issue:
- Whether Taxpayer is liable for additions to tax and penalties for tax years in which he paid restitution for the Government’s estimate tax loss for those years?
- The Tax Court determined that the tax accrued before the restitution was ordered, therefore the taxpayer was liable for the amounts.
Key Points of Law:
- The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Comm’r, 116 T.C. 73, 74 (2001). A court may grant summary judgment regarding issues as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); see Sundstrand Corp. v. Comm’r, 98 T.C. 518, 520 (1992). In deciding whether to grant summary judgment, a court construes factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Sundstrand Corp., 98 T.C. at 520. However, the nonmoving party may not rest upon the mere allegations or denials of his pleadings but instead must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); see Sundstrand Corp., 98 T.C. at 520.
- Section 6201(a)(4)(A) provides that the Secretary shall assess and collect the amount of restitution ordered by a sentencing court for failure to pay any tax imposed under this title in the same manner as if such amount were such tax. The IRS may not make such an assessment until the defendant has exhausted all appeals and the restitution order has become final. SeeR.C. §6201(a)(4)(B). The restrictions on assessment imposed by section 6213 do not apply to restitution-based assessments. SeeI.R.C. §6213(b)(5). The IRS therefore is not required to send the taxpayer a notice of deficiency before making an assessment of this kind.
- In Klein v. Commissioner, 149 T.C. 341, 362 (2017), the Tax Court held that additions to tax do not arise on amounts assessed under section 6201(a)(4) because a restitution obligation is not a civil tax liability, or a tax required to be shown on a return. Rather, restitution is assessed in the same manner as if such amount were such tax. I.R.C. §6201(a)(4)(A). The Tax Court explained that the IRS was not thereby disabled from collecting such sums. If the IRS wishes to collect additions to tax, it is free to commence a civil examination of the taxpayer’s returns at any time. Klein, 149 T.C. at 362.
- Section 6651(a)(1) provides for an addition to tax of 5% of the tax required to be shown on the return for each month or fraction thereof for which there is a failure to file the return, not to exceed 25% in total. The IRS has the burden of production on this issue. See R.C. §7491(c). The taxpayer’s admission to not submitting a tax return is sufficient to satisfy the Commissioner’s burden of production. See Gates v. Comm’r, 135 T.C. 1, 14 (2010).
- Section 6651(f) provides that if any failure to file any return is fraudulent, the addition to tax imposed by section 6651(a)(1) shall accrue at a rate of 15% per month, not to exceed 75% in the aggregate. The Commissioner has the burden of production and burden of proof on this issue. See R.C. §§ 7454(a), 7491(c).
- Section 6651(a)(2) provides for an addition to tax when a taxpayer fails to pay timely the tax shown on a return unless the taxpayer proves that the failure was due to reasonable cause and not due to willful neglect. To meet his burden of production under section 7491(c) with respect to the section 6651(a)(2) addition to tax, the Commissioner must provide evidence of a tax return. See Wheeler v. Comm’r, 127 T.C. 200, 208-211 (2006). An SFR that meets the requirements of section 6020(b) is treated as the “return” filed by the taxpayer for this purpose. SeeR.C. §6651(g)(2).
- Section 6654 imposes an addition to tax on an individual who underpays his estimated tax. The addition to tax is calculated with reference to four required installment payments of the taxpayer’s estimated tax liability. I.R.C. §6654(c) and (d). Each required installment is equal to 25% of the “required annual payment.” I.R.C. §6654(d). The Commissioner’s burden of production under section 7491(c) requires him to produce, for each year for which the addition is asserted, evidence that the taxpayer had a “required annual payment.” See Wheeler, 127 T.C. at 211. Where the taxpayer filed no return for the current tax year or the immediately preceding tax year, the required annual payment is equal to 90% of the tax due for the current year. I.R.C. §6654(d)(1)(B).
Insight: The Tax Court’s decision brings a deluge of life lessons. Namely, crime doesn’t pay. However, that old cliché needs a caveat – But the criminal sure will. The Court made it clear that an IRS’ assessment of penalties and additional tax stands independent from a criminal order, even when the same tax years are at issue. To soften the blow, the restitution payments allow for a tax credit on taxes owed.
Hussey v. Commissioner, 156 T.C. No. 12
Tax Dispute Short Summary:
In 2009, the petitioner purchased 27 investment properties on which he assumed outstanding loans totaling $1,714,520. All of the loans were held by the same bank. By 2012, petitioner began to struggle with making payments on the loans.
In 2012, the petitioner sold short 16 investment properties and received from the mortgage lender a discharge of indebtedness totaling $754,054 for 15 of those properties. In 2013, petitioner sold 7 investment properties. He did not receive from the lender a discharge of indebtedness relating to the 2013 property sales.
Although the petitioner originally filed his returns for 2012 through 2014, he believed that the tax treatment for the sale and indebtedness reported on his original returns was incorrect. Accordingly, he hired a tax law firm to file amended returns for 2012 and 2013. On the amended 2012 return, petitioner reported a loss of $613,263 related to the sales of properties. On Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), petitioner reported that he had excludable income of $685,281 “for a discharge of qualified real property business indebtedness (QRPBI) applied to reduce the basis of depreciable property.” On his 2013 return, petitioner reported a loss totaling $499,417 related to the sale of the investment properties and his primary residence. The losses for 2013 were carried forward by petitioner on his 2014 return.
The IRS issued a notice of deficiency to petition for taxable years 2013 and 2014. For 2013, the IRS disallowed the loss deductions. For 2014, the IRS disallowed the loss carryover deduction from 2013.
Tax Litigation Key Issues:
- Whether, under sections 1017(a) and (b)(3)(F)(iii) and 108(c)(2)(B), petitioner must reduce his bases in real properties for 2012 or 2013 as a result of his sale of depreciable real properties in 2012.
- Whether petitioner received a discharge of debt in 2013?
- Whether petition is liable for accuracy-related penalties under section 6662 for tax years 2013 or 204?
- (1) Petitioner is required to reduce the bases of depreciable real properties in 2012; (2) The lending bank did not discharge any of petitioner’s QRPBI in 2013; and (3) Petitioner is not liable for accuracy-related penalties for 2013 and 2014 because he relied in good faith on a professional for tax advice in preparing his returns for those years.
Key Points of Law:
- Sections 61(a)(10) and 108(a)(1)(D) provide an exclusion from income for forgiveness of QRPBI. When that exclusion applies, the taxpayer must reduce his or her bases in the depreciable real properties. 108(c)(1).
- Section 108(c)(2)(B) provides that the amount excluded under subparagraph (D) of subsection (a)(1) [discharge of QRPBI] sha not exceed the aggregate adjusted bases of depreciable real property (determined after any reductions under subsections (b) and (g)) held by the taxpayer immediately before the discharge (other than depreciable real property acquired in contemplation of such discharge). In other words, the amount of discharged QRPBI excluded from a taxpayer’s income may not exceed the aggregate bases of the taxpayer’s depreciable real properties held immediately before the discharge.
- Section 1017(b)(3)(F)(iii) also provides that in the case of “property taken into account under section 108(c)(2)(B)” (e., depreciable real property which was used to show that he had aggregated bases in excess of the discharge amount) in the same year as the discharge, the basis reduction must occur immediately before the sales of the properties and not in the year following the sales.
- For basis reductions under section 108(c), a taxpayer must reduce the adjusted basis of the qualifying real property to the extent of the discharged qualified real property business indebtedness before reducing the adjusted bases of other depreciable real property. Reg. § 1.1017-1(c)(1).
- The Tax Court looks to the governing text in determining issues of statutory interpretation. See Allen v. Comm’r, 118 T.C. 1, 7 (2002). Even if a statute is unambiguous, the Tax Court may look to Congress’ statements about a statute’s purpose in the legislative history to determine the proper application of a statutory provision. See U.S. v. Am. Trucking Ass’ns, Inc., 310 U.S. 534, 543-44 (1940).
- Legislative history shows that the provisions central to this case were enacted in 1993 to provide relief to owners of certain real estate which had declined in value. Consistent with this purpose, section 108(c)(2)(A) limits the income exclusion to the amount by which the value of the property is less than the indebtedness on the property (e., the amount the property is “underwater”). The form of relief was to convert the consequence of the discharge of certain indebtedness (QRPBI) from income, as would generally result under Section 108, to a basis adjustment.
- The Tax Court may refuse to consider an issue not raised in the pleadings and raised with the Court for the first time in the party’s pre-trial memorandum, if consideration of the issue would surprise or prejudice the opposing party. Fox Chevrolet, Inc. v. Comm’r, 76 T.C. 708, 733-36 (1981).
- If an amount charged off is retained on a creditors books (e., moved to a reserve account), the charge-off is not a discharge of indebtedness. See Int’l Proprietaries, Inc. v. Comm’r, 18 T.C. 133, 139 (1952) (“[T]here is no authorization for a taxpayer[-creditor] to use at the same time a charge-off and a reserve method for the deduction of bad debts.”).
- The term “loan loss reserve” is familiar to this Court. See, e.g., Bank One Corp. v. Comm’r, 120 T.C. 174 (2003). “Loss reserve” is defined as “a bank’s reserve set aside to cover possible losses, as from defaulting loans.” Black’s Law Dictionary 1422 (9th 2009).
- Taxpayers are not liable for penalties under section 6662 for any part of an underpayment if the taxpayer had reasonable cause and acted in good faith. 6664(c)(1). Reliance on the advice of a professional tax adviser may demonstrate reasonable cause and good faith. Treas. Reg. § 1.6664-4(b)(1). The Tax Court may recognize reasonable reliance on professional advice if the taxpayer shows that: (1) the adviser was a competent professional who had sufficient expertise to justify the taxpayer’s reliance on him or her; (2) the taxpayer provided necessary and accurate information to the adviser; 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, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).
- The Tax Court decides whether a taxpayer relied in good faith by considering all of the facts and circumstances, including the taxpayer’s “experience, knowledge, and education.” Reg. § 1.6664-4(b)(1).
Insight: The Hussey decision demonstrates that taxpayers may be able to avoid federal tax penalties for reporting positions if they rely in good faith on a tax professional for the preparation of a tax return.
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, and 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.