The Tax Court in Brief May 31 – June 4, 2021

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The Tax Court in Brief May 31 – June 4, 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 31 – June 4, 2021

ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2021-68 

June 3, 2021 | Weiler, J. | Dkt. No. 13471-17

Tax Dispute Short Summary

In the relevant tax year, Petitioner, a partnership for U.S. tax purposes, became part of a labyrinth of entity ownership.  The initial structure saw a single individual owning 100% interest in an incorporated entity.  The incorporated entity owned all the shares for all the classes of stock in a limited liability company (“LLC1”).  LLC1 owned all the shares for all the classes of stock in another LLC (LLC2).  All entities were considered disregarded entities.

Petitioner exercised a call option granted by the incorporated entity to acquire all of a particular class of stock in an entity wholly owned by the incorporated entity granting the option.  Under the call option, petitioner agreed to provide services to the incorporated entity, in exchange for the option to pay $100,000 to the incorporated entity for the class of stock in LLC1.  Specifically, the services included providing strategic advice for the purpose of enhancing the performance of the incorporated entity’s business and assemble an investor group that would purchase forty percent of the incorporated entity’s business for a substantial amount of money. At the end of the assignment, the petitioner owned interest in LLC1, along with the incorporated entity.

IRS issued a final partnership administrative adjustment (FPAA) for the relevant tax year.  The FPAA increased petitioner’s income and issues section 6662 accuracy-related penalties to the petitioner’s members.

Tax Litigation Key Issue:

Primary Holdings

Key Points of Law:

Insight: There is a fine line when providing services in exchange for an interest in a partnership or other disregarded entity.  The transfer of the partnership interest resembles payment for rendered services.  The IRS and the Tax Court treat such an exchange no different than a neighbor paying for lawn maintenance services with Apple stock instead of money.  This pitfall is too well-established for this issue to keep repeating.  Taxpayers need to pause and think before jumping into these types of partnerships or disregarded entity contributions.

Michael Torres v. Commissioner, T.C. Memo. 2021-66 

June 2, 2021 | Kerrigan, J. | Dkt. No. 6954-19

Tax Dispute Short Summary

Petitioner is the sole shareholder of a flow-through S corporation.  In the relevant tax year, the petitioner suffered an illness that prevented him from reading, working or timely filing his tax return.  During this period, the S corporation issued a FORM 1099-MISC, Miscellaneous Income, to a former shareholder but current manager of S corporation’s books and records.  Two years later, petitioner relearned how to read and started handing the S corporation’s tax matters.

After learning of the income issued to the former shareholder, the petitioner filed a lawsuit, claiming misappropriation of funds.  The lawsuit was still pending as of the time of this opinion.  Additionally, petitioner and the S corporation failed to timely file their Form 1040 and Form 1120S, respectively.  The following year, IRS issued a notice of deficiency.  Two weeks later, the S corporation submitted an amended return claiming an additional expense for outside services, reflecting the S corporations increase in expenses.  Likewise, petitioner submitted an amended tax return that reduced his flow through income to the amount claimed as embezzled.  IRS neither accepted nor filed the amended tax returns.

Tax Litigation Key Issues:

Primary Holdings

Key Points of Law:

Insight: This is one of those decisions that seems unfair to the taxpayer.  Although the Tax Court followed the letter of the law, one can just feel the “sigh” that the taxpayer must feel.  However, the decision plays a helpful reminder that when claiming a theft loss deduction to ensure that it is satisfied that an actual theft took place!  Further, the Code rules supreme and tells the taxpayer when it is able to take a theft loss deduction.  These simple checks can prevent a taxpayer future headaches.

New Capital Fire, Inc. v. Commissioner, T.C. Memo. 2021-67

June 2, 2021 | Goeke, J. | Dkt. No. 25505-06 

Tax Dispute Short Summary

Under a plan of merger, the taxpayer acquired the target company’s appreciated assets in the tax year at issue.  Taxpayer subsequently sold the assets, reported a carryover basis in the assets, and reported capital gains that were offset by loss deductions.  The year of the merger, the target company failed to file a tax return.  Rather, the acquiring entity attached a pro forma return for the target company on its tax return.  For several years, the taxpayer and the target company heard nothing.

Subsequently, the IRS began an audit for the taxpayer’s tax year at issue.  Taxpayer refused to cooperate during the audit.  The audit failed to consider the structure of the taxpayer’s merger in the tax year at issue.  Further, the IRS employees assigned to the audit failed to question the taxpayer about the merger or the target company.  Accordingly, the IRS issued a notice of deficiency to the taxpayer for the tax year at issue.

After the discovery period for the taxpayer’s case ended, the IRS opened an audit into the target company.  The IRS determined that the target company failed to file a tax return ending on the merger date and that the merger did not qualify as an F reorganization. The IRS then prepared a substitute for return for the target company and issued a notice of deficiency.  The taxpayer, as successor in interest to the target company, filed a Tax Court petition.  The Tax Court held that the notice of deficiency was untimely, and that the statute of limitations barred the assessment for the tax year at issue.

The taxpayer, in return, amended its tax return to claim it did not realize capital gain from the sale of assets.  Rather, taxpayer alleged that, because the merger failed to qualify as an F reorganization, the target company realized capital gains and the taxpayer took a basis in the target’s securities equal to the fair market value.  Taxpayer changed course in categorizing the merger, agreeing with the IRS’ position.  As a consequence of this amended return, IRS issued a notice of deficiency for the taxpayer’s tax year at issue.  In response, the taxpayer filed a Tax Court petition.

Key Issues:

Primary Holdings

Key Points of Law:

nsightWhen the Tax Court gives you a win, please hesitate before trying to take a second bite of the apple.  The statute of limitations has the primary purpose of shielding against liability.  In the tax regime, taxpayers should avoid utilizing the statute of limitations as an income-reducing tool because it likely means opening oneself up to the type of scrutiny this Court displayed.  The Duty of Consistency, or estoppel in this case, exists for the sole purpose to prevent the taxpayer from continuously altering to the most favorable position at the most opportune time.


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.