The Tax Court in Brief August 9 – August 13, 2021

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The Tax Court in Brief August 9 – August 13, 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 August 9 – August 13, 2021

Manuelito B. Rodriguez & Paz Rodriguez v. Comm’r, No. 19122-19

August 9, 2021 | Kerrigan, J. | Dkt. No. 19122-19

Tax Case Short SummaryThe case, rendered on oral findings and opinions, involved whether the taxpayers were entitled to deduct business expenses, COGS, a capital loss, and a section 6662 penalty.

Manuelito B. Rodriguez and Paz Rodriguez (the taxpayers) filed a Schedule C for an automotive repair business for the period 2014-2016. For 2014-2015, they filed a Schedule C for the ownership of a Seven-Eleven store, sold in 2015 and for which they claimed a loss of $98,217. The IRS disallowed rent expenses and COGS for the automotive repair business.

The Tax Court determined that the taxpayers did not met their burden of proving that the IRS’ determinations were incorrect and sustained the deficiencies.

It must be noted that this case has no precedential value.

Key Tax  Issues: Whether the taxpayers met their burden of proof in regard to the various items subject to litigation.

Primary Holdings: The taxpayers did not meet their burden of proof concerning the IRS’ disallowance of various items, including expenses, NOLs, and capital losses.

Key Points of  The Tax Law:

IRS’ determinations are presumed correct, and the taxpayer bears the burden of proving those determinations are incorrect. Rule 142(a); See Welch v. Helvering, 290 U.S. 111 , 115. COGS is not a deduction but rather an offset subtracted from gross receipts to determine gross income. See Metra Chem Corp. v. Commissioner, 88 T.C. 654 , 661 (1987). COGS must be substantiated by the taxpayer. Ordinary and necessary expenses are deductible when incurred in a trade or business under Section 162(a), and deductions are matter of legislative grace, which the taxpayer must prove his/her entitlement. SeeINDOPCO, Inc. v. Commissioner, 503 U.S. 79 , 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). In certain cases, however, the Court may estimate the amount of a deductible expense, if the taxpayer established that the expense is deductible but is unable to substantiate the precise amount, known as the “Cohan Rule”. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).

Tax Court Motion: In this case, the taxpayers did not provide any evidence to support their deductions, their unreported income and capital losses, thus failing to meet their burden of proof. Finally, as to the penalties imposed under Section 6662(a), such penalty was sustained because the taxpayers did not show.

Tax Law Insight:  Although this case has no value as a precedent, it serves as a clear example that taxpayers must substantiate every expense that they claim on a tax return. Failure to do so, will unequivocally lead to a fatal result in Tax Court.

Christian D. Silver v. Comm’r, T.C. Memo 2021-98

August 9, 2021 | Copeland, J. | Dkt. No. 8805-18.

Tax Dispute Short SummaryThe case involved the analysis of a tax protestor’s arguments to sustain the not reporting of income. More interestingly, this case discusses whether a penalty under Section 6673 should be imposed under the circumstances of the case.

During 2012, Mr. Silver (the taxpayer) worked for 11 different businesses, for which he received wages and an additional business, for which he received compensation as an independent contractor (1099-Misc). When filing his tax return, he attached 11 (one per job he had) Forms 4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R, Distribution From Pensions, Annuities, Retirement or Profit Plans, IRA’s Insurance Contracts, Etc. For the independent contractor payment, he attached a “corrected” Form 1099-Misc. On the 4852 the taxpayer claimed that he received $0.00 as income. On the “corrected” 1099-Misc the taxpayer stated that such document was to “rebut the 1099-Misc” filed by the payor. In other words, the taxpayer argued that the compensation he received for his job/services was not taxable.

Tax Court Motion: The Court determined that the taxpayer’s arguments were that of a tax protestor and plainly rejected them, and qualified them as “groundless and frivolous”. However, the Court analyzed whether a penalty under Section 6673 – penalties for positions that are frivolous or groundless – applied, and ruled that such penalty was not applicable in this case.

Key Issues: Whether wages or compensation for independent services are subject to tax income. Whether a taxpayer should be sanctioned with a penalty under Section 6673 when he has not been advised of the applicability of the penalty before trial.

Primary Holdings: Wages constitute income. A penalty under Section 6673 requires that the taxpayer knows of the applicability of the penalty before trial, in order to be imposed by the Court.

Key Points of Law:

The seminal rule of income tax is that gross income includes all income from whatever source derived. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 , 429 , 75 S. Ct. 473 , 99 L. Ed. 483 , 1955-1 C.B. 207 (1955) (quoting Helvering v. Clifford, 309 U.S. 331 , 334 , 60 S. Ct. 554 , 84 L. Ed. 788 , 1940-1 C.B. 105 (1940)). A payment that is an undeniable accession to wealth constitutes taxable income. Wages are considered as an accession to wealth, thus subject to tax income.

In this case, the taxpayer did not deny receiving income but rather argued that he was not a taxpayer or that he did not received taxable compensation but rather exchanged his services for remuneration paid to him. The Tax Court determined that such arguments were groundless and frivolous. See  Wnuck v. Commissioner, 136 T.C. 498 (2011). The Court did not even refute the taxpayer’s arguments because they did not have any colorable merit.

Section 6673 provides the imposition of a penalty not in excess of $25,000 when it appears that the taxpayer’s position is frivolous or groundless. Such penalty is entirely within the discretion of the Court. In this case, the Court explained that although the taxpayer had two other pending petitions in the Court, he was not warned that the penalty could be imposed on him. Relevant also, is the fact that the penalty request was not advanced before trial. Under these circumstances, the Court determined to not impose the penalty, but warned the taxpayer that advancing similar positions in future cases would carry the imposition of the penalty.

Insight: A penalty under Section 6673, for frivolous or groundless positions, is an additional weapon that the IRS can request against the taxpayer. This case shows that the Tax Court will not impose such types of penalties easily, but rather it considers that the threshold to impose them is quite high.

Wathen v. Comm’r, No. 4310-18, T.C. Memo 2021-100

August 11, 2021 | Pugh | Dkt. No. 4310-18

Tax Litigation Short SummaryThis case involved a combination of underreported income and unsubstantiated deductions.  The Petitioner, a bankruptcy attorney, under-reported certain gross receipts for 2010 and 2011.  He further failed to report partnership income.  Finally, he was unable to substantiate most of his claimed expenses – including some that were subject to the heightened substantiation requirement of I.R.C. §274(d), and even some that were only subject to the general substantiation requirement.  Finally, in a slightly varied fact pattern, Petitioner argued that a Chapter 13 bankruptcy case filed in 2012, and for which the Petitioner received a discharge in 2017, served as res judicata and thereby precluded the IRS from assessing the amounts at issue.  The Court ultimately found that res judicata did not apply because the issues before the Tax Court in this case were not before the Bankruptcy Court.

Tax Dispute Key Issue:  The Court identified seven (7) discreet issues for determination in this case:

Primary Holdings

Key Points of  Tax Law:

Tax Litigation Insight: This case provides yet another example of the benefits of good record keeping.  It seems likely that many of this taxpayer’s expenses were legitimate, but it is incumbent on a taxpayer to be able to prove the legitimacy of those expenditures.

Kidz University, Inc. v. Comm’r, T.C. Memo. 2021-101 

August 12, 2021 | Urda, J. | Dkt. No. 23866-18L

Tax Dispute Short Summary: Petitioner Kidz University, an Arkansas childcare company, belatedly filed certain Forms 941 for tax years 2012 and 2013 between June 2014 and October 2015. In response, the IRS assessed taxes, as well as interest and penalties under Sections 6651(a)(1); 6651(a)(2); and 6656(a). The IRS issued a Notice of Intent to Levy to Kidz University, and the Petitioner timely filed a Request for Collection Due Process Hearing.

Tax Court Motion:

Over several months, the representative for Kidz University and the IRS Appeals Officer communicated via phone and fax. IRS Appeals requested, on more than one occasion, verification of current tax filing and payment compliance. Moreover, IRS Appeals requested completed Forms 433-A and 433-B. After the representative was silent and non-responsive to attempted communications by IRS Appeals in August, September, and October 2018, IRS Appeals issued a notice of determination, stating Kidz University did not qualify for a collection alternative. Kidz University filed its petition with the Tax Court, and Respondent filed a motion for summary judgment.

Tax Litigation Key Issues:

Primary Holdings:

Key Points of Tax Law:

Tax Litigation Insight: As noted in other recent Tax Court decisions, tax filing and payment compliance should be viewed by taxpayers as a minimum threshold to pursue collection alternatives. Further, a taxpayer should be selective in choosing a representative before the Internal Revenue Service. Lack of communication is hardly a recipe for success in dealing with the IRS.


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, 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.