The Tax Court in Brief August 16 – August 20, 2021

Share this Article
Facebook Icon LinkedIn Icon Twitter Icon

Freeman Law is a tax, white-collar, and litigation boutique law firm. We offer unique and valued counsel, insight, and experience. Our firm is where clients turn when the stakes are high and the issues are complex.

The Tax Court in Brief August 16 – August 20, 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 16 – August 20, 2021

Catlett v. Comm’r, No. 13058-14, T.C. Memo 2021-102 

August 16, 2021 | Lauber | Dkt. No. 13058-14

Tax Dispute Short SummaryThe taxpayer was convicted in 2011 on Federal criminal charges, including tax crimes and conspiracy to defraud the United States. In March 2011 he was sentenced to 210 months in prison. After he was remanded to custody, the IRS completed a civil examination of his 2006-2010 tax years.  The IRS subsequently assessed substantial deficiencies, along with additions to tax and penalties.  The taxpayer timely petitioned the Tax Court in June 2014.  However, because of his incarceration, the case was repeatedly continued.  The taxpayer died in January 2020, and the IRS filed a motion to dismiss the case based on lack of prosecution.

Tax Dispute Key Issue:  The key issue is the standard for dismissal when a taxpayer fails to prosecute their case.  Various burdens come into play that the IRS must still meet despite the failure of the taxpayer to prosecute his case.

Primary Holdings

Key Points of Tax Law:

InsightThis case represents a tragic set of facts in which a taxpayer checked all the boxes to earn a finding of filing fraudulent returns.  From a procedural standpoint, however, this case provides a useful guide to the various burdens applicable to both taxpayers and the IRS in Tax Court.

Catherine S. Toulouse v. Comm’r, 157 T.C.

August 16, 2021 | Goeke, J. | Dkt. No. 19122-19

Tax Dispute Short SummaryThe case discussed the applicability of the foreign tax credit (FTC) against the Net Investment Income Tax (NIIT) under the tax treaties between the U.S. and France and Italy. The Court concluded that under the text of such treaties, the foreign tax credit cannot be applied against the NIIT.

Catherine Toulouse (the petitioner), a U.S. citizen residing in a foreign country, filed her tax return for 2013 claiming FTC paid to France and Italy to offset her income tax. She also reported a carryover of FTCs to offset her income tax. Despite having NIIT in the amount of $11,540.00 USD, the petitioner claimed that her NIIT was zero. This calculation resulted because the petitioner added two lines to the return: the first to claim an FTC against the NIIT and the second resulting in NIIT due in the amount of zero. The petitioner disclosed her tax position by filing forms 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), and form 8275, Disclosure Statement, where she explained that under article 24(2)(a) of the U.S.-France tax treaty, and article 23(2)(a) of the U.S.-Italy tax treaty, she was allowed to apply FTC against the NIIT.

The IRS issued a notice of math error to the petitioner adjusting the NIIT amount owed and eventually disallowed the FTC and issued an assessment. Upon the issuance of the notice of intent to levy and notice of a right to a hearing, the petitioner timely filed a Collection Due Process (CDP) request. Appeals sustained the assessment and issued a notice of determination.

The Tax Court determined that the FTC is not applicable to offset the NIIT, under the text of the tax treaties between the U.S. and France and Italy respectively and in accordance with the provisions of the Code.

Key Issues: Whether under the tax treaties between the U.S. and France and Italy, a U.S. taxpayer is allowed to apply an FTC against the NIIT.

Primary Holdings: The petitioner is not allowed to apply the FTC against the NIIT under the tax treaties between the U.S. and France and Italy.

Key Points of Tax Law:

Section 6330 of the Code provides that a taxpayer that timely requests a CDP is entitled to a hearing, where the taxpayer can challenge can raise any relevant issue related to the unpaid tax or proposed levy, and also, can challenge the underlying tax liability. When the underlying tax liability is at issue on a CDP hearing, the Court reviews the liability de novo. See Davis v. Commissioner, 115 T.C. 35, 39 (2000). In this case, the petitioner challenged the underlying liability, and the Court reviewed such assessment de novo.

Section 27 of Chapter 1 of the Code allows the taxpayers to apply a credit for the amount of taxes imposed by foreign countries against the tax imposed by “this chapter” to the extent provided in section 901. Section 901 establishes an FTC against regular tax. These two provisions state that the FTC reduces only tax imposed under chapter 1 of the Code.

The NIIT is in chapter 2A, subtitle A, Income taxes. Consequently, the FTC under section 27 (applicable only for taxes under chapter 1), does not apply by its terms to offset the NIIT. Treas. Reg. 1.411-1(a) provides that all the IRC provisions that apply for chapter 1 purposes in determining taxable income, as defined in section 63(a), also apply in determining the NIIT. Section 63(a) does not include credits to determining taxable income, thereby, the FTC (a credit) is not applicable to the NIIT.

Article 24(2)(a) of the tax treaty between the U.S. and France provides respectively the following: “In accordance with the provisions and subject to the limitations of the law of the U.S, the U.S. shall allow to a citizen… of the U.S. as a credit against the U.S. income tax:(i) the French income tax paid by or on behalf of such citizen…”. Art. 23(2)(a) of the tax treaty between U.S.-Italy is in similar terms.

Such treaties must be interpreted using their ordinary meaning and must be construed liberally to give the purpose of the treaty. Under this approach and under the express terms of the treaties, the Court stated that any allowable foreign tax credit must be determined in accordance with the Code and is limited to by the Code’s provision of a credit. Accordingly, if the Code provides for a credit, then such credit will be allowable under the treaty. Because section 1411(c)(1)(B) expressly provides for deductions to compute the NIIT, but does not provide for credits, it is clear that the FTC is not applicable against the NIIT.

This interpretation is supported by additional arguments. First, the purpose of the treaties is to provide general protection against double taxation, not to provide absolute protection. Nothing in the text of the tax treaty between the U.S. and France and Italy, respectively, provides for the elimination of all double taxation. Second, the Court’s interpretation is affirmed by the contemporary explanation provided by the Treasury Department of both treaties, which basically states that the credits under the “Convention are allowed in accordance with the provisions and subject to the limitations of U.S. law”… “thus, although the Convention provides for a foreign tax credit, the terms of the credit are determined by the provisions of the U.S. statutory credit at the time the credit is given”.

Based on the previous, the Court concluded that the FTC, applicable only to the tax under section 1 (income tax) is not applicable to the NIIT, under the terms of the texts of the U.S.-France and the U.S.-Italy tax treaties.

Insight:  Tax treaties are relevant when determining the tax implications of international taxpayers. Careful consideration must be given to the text of each treaty because relevant differences are usually found among the multiple treaties. In this particular case, there was an express provision in the Code that limited the FTC to income tax disallowing its application to the NIIT.

More problematic is the application of a treaty for newly enacted measures, for example, a unilateral measure on digital taxation imposed by the other treaty jurisdiction. This case is relevant in the short-term for the prospective tax reform and the implementation of Pillar 1 & 2 currently in development by the OECD.

Lissack v. Comm’r, 157 T.C. No. 5

August 17, 2021 | Lauber, J. | Dkt. No. 399-18W

Tax Dispute Short Summary

The taxpayer Lissack was a whistleblower who submitted Form 211, Application for Award for Original Information, claiming that taxpayer Target (an affiliated group of entities) had failed to report membership fees as gross income. The membership fees in question were for golf and beach club memberships to residents of Target’s condominiums. The taxpayer claimed that Target had improperly treated the membership fees as nontaxable deposits in the years received. Upon receiving the whistleblower claim, the IRS Whistleblower Office (Office) referred the claim to the Office’s senior tax analyst. The analyst determined that the claim appeared to identify a discernible Federal tax issue and accordingly, she forwarded the case to the IRS Large Business & International Division (LB&I), which then assigned the investigation to a revenue agent (RA) who reviewed the taxpayer’s allegations.

The RA noted that the information provided by the taxpayer whistleblower was sufficient to warrant the beginning of the examination. Upon further examination, the RA concluded that Target properly treated the membership fees as nontaxable deposits in the years received, as Target “did not have unfettered right and dominion over the deposits.” However, the RA also recognized a separate issue with taxpayer Target’s return for the same tax year, namely that Target had improperly claimed a deduction in excess of $60 million for “intercompany bad debt.” The RA noted that this bad debt issue was “unrelated to the subject of the whistleblower[‘s] claims.” Once the RA had completed his examination, the IRS had issued Target notices of proposed adjustments, disallowing the $60 million bad debt deduction.

The RA had informed the Office’s assigned tax analyst that the the taxpayer had not “provided any information for the adjusted issues.” The tax analyst relayed the same to the Office, which then issued a final determination letter to the taxpayer denying the taxpayer’s claim for a whistleblower award. The reason provided by the Office was that the “IRS took no action on the issues you raised.”

The taxpayer petitioned the Tax Court for review of the Office’s determination. In response, Respondent Commissioner filed a motion for summary judgment.

Tax Litigation Key Issue:

Primary Holding

Key Points of the Tax Law:

Insight: When determining whether a whistleblower is entitled to an award under I.R.C. § 7623, the Court will first look at whether the claims brought forth by the whistleblower and the claims the IRS has pursued against the taxpayer at issue are essentially the same. When the claims are different, a Tax Court will look at whether the claims pursued are related to those alleged by the whistleblower (i.e., whether the underlying facts as to the whistleblower’s claim and the claims actually pursued as substantially the same). The whistleblower is only entitled to an award if the IRS collects proceeds from the action AND if the action is related to the allegations brought forth by the whistleblower.

Deborah C. Wood v. Comm’r; T.C. Memo. 2021-103 

August 18, 2021, Lauber, J. | Dkt. Nos. 23239-18, 23260-18

Tax Litigation Short Summary:  The IRS determined that Wood, a government contractor who earned all her income on a U.S. military base in Afghanistan, owed roughly $95,000 in income tax deficiencies, plus additional tax and accuracy-related penalties. Wood petitioned the tax court, which mainly found in her favor. The court held that she qualified for section 911(a)(1)’s “foreign earned income” exclusion and that she was not liable for a late-filing addition to tax under section 6651(a)(1) because she was serving in support of the military in a combat zone during the relevant time.

Key Issues: The two requirements for qualifying for the foreign earned income exclusion turn on a variety of factors. Here, the taxpayer’s somewhat unique work circumstances easily qualified her for the exclusion.

Primary Holdings:

Section 61(a) provides that gross income means “all income from whatever source derived.”  Section 911(a)(1) provides that a “qualified individual” may elect to exclude from gross income, subject to certain limitations, “foreign earned income.” Foreign earned income is “the amount received by such individual from sources within a foreign country or countries which constitute earned income attributable to services performed by such individual.” Sec. 911(b)(1)(A).

There was no dispute that Wood’s compensation for her work as a contractor in Afghanistan was “foreign earned income.” The issue was whether she was a “qualified individual” and eligible to exclude that compensation from her gross income. The court agreed with Wood that she was.

There are two requirements to qualify for this exclusion: “First, she must either be a ‘bona fide resident’ of one or more foreign countries or be physically present abroad for a specified period. Sec. 911(d)(1). Second, she must show that her ‘tax home is in a foreign country.” Sec. 911(d)(1) (flush language).” Wood at 11-12.

To establish bona fide foreign residency, the taxpayer must provide “strong proof” (more than a preponderance) of that residence. Courts look at a number of factors, including: “(1) intention of the taxpayer; (2) establishment of her home temporarily in the foreign country for an indefinite period; (3) participation in the activities of her chosen community on social and cultural levels, identification with the daily lives of the people, and, in general, assimilation into the foreign environment; (4) physical presence in the foreign country consistent with her employment; (5) nature, extent, and reasons for temporary absences from her temporary foreign home; (6) assumption of economic burdens and payment of taxes to the foreign country; (7) status of resident contrasted to that of transient or sojourner; (8) income tax treatment accorded by her employer; (9) marital status and residence of her family;(10) nature and duration of her employment and whether assignment abroad could be completed more expeditiously; and (11) whether residence abroad reflects good faith (as opposed to a tax evasion purpose).” Wood at 12-13 (citations omitted).

In reviewing Wood’s testimony and other evidence at trial to analyze these factors, the court also considered the unique circumstances of a government contractor in Afghanistan. Factors that might have ordinarily weighed in the government’s favor, were neutral at best, in those circumstances. For example, Wood maintained a Texas driver’s license as a condition of her employment. Likewise, doing her banking locally in Afghanistan would have been impractical, if not impossible. Participation in the local community was similarly impossible; she was not permitted to leave the base where she was stationed.

Based on its analysis of these factors, the court held that Wood was a bona fide resident of Afghanistan during 2012-2015. Wood was not a bona fide Afghanistan resident in 2016; she lived in her house in Texas from April (after losing her job) until December (when she returned to Afghanistan for a different contractor). She did, however, qualify for the exclusion (for part of the year) via the 330-day physical presence requirement. This requires that the taxpayer, “during any period of 12 consecutive months, * * * [be] present in a foreign country or countries during at least 330 full days in such period.” Sec. 911(d)(1)(B).” Id. 17-18.

The second requirement for the foreign earned income exclusion is to show that the taxpayer’s “tax home is a foreign country.” Sec. 911(d)(1). As the court noted, this inquiry overlaps with the first requirement.

The court concluded that Wood met both requirements for the exclusion for tax years 2012-2015 and part of 2016. The court also found that Wood was not liable for any additional tax or penalty for her late filing based on extensions for taxpayers serving in support of U.S. Armed Forces in a combat zone.

Key Points of Law:

Proof of bona fide foreign residency requires strong evidence, more than a preponderance. The inquiry is fact-intensive.

Tax Litigation Insight: Wood’s fairly unique circumstances (government contractor in Afghanistan) limit the application of this case. The court would likely review the relevant factors differently for a government contractor stationed elsewhere (for example, Europe), and very different for taxpayers earning income abroad in less restrictive circumstances.


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.