The Tax Court in Brief September 12 – 18, 2020

The Tax Court in Brief September 12 – September 18, 2020

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 for The Week of September 12 – September 18, 2020

• Deckard v. Comm’r, 155 T.C. No. 8
• Cindy Damiani v. Comm’r, T.C. Memo. 2020-132
• Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

Deckard v. Comm’r, 155 T.C. No. 8 

September 17, 2020 | Thornton, J. | Dkt. No. 11859-17

Short Summary:  Waterfront Fashion Week, Inc. (Waterfront) was organized under Kentucky law as a nonstock, nonprofit corporation in 2012.  Mr. Deckard was Waterfront’s president and one of its three directors.  Waterfront never applied for recognition of tax-exempt status with the IRS.

On October 28, 2014, Waterfront mailed to the IRS Form 2553, Election by a Small Business Corporation.  In the Form 2553, Waterfront sought to elect to be an S corporation retroactively as of the date of its incorporation in 2012.  Mr. Deckard signed the Form 2553 in his capacity as Waterfront’s president.  In addition, Mr. Deckard signed the Form 2553 shareholder’s consent statement, indicating that he owned 100% of Waterfront.

In 2015, Waterfront filed Forms 1120S, U.S. Income Tax Return for an S Corporation, for its taxable years 2012 and 2013, reporting operating losses.  Mr. Deckard reported these flow-through losses on his 2012 and 2013 returns.

The IRS disallowed the losses on the ground that Waterfront filed to make a valid S corporation election and alternatively that Mr. Deckard was not a shareholder of Waterfront.  Mr. Deckard filed a timely petition with the United States Tax Court.

Key Issue:  Whether Mr. Deckard can claim the losses from Waterfront on his 2012 and 2013 tax returns?

Primary Holdings: 

• Deckard may not claim the losses attributable to Waterfront because he held no ownership interest in Waterfront equivalent to that of a shareholder for purposes of applying subchapter S of the Code.

Key Points of Law:  

• Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Peach Corp. v. Comm’r, 90 T.C. 678, 681 (1988).  The Court may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law.  Rule 121(b).  The moving party bears the burden of proving that there is no genuine dispute as to any material fact, and factual inferences will be read in a manner most favorable to the party opposing summary judgment.  Sundstrand Corp. v. Comm’r, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7^th Cir. 1994).
• Subchapter S allows a qualified corporation, with the consent of all its shareholders, to be treated as a passthrough entity for purposes of federal income tax. Sections 1361-1366.  Consequently, an S corporation, unlike a traditional C corporation, generally pays no federal income tax.  Instead, a shareholder of an S corporation must report a pro rata share of the S corporation’s taxable income, losses, deductions, and credits.  1366(a)(1)(A); Treas. Reg. § 1.1366-1(a); see also Gitlitz v. Comm’r, 531 U.S. 206, 209 (2001); Maloof v. Comm’r, 456 F.3d 645, 647 (6^th Cir. 2006).
• The subchapter S regulations provide: “Ordinarily, the person who would have to include in gross income dividends distributed with respect to the stock of the corporation (if the corporation were a C corporation) is considered to be the shareholder of the corporation.”  Reg. § 1.1361-1(e)(1).  Citing this regulation, one court has observed that “the question whether a person was a shareholder on the date of the election to be taxed under subchapter S is equivalent to the question whether, had there been a valid election, he would have been required to report as personal income profits earned by the corporation on that date.”  Cabintaxi Corp. v. Comm’r, 63 F.3d 614, 616 (7^th Cir. 1995).  The resolution of this question depends on whether the person “would have been deemed a beneficial owner of shares in the corporation, entitled therefore to demand from the nominal owner the dividends or any other distributions of earnings on those shares.”  Id.
• The courts look to State law to determine whether a person is a beneficial owner of corporate shares. at 617 (citing U.S. v. Nat’l Bank of Commerce, 472 U.S. 713, 722 (1985).
• Consistently with these precepts, in deciding whether a person is properly treated as an S corporation shareholder, courts have frequently considered whether the person is a beneficial owner of the corporation’s stock. See, e.g., Pahl v. Comm’r, 150 F.3d 1124; Cabintaxi Corp. v. Comm’r, 63 F.3d 614; Wilson v. Comm’r, 560 F.2d 687 (5^th 1977).
• Nonprofit corporations are not generally considered to have owners. See Farrow v. Saint Francis Med. Ctr., 407 S.W.3d 579, 593 (Mo. 2013).  The reason nonprofit corporations are not generally considered to have owners is that they are prohibited from distributing profits to insiders who are in positions to exercise control, such as members, officers, and directors.  Austin v. Mich. Chamber of Commerce, 494 U.S. 652, 675 n. 6 (1990) (Brennan, J., concurring).
• Taxpayers are generally bound by the form of the transaction they choose. As the Supreme Court has stated:  “[W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not.” Comm’r v. Nat’l Dehydrating & Milling Co., 417 U.S. 134, 149 (1974); see Maloof v. Comm’r, 456 F.3d at 651 (“[A]s a general rule, courts will deem the form of a transaction to reflect its substance.”); Television Indus., Inc. v. Comm’r, 284 F.2d 322, 325 (2d Cir. 1960).

Insight: The Deckard decision was an interesting one in that it is unusual for taxpayers to request subchapter S status for a nonprofit corporate entity.  Rather, most taxpayers who organize a nonprofit corporation under State law also file an IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.  The decision is a good read for those that want to see how state law interacts with federal tax law.

Cindy Damiani v. Comm’r, T.C. Memo. 2020-132 

September 17, 2020 | Lauber, J. | Dkt. No. 14914-19W

Short Summary:  The case involved the rejection of a whistleblower award to a foreign national. The foreign national argued that the IRS abused its discretion when rejecting the award. The Tax Court determined that the IRS did not abuse its discretion because the foreign national did not provided information concerning a Federal Tax violation.

In 2019, Mrs. Cipriani (the “whistleblower”), a foreign national with residence in Germany, filed Form 211, Application for Award for Original Information. She identified two targets, a German insurance company and the managing director of such company. On her application, she alleged that the targets have committed multiple illegal acts, such as fiduciary fraud, bond fraud, securities fraud and identity theft. She also alleged that they have committed money laundering and tax fraud. On her application she asked the IRS if Form 1099-OID was required and if Form 1040 has already been submitted by the managing director. To support her allegations, she provided Form 3949-A, Information Referral and Form 14039, Identity Theft Affidavit and invoices in German.

The IRS Whistleblower Office (the “Office”) began two different claims, one for each target. After conducting the research on the targets, the Office determined that no US person or entity was part of the allegations and concluded that the whistleblower did not identified a federal tax issue. The whistleblower petitioned, after the 30-day period specified in section 7623(b)(4), the Tax Court for review the Office’s rejection. The IRS filed a motion for summary judgment, which the whistleblower did not responded. The Tax Court affirmed the IRS’ rejection.

Key Issues:  Whether the IRS can reject a claim under section 7623(b)(1) under the abuse of discretion standard, when the claim does not raise a federal tax issue involving the violation or underpayment of the US tax laws.

Primary Holdings: The IRS did not abuse its discretion when rejecting the award, because the whistleblower did not raise a federal tax issue involving the violation or underpayment of the US tax laws.

Key Points of Law:

• Before analyzing the main issue in this case, the Tax Court analyzed whether it had jurisdiction over the untimely petition filed by the whistleblower. Following the guidance offered by the D.C. Circuit in Myers, the Tax Court determined that it had jurisdiction over the untimely petition filed by the whistleblower. In Myers, the U.S. Court of Appeals for the D.C. Circuit determined that section 7623(b)(4) sets forth a non-jurisdictional claim-processing rule, and its violation does not deprive a court of authority to hear the case, but rather such filing period is subject to equitable tolling. See Myers v. Commissioner, 928 F.3d 1025, 1036 (D.C. Cir. 2019), rev’g and remanding 148 T.C. 438 (2017). The Tax Court applied such precedent because the D.C. Circuit is the appellate venue on whistleblower cases generally.
• The applicable standard to review a determination of the IRS for a whistleblower claim that fails to meet certain basic criteria is abuse of discretion. In this regard, the IRS can reject an award if the claim only supplies “speculative information” or provides information that is not regarding tax underpayments or violations of the internal revenue laws. Additionally, the IRS must state the basis for rejection. If the rejection meets these requirements there is no abuse of discretion.
• Section 7623(b)(1) provides for nondiscretionary awards ranging from 15% to 30% of the collected proceeds to a whistleblower. To award such amounts, the IRS must proceed with and administrative or judicial action and collect proceeds from the target taxpayers. If there is no administrative or judicial action, there can be no award.
• In the particular case, the whistleblower’s allegations concerning the application of US tax law was the allegedly “tax fraud”. Although the whistleblower mentioned the filing of Form 1099-OID and the filing of Form 1040 by the managing director of the German insurance company, she did not provided information to determine if the targets were required to file the mentioned forms. Under sec. 1.6049-5(b)(6), Income Tax Regs., amounts paid and received outside the US are not reported on Form 1099-OID and form 1040 is not required to file by a nonresident unless he is engaged in a trade or business in the US. Based on such analysis, both targets did not have any connection with the US tax laws.
• The Tax Court determined that the IRS did not abused its discretion when rejecting the award, because the information provided by the whistleblower was not regarding a violation of the US tax laws.

Insight: This case evidences the importance of providing clear information on whistleblowers claims. Although abuse of discretion can be used as a defense against the rejection of a claim in these types of cases, the claim necessarily must specify the underpayment of taxes or violation of the US tax laws committed by the targets.

Felix Ewald Friedel v. Comm’r, T.C. Memo. 2020-131

September 17, 2020 | Lauber, J. | Dkt. No. 11239-19W

Short Summary:  The case involved the rejection of a whistleblower award to a foreign national. The foreign national argued that the IRS abused its discretion when rejecting the award. The Tax Court determined that the IRS did not abuse its discretion because the foreign national did not provided information concerning a federal tax violation.

In 2019, Mr. Friedel (the “whistleblower”), a foreign national with residence in Germany, filed Form 211, Application for Award for Original Information. He identified six targets, allegedly German Government officials. He alleged that the targets have committed multiple illegal acts, such as fiduciary fraud, bond fraud, identity theft and human trafficking, among others. He also alleged that they have committed tax fraud by refusing to submit Forms 1099-OID, f1096 and f1040. To support his allegations, he provided Form 3949-A, Information Referral and Form 14039, Identity Theft Affidavit and letters issued by a German court and prosecutor written in German.

The IRS Whistleblower Office (the “Office”) began six different claims, one for each target. After conducting the research on one target, the German court, the Office determined that the allegation lacked credibility, noting the whistleblower’s failure to supply documents to support the claim and rejected the claim. On the other five targets, the IRS determined that no US person or entity was part of the allegations and concluded that the whistleblower did not identified a federal tax issue, or tax period or money amounts involved. The whistleblower petitioned, after the 30-day period specified in section 7623(b)(4), the Tax Court for review the Office’s rejection. The IRS filed a motion for summary judgment, which the whistleblower did not responded. The Tax Court affirmed the IRS’ rejection.

Key Issues:  Whether the IRS can reject a claim under section 7623(b)(1) under the abuse of discretion standard, when the claim does not raise a federal tax issue involving the violation or underpayment of the US tax laws.

Primary Holdings: The IRS did not abuse its discretion when rejecting the award, because the whistleblower did not raise a federal tax issue involving the violation or underpayment of the US tax laws.

Key Points of Law:

• Before analyzing the main issue in this case, the Tax Court analyzed whether it had jurisdiction over the untimely petition filed by the whistleblower. Following the guidance offered by the D.C. Circuit in Myers, the Tax Court determined that it had jurisdiction over the untimely petition filed by the whistleblower. In Myers, the U.S. Court of Appeals for the D.C. Circuit determined that section 7623(b)(4) sets forth a non-jurisdictional claim-processing rule, and its violation does not deprive a court of authority to hear the case, but rather such filing period is subject to equitable tolling. See Myers v. Commissioner, 928 F.3d 1025, 1036 (D.C. Cir. 2019), rev’g and remanding 148 T.C. 438 (2017). The Tax Court applied such precedent because the D.C. Circuit is the appellate venue on whistleblower cases generally.
• The applicable standard to review a determination of the IRS for a whistleblower claim that fails to meet certain basic criteria is abuse of discretion. In this regard, the IRS can reject an award if the claim only supplies “speculative information” or provides information that is not regarding tax underpayments or violations of the internal revenue laws. Additionally, the IRS must state the basis for rejection. If the rejection meets these requirements there is no abuse of discretion.
• Section 7623(b)(1) provides for nondiscretionary awards ranging from 15% to 30% of the collected proceeds to a whistleblower. To award such amounts, the IRS must proceed with and administrative or judicial action and collect proceeds from the target taxpayers. If there is no administrative or judicial action, there can be no award.
• In the particular case, the whistleblower’s allegations concerning the application of US tax law was the allegedly “tax fraud”. Although the whistleblower claimed the failure to file Form 1099-OID and the filing of Form 1040 by the targets, he did not provided information to determine if the targets were required to file the mentioned forms. Under sec. 1.6049-5(b)(6), Income Tax Regs., amounts paid and received outside the US are not reported on Form 1099-OID and form 1040 is not required to file by a nonresident unless he is engaged in a trade or business in the US. Based on such analysis, the targets did not have any connection with the US tax laws.
• The Tax Court determined that the IRS did not abused its discretion when rejecting the award, because the information provided by the whistleblower was not regarding a violation of the US tax laws.

Insight:  This case evidences the importance of providing clear information on whistleblowers claims. Although abuse of discretion can be used as a defense against the rejection of a claim in these types of cases, the claim necessarily must specify the underpayment of taxes or violation of the US tax laws committed by the targets.

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