Case Summaries

Right to Swap Easements Violates Perpetuity Requirement and Eliminates Deduction.

The petitioner purchased a 410-acre tract and developed a residential community and golf course.  Later, the petitioner donated a conservation easement on the golf course and claimed an associated income tax deduction of $10.5 million.  The easement agreement allowed the petitioner to swap the land subject to the easement for an equal or greater amount of contiguous land so long as the substitute property met certain conditions.  The Tax Court held that swap right violated the perpetuity requirement of I.R.C. Sec. 170(h)(2)(C).  On appeal, the court affirmed.  The appellate court noted that the restriction on "the real property" as required by statute was not perpetual because it was not tied to a specific tract in perpetuity.  By having the ability to substitute property under the easement restriction, the court noted that the petitioner could obliviate the appraisal to serve as the verification of the value of the restricted property and the condition of the property.  A "savings clause" in the easement agreement which would void the swapping right if a court found that it violated I.R.C. Sec. 170, was also of no effect because it would have, in essence, rewritten the easement in response to the court's holding.  Belk v. Comr., No. 13-2161, 2014 U.S. App. LEXIS 23680 (4th Cir. Dec. 16, 2014), aff'g., 140 T.C. 1 (2013). 


Taxpayer Earns Penalty For Bad Arguments and No Evidence.

 The petitioner, a lawyer, was the non-custodial parent of his children.  He claimed a child tax credit and an additional child tax credit for a year in which the children lived with his former spouse who had custody, but the IRS disallowed the credits because the children were not "qualifying children in accordance with I.R.C. Sec. 152(c).  The IRS also disallowed a dependency exemption because the petitioner did not attach Form 8283 to the return or other written declaration of exemption release from his former spouse and the divorce decree was not signed by the former spouse.  The court also upheld the IRS' disallowance of a deduction for telephone expenses attributable to the petitioner's business due to a lack of substantiation.   The court also upheld the denial of other claimed business deductions associated with the petitioner's law practice due to a lack of substantiation.  The court also disallowed a charitable deduction due to the lack of a contemporaneous written acknowledgement for contributions above $250.  Interestingly, the petitioner had written an acknowledgement letter to himself thanking himself for the contribution.  The court also disallowed a domestic production activities deduction attributable to grading and surveying expenses on property claimed to be held for timber harvesting because no timber had been harvested and, hence, the property didn't generate any gross receipts or QPAI.  In addition, the court denied medical expense deductions associated with in vitro fertilization treatments because the petitioner failed to prove that he was sterile.   Claimed deductions were also disallowed for payment of a child's college tuition and fees due to the lack of substantiation.  The court also disallowed a business mileage deduction due to a lack of substantiation.  The court did allow a  partial deduction for expenses attributable to the petitioner's office in the home, but denied part of the claimed expenses due to a lack of substantiation.  The court upheld an accuracy-related penalty of 20 percent of the underpayment due to negligence and lack of proof that he engaged a competent professional to prepare the return.  Longino v. Comr., No. 14-11508, 2014 U.S. App. LEXIS 23355 (11th Cir. Dec. 12, 2014), aff'g., T.C. Memo. 2013-80. 


Tax Character of Assets Matter When Dividing Marital Assets.

The parties were married in mid-2007.  At the time of the marriage the wife had a net worth of $68,000 and the husband estimated his net worth to be $364,534.  During the marriage, the husband received a CD as a gift from his grandmother of $27,308.76 and a $16,000 settlement on account of an auto accident.  The husband farmed with his father, sharing labor and equipment, grain storage and cattle herd.  Due to debt levels, the husband sought a sale of assets to pay debt, with the balance split between the parties.  The trial court set-off the husband's injury settlement and CD gift and did not consider tax consequences that might result from the decree.  The trial court valued the marital assets at $1,022,598 and ordered the husband to pay the wife $431,495 over time until paid in full.  The husband claimed the property division was not fair because it failed to account for the father's gift of farm machinery or the premarital property brought into the marriage, and the tax consequences of any sale of the property.  On appeal, the court determined that that value of the premarital property should be considered.  The court also determined that the tax character of the assets should be considered, noting that the assets were substantially depreciated which would result in recapture of depreciation on sale, or the inability to depreciate further if retained.  Ultimately, the court determined that the marital assets available for division were worth $767,178 and that if the assets were sold $250,000 of tax would be triggered which would reduce the marital assets to $517,178.  The court determined that an equalization payment of $260,000 was owed to the wife.  In re Marriage of Johnston, No. 13-1751, 2014 Iowa App. LEXIS 1178 (Iowa Ct. App. Dec. 10, 2014).   


Lack of Evidence Existed To Support Taxpayer Claims.

The petitioner operated a leasing business and an automobile salvage yard.  The IRS claimed that the petitioner overstated his gross receipts from the salvage yard, but the court determined that the evidence did not support that claim.  However, many of the petitioner's claimed business expenses, including travel expenses, were disallowed due to lack of substantiation of a business connection.  Safakish v. Comr., T.C. Memo. 2014-242. 


Depletion Deduction Allowed Because Taxpayer Retained Production Royalty.

Here, the taxpayer is a mining company that transferred its interest in a mine to a company for consideration but retained a bonus royalty and production royalty.  As is typical with a bonus royalty, it was paid in a single lump sum after a specified amount of cumulative reserves had been added to existing reserves.  As for the production royalty, it was paid based on a sliding scale that maxed-out at a fixed percentage for the commodity price beyond a set level again after a certain amount of reserves had been produced.  The IRS determined that the taxpayer could claim a depletion deduction attributable to the retained production royalty because the taxpayer retained an economic interest in that production royalty that satisfied Treas. Reg. §1.611-1(b) and Treas. Reg. §1.614-1(a)(2).  The IRS determined, however, that the retained bonus royalty was not a retained economic interest in mineral in place.  Tech. Adv. Memo. 201448020 (Jun. 3, 2014).


No Supreme Court Review of Estate Valuation Case.

The U.S. Supreme Court has declined to review a decision on the U.S. Court of Appeals for the Ninth Circuit which affirmed a Tax Court decision involving a decedent’s estate that claimed valuation discounts and deductions associated with claims against the estate.  Under the facts of the case, the decedent and her pre-deceased spouse founded a mail-order horticulture business.  They sold their shares to a company ESOP with the company funding the purchase by borrowing $70 million on an unsecured basis with one lender being the trustee of the ESOP.  The pre-deceased spouse contributed  his sale proceeds ($33 million) to his revocable trust.  Upon his death, the trust split into marital trusts, with the ESOP trustee being the trustee of the marital trusts.  The company’s earnings declined and the ESOP lenders wanted to restructure the loans so that they would be secured.  The company filed bankruptcy after the ESOP beneficiaries sued for breach of fiduciary duty.  Pending the outcome of the litigation, the ESOP trustee barred the decedent from receiving trust distributions from one of the marital trusts.  The trial court ruled against the beneficiaries, and the decedent then died while the appeal was pending.  On the decedent’s estate tax return, a $15 million liability was listed which related to the litigation associated with the three trusts.  The Tax Court denied any discount for litigation hazards and lack of marketability.  The court reasoned that the lawsuit would not have impacted a buyer’s rights.  Also, the bar on the decedent getting distributions had no impact on the value of the assets in the trust.  On the estate’s potential liability, no discount was allowed because the estate did not establish it’s liability with reasonable certainty.  On appeal, the Ninth Circuit affirmed on the same grounds that the Tax Court ruled against the estate.  The U.S. Supreme Court declined to review the case.  Estate of Foster v. Comr., 565 Fed. Appx. 654 (9th Cir. 2014), aff’g., T.C. Memo. 2011-95, cert. den., Bradley v. Comr., No. 14-267, 2014 U.S. LEXIS 8142 (U.S. Sup. Ct. Dec. 8, 2014).


Business Sponsorship Turned Son's Motocross Activity Into Deductible Expenses for Dad.

The plaintiff's company sponsored the motocross activity of the plaintiff's son.  The son was a nationally recognized figure in motocross racing with numerous sponsors.  The plaintiff's business spent more than $150,000 to cover the son's motocross expenses, and the plaintiff's business did recognize additional activity as a result of the sponsorship.  IRS claimed that the business expenditures were nondeductible personal expenses, but the Tax Court disagreed.  The court noted that the plaintiff's business benefitted from the sponsorship, including the securing of a major source of financing.  The court also noted that the plaintiff's business was not the sole sponsor of the son's motocross activity and that the son had achieved national prominence before the plaintiff's business became a sponsor.  Evans v. Comr., T.C. Memo. 2014-237.


Date of Purchase For Stamp Printed Online Does Not Override Postmark Date.

 In this case, the taxpayer got a deficiency notice letter from the IRS (90-day letter) and had to file a petition with the court by March 3, 2014.  The taxpayer printed a stamp from stamps.com on March 3 and put it on the envelope containing the petition and dropped off the envelope at the post office.  The post office affixed a post-mark of March 4 and the IRS claimed that the petition was late based on the USPS post-mark.  The court agreed with the IRS based on Treas. Reg. Sec. 301.7502-1(b)(3) which says that the USPS postmark controls when it is combined with a different postmark.  Under the facts of the case, the taxpayer actually went to the post-office and mailed the petition certified, but because of long lines, put the envelope in a box and didn't get a hand-stamped receipt.  Sanchez v. Comr., T.C. Memo. 2014-223. 


No Mortgage Interest Deduction For Home Taxpayer Doesn't Own.

The petitioner made mortgage payments on her brother's behalf.  The IRS denied the deduction because the petitioner couldn't prove that she had either a legal or equitable interest in the home under state (CA) law.  The court agreed with the IRS, noting that the petitioner failed to overcome the presumption that because the brother's name was on the deed to the home he was presumed to be the full legal owner of the home.  The petitioner could not show that there was any agreement or understanding between the petitioner and her brother that demonstrated an intent that was contrary to the deed.  The only thing that the petitioner did was pay for the house.  Lourdes v. Comr., T.C. Memo. 2014-224.   


No Deductions For Expenses Related To Hop Crop Because No Business Conducted.

The petitioners, a married couple, had an S corporation with an office in Virginia.  The husband worked full time in the oil industry, but bought a 79-acre tract in North Carolina in 2004 and completed the construction of a warehouse on part of the property.  The warehouse was built to store hops for distribution to local breweries.  In 2008 and 2009, the husband planted hop seeds, but weather problems stalled crop growth and no hops were harvested or sold during these years.  During this time, the husband also called local breweries to determine their interest in buying hops.  The petitioners deducted business losses on Schedule C for both 2008 and 2009 related to the hop crop.  The court upheld the IRS denial of Schedule C deductions because the court determined that the North Carolina activity was not functioning as a going concern in either 2008 or 2009 because the petitioners did not engage in the activity with the requisite continuity, regularity and with the primary purpose of deriving a profit.  However, the court agreed with the IRS that some related expenses were deductible as personal expenses related to their investment in the North Carolina property.  Powell v. Comr., T.C. Memo. 2014-235.   


Gambling Losses Not Deductible Due To Lack of Records.

The taxpayer had substantial losses from gambling activities, but the IRS denied any related deductions due to lack of records.  The taxpayer did not maintain records of gambling winnings and losses, did not testify, and failed to provide evidence of tickets, receipts logs, canceled checks, etc.  The Tax Court determined that it could not estimate the taxpayer's gambling losses because the taxpayer failed to establish the entitlement to any deductions.  On appeal, the court affirmed on the basis that the Tax Court did not err in finding that that taxpayer's evidence (consisting of unexplained, non-contemporaneous documentation) was insufficient to substantiate his claim that he was entitled to deductions for gambling losses.  Similarly, the appellate court held that the Tax Court did not err in refusing to estimate the taxpayer's gambling losses because the taxpayer failed to establish entitlement to any deduction at all.  Rios v. Comr., No. 12-72440, 2014 U.S. App. LEXIS 22190 (9th Cir. Nov. 24, 2014), aff'g., T.C. Memo. 2012-128.


This Is The Way You Count Your Travel Days, Count Your Travel Days, Count Your Travel Days….

The petitioners bought a vacation home in 2007 over 300 miles from their home, and spent time remodeling it over the next three years.  The petitioners stayed overnight on numerous trips to the vacation home with some of those trips being exclusively for the purpose of remodeling the vacation home.  However, some trips were exclusively for personal purposes and others were for both business and pleasure.  The petitioners claimed deductions for rental real estate losses, but the IRS limited the loss deductions in accordance with I.R.C. §280A which bars deductions for expenses associated with a personal residence unless business use (including a rental use but not including repairs and maintenance) can be established.  At issue was how many days the petitioners spent at the vacation home were personal use days, and how the first and last days of each trip were to be characterized.  The court determined that days traveling to the vacation home would not be classified as personal days if the principal purpose of the trip was to perform repairs and maintenance.  Based on the evidence, the court determined that six of the 12 days at issue were for the purposes of repairing and maintaining the vacation home. Thus, the first and last day of the trip counted as business days. The balance of the trips was for a combination of business and personal purposes.  For those trips where most days were devoted to repairing and maintaining the vacation home, the court counted the first and last days of the trip as business days.  The converse was also true with respect to some trips.  While the petitioners claimed that a relative paid approximately $1,000 to rent the home for a week, the petitioners could not substantiate the alleged payment.  Thus, the relative’s days were counted as personal use days of the petitioners.  The bottom line was that the petitioners were able to counter, based on records, some of the IRS assertions.  Van Malssen v. Comr., T.C. Memo. 2014-236.   


Capital Gain Results Sale of Rights in Contract Lawsuit.

The plaintiff, a real estate developer, entered into a contract with another party to buy land on which the plaintiff was planning on building a high-rise condominium building.  The plaintiff hired architects, sought a zoning permit, printed promotional materials about the condominium, negotiated contracts with purchasers of condominium units and obtained deposits for units.  However, the seller of the land unilaterally terminated the contract.  The plaintiff sued for specific performance and the trial court ordered the seller to honor the contract.  While the trial court's decision was on appeal, the plaintiff sold his position as the plaintiff in the contract litigation to a buyer for $5.75 million.  The IRS characterized the $5.75 million as ordinary income rather than capital gain.  The Tax Court agreed with the IRS on the basis that the plaintiff held the property (which the court said was the land subject to the contract) primarily for sale to customers in the ordinary course of business.  On appeal, the court reversed on the basis that the taxpayer never actually owned the land and instead sold a right to buy the land - a contractual right.  Accordingly, there was no intent to sell contract rights in the ordinary course of business.  The plaintiff intended the contract to be fulfilled and develop the property, and the sale of the right to earn future undetermined income was a capital asset.  Long v. Comr., No. 14-10288, 2014 U.S. App. LEXIS 21876 (11th Cir. Nov. 20, 2014).   


Horse Activity Engaged in For Profit

The petitioners, a married couple, operated a concrete business but also got involved in breeding and racing horses.  The court determined that they were entitled to the presumption that they were operating the horse activity for a profit in accordance with I.R.C. Sec. 183 based on an analysis of all of the nine factors set forth in the regulations.  They did keep business records of the horse activity, had a business plan (although it was unwritten), conducted the horse activity comparable to horsing activities conducted by other persons, undertook efforts to improve profitability, and generally conducted the activity in a manner indicating it was a legitimate business intended to turn a profit.  The court also noted that the assets were likely to appreciate in value significantly.  Certain factors did predominate in the government's favor, such as many years of losses that were used to offset income from other activities, and the high level of pleasure the petitioners derived from the activity.  However, the factors predominating in the government's favor were insufficient to overcome the other factors in the petitioners' favor.  Annuzzi v. Comr., T.C. Memo. 2014-233. 


To Be A Real Estate Professional, Coding Activities Properly Can Matter.

The petitioner owned rental properties and materially participated in their operation.  The petitioner also worked full-time in his company, ABS Glass.  Included on the petitioner’s Schedule C was NAICS Code No. 811120, “Automotive, Paint, Interior, and Glass Repair.” The petitioner incurred over $45,000 of losses from the real estate activities which he sought to fully deduct against the substantial income from the petitioner’s proprietorship which exceeded $700,000.  The petitioner did not maintain records to establish that he spent more than 750 hours in the rental activities, but claimed that the residential division of his company were services provided in a real estate trade as “construction” or “reconstruction” activities.  As such, the petitioner claimed that he qualified as a “real estate professional.”   The court disagreed, noting that the petitioner did not code the residential division of his business as 28150 – Glass and Glazing Contractors.  Cantor v. Comr., T.C. Sum. Op. 2014-103.


Tax-Free Cash Housing Allowance for Parsons Remains the Law

The plaintiff, an atheist organization, challenged as unconstitutional the cash allowance provision of I.R.C. §107(2) that excludes from gross income a minister’s rental allowance paid to the minister as part of compensation for a home that the minister owns.  The trial court determined that I.R.C. §107(2) is facially unconstitutional under the Establishment Clause based on Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989) because the exemption provides a benefit to religious persons and no one else, even though the provision is not necessary to alleviate a special burden on religious exercise.  The court noted that religion should not affect a person’s legal rights or duties or benefits, and that ruling was not hostile against religion.  The court noted that if a statute imposed a tax solely against ministers (or granted an exemption to everyone except ministers) without a secular reason for doing so, the law would similarly violate the Constitution.  The court also noted that the defendants (U.S. Treasury Department) did not identify any reason why a requirement on ministers to pay taxes on a housing allowance is more burdensome for them than for non-minister taxpayers who must pay taxes on income used for housing expenses.  In addition, the court noted that the Congress could rewrite the law to include a housing allowance to cover all taxpayers regardless of faith or lack thereof.  On appeal, the court vacated the trial court's decision and remanded the case for dismissal because the plaintiff lacked standing.  While the plaintiff claimed that they had standing because they were denied a benefit (a tax exemption for their employer-provided housing allowance) that is conditioned on religious affiliation, the court noted that the argument failed because the plaintiff was not denied the parsonage tax break because they had never asked for it and were denied.  As such, the plaintiff's complaint is simply a general grievance about an allegedly unconstitutional tax provision.  Importantly, I.R.C. §107(1) is not implicated in this litigation and, as such, a church can provide a minister with a parsonage and exclude from the minister’s income the rental value of the parsonage provided as part of the minister’s compensation.  Freedom From Religion Foundation, Inc. v. Lew, No. 14-1152, 2014 U.S. App. LEXIS 21526 (7th Cir. Nov. 13, 2014), vacating and remanding, No. 11-cv-626-bbc, 2013 U.S. Dist. LEXIS 166076 (W.D. Wisc. Nov. 22, 2013).


Indirect Gift Triggered Upon Sale of Stock Back To Company.

The decedent was a famous Texas oil man that sold his stock in his company back to it for a price below its fair market value.  The sale increased the value of the stock of the remaining stockholders - five other individuals and trusts including a Grantor Retained Income Trust (GRIT), which paid income to a prior spouse that he was married to from 1931-1961.  As part of her divorce settlement, the former spouse received stock shares. In 1984, the prior spouse transferred all of her shares to a Living Trust, and a few years later, the Living Trust split those shares into four trusts. Slightly more than half of the shares were transferred into three Charitable Remainder Annuity Trusts (CRATs), and the remaining shares were put into the GRIT. The GRIT was designed to pay income to Stevens for ten years and then terminate, with one of the decedent's children as the remainder beneficiary. When the stock shares were transferred to the three CRATs and the GRIT, the shares were cancelled and then reissued in the name of the four trusts.  The IRS determined that the decedent's sale of stock back to the company at less than fair market value constituted indirect gifts to the remaining shareholders and triggered gift tax liability of over $3 million.  The trial court largely agreed.  On appeal, the donees argued that their were not independently liable for the gift tax and/or they weren't donees by virtue of their income interest in the GRIT and/or they weren't liable as fiduciaries for distributions from the Living Trust or the estate of the decedent's prior spouse.  The appellate court affirmed, and also held that interest accrued on the donee's liability for the unpaid gift taxes and that the interest is not limited to the extent of the value of the gift.  United States v. Marshall, No. 12-20804, 2014 U.S. App. LEXIS 21731 (5th Cir. Nov. 10, 2014).


Bank Beats IRS in Battle of Competing Liens.

The debtor failed to pay employment taxes which ultimately resulted in the IRS filing a notice of federal tax lien against the debtor's property.  However, six days before the IRS filed its lien, the debtor had borrowed money from a bank giving the bank a note and deed of trust on two parcels of land adjacent to the tract on which the IRS filed its lien.  The bank recorded the deed of trust to secure repayment of the note five weeks after the IRS filed its lien.  Over six years later, the debtor filed Chapter 11 bankruptcy.  The IRS filed a proof of claim for over $60,000 in unpaid taxes, interest and penalties, and the bank brought an adversary proceeding to determine priority of the competing liens.  The bank relied on a state (MD) statue that relates back a deed of trust's effective date upon recordation to the date when the deed of trust was executed, and also claimed that they had a prior equitable lien.  Both the bankruptcy court and the district court agreed with the bank's reliance on the relations back theory under MD statutory law, with the bankruptcy court also stating that the bank had priority even if the deed of trust had never been recorded.  On appeal, the IRS argued that the lower courts erred in construing I.R.C. Sec. 6323(h)(1) because, according to the IRS, the key was whether a security interest existed at the time when the IRS filed its lien and that a security interest only exists when it has become protected under local law - which occurred when the deed of trust was recorded.  The appellate court noted that, under I.R.C. Sec. 6323(h)(1), a security interest must exist and be protected under state law to obtain priority over an IRS lien.  The court reasoned that the language of I.R.C. Sec. 6323(h)(1)(A) precluded the application of the relation back doctrine under MD law, but that the bank still had priority by reason of having an equitable security interest under the MD doctrine of equitable conversion which I.R.C. Sec. 6323(h)(1) incorporated.  In re Restivo Auto Body, Inc. v. United States, No. 13-2249, 2014 U.S. App. LEXIS 20927 (4th Cir. Oct. 31, 2014).

 


Mortgage Interest Deduction Only Applies To Amounts Paid.

The petitioner bought a home for $300,000 and later refinanced it for $600,000 and then even later had the loan modified.  As a result of the modification, the interest rate was reduced.  Before the modification, the loan balance was $579,275 and after the modification it was $623,953.  The increased loan balance included $30,273 of past due interest that was added to principal.  The lender issued Form 1098 reflecting $9,253 of mortgage interest paid during the year.  The petitioner deducted $39,536 of interest for the year and IRS denied the additional $30,273 deduction because it had not yet been paid.  The court upheld the IRS position.  Copeland v. Comr., T.C. Memo. 2014-226.


No Mortgage Interest Deduction When Not Legal Owner.

The petitioner's brother owned a home but became unemployed and could no longer make the monthly mortgage payment.  The petitioner's made the mortgage payments for her brother and attempted to deduct the mortgage interest paid for the tax year at issue.  The IRS denied the deduction and the court agreed.  To deduct mortgage interest, the petitioner had to be the "owner" of the home.  The court noted that the petitioner's brother was the sole legal owner of the home under state (CA) law, and the brother was also the beneficial/equitable owner under CA law.  There was no agreement to give the petitioner an ownership interest in the home and the petitioner voluntarily made the payments, never contributed to the down payment and provided no other evidence of any ownership interest in the home.  Puentes v. Comr., T.C. Memo. 2014-224.


IRS Says Banks and Similar Institutions Need Not File Form 1099-C After 36 Months of Non-Payment.

I.R.C. Sec. 6050P lists the events that trigger discharge of indebtedness reporting requirements, including a 36-month non-payment period.  The IRS has not proposed removing the reporting requirement associated with the 36-month non-payment period because the expiration of the 36-month period may not necessarily reflect that debt has been discharged.  Instead, the period may expire before any debt has been discharged and IRS may not then be notified when the debt is actually discharged.  Notice of Prop. Treas. Reg. 136676-13 (Oct. 14, 2014).   


State Revenue Department Has Four Years To Review Validity and Value of Conservation Easement Credits.

 The taxpayers, three pairs of landowners, created conservation easements on their lands, had the easements appraised and sold them to a land trust for a portion of their appraised value.  They claimed state (CO) income tax credits on their 2004 returns which they applied against their income tax liability, carrying the balance of the credits forward.  In late 2009, the defendant (CO Department of Revenue) disallowed the credits due to an alleged deficiency in the appraisals.  The taxpayers claimed that the statute of limitations period had run before the defendant acted to disallow the credits.  The trial court agreed and granted summary judgment to the taxpayers.  On appeal, the defendant claimed that the statute of limitations began to run each time a donor (or transferee of the credits) applied the credits to their tax liability.  The appellate court affirmed, noting that Colo. Rev. Stat. Sec. 39-21-107(2) specified that the defendant had to make assessment of tax within one year of the expiration of the statute of limitations of the time provided for assessing a deficiency in federal income tax.  The federal statute of limitations is three years.  Thus, the question was what event triggered the commencement of the four-year period.  Based on legislative history, the appellate court determined that the legislature did not intend the limitations period to restart each time a conservation easement credit is used.  Such a construction would, the court noted, yield the unacceptable result of allowing the defendant to potentially disallow a credit claimed 24 years earlier.  Markus, et al. v. Brohl, No. 13 CA1656, 2014 Colo. App. LEXIS 1788 (Colo. Ct. App. Oct. 23, 2014).      


No Bona Fide Loan Resulted In Income From Services.

The petitioner worked as an independent contractor for a medical services company, was paid, but did not receive a Form 1099.  She claimed that the payment was a loan from the company, but the IRS determined otherwise.  The court agreed with the IRS.  The facts did not support characterizing the payment as a loan, and the owner of the company testified that the petitioner was paid for her services.  Fisher v. Comr., T.C. Memo. 2014-219.


You Gotta Know When To Fold Up - And Substantiate.

The petitioner was a recreational gambler who incurred substantial gambling losses.  The court sustained the denial of gambling-related deductions, and even denied more gambling loss-related deductions than IRS asserted, because the petitioner failed to substantiate the losses.  While the petitioner submitted "cash submitted" and "cash recycled" documents as evidence of losses, the petitioner's documents and other evidence did not show how much money she left with daily.  Burrell v. Comr., T.C. Memo. 2014-217.


IRS Guidance on Elections To Increase Basis.

For deaths in 2010, the federal estate tax was inapplicable.  That also meant that a carryover basis applied to estate assets in the hands of an heir.  However, the Congress retroactively reinstated the estate tax, but an executor could elect to not have the estate tax apply with a modified carryover basis then applying to estate assets.  The election was to be made via Form 8939 on or before Nov. 15, 2011.  IRS later granted limited relief from that deadline in accordance with Notice 2011-66.  Here, a late Form 8939 was filed and the estate sought an extension of time to refile Form 8939 to make the election and allocate basis to eligible estate property.  The IRS granted the estate a 120-day extension of time to refille From 8939.  Priv. Ltr. Rul. 201442019 (Jul. 7, 2014).  In separate guidance, the IRS denied an estate's request for an extension of time to make the I.R.C. 1022 election to allocate basis.  The executor claimed that the U.S. Postal Service lost the mailed Form 8939.  The IRS noted that the estate couldn't prove that the Form was mailed by either registered or certified mail, so the "mailbox rule" didn't apply.  Priv. Ltr. Rul. 201442015 (Jul. 15, 2014). 


You Really Can Take It With You- Surviving Joint Tenant Gets Property Free of Lien.

The decedent owned a property in joint tenancy with another party.  Five years after acquiring the property, the IRS filed a lien against the decedent.  The decedent died the following year, with the decedent's undivided one-half interest in the property passing by survivorship to the other party who then had full ownership of the property.  The IRS sought enforce its lien.  However, the court determined that the decedent's death extinguished the lien - it died with the decedent.  The Court noted that federal tax liens do not give the IRS any rights that extend beyond state law.  Instead, the IRS obtains only those rights that other lienholders acquire.  The court noted that a surviving joint tenant(s) does not succeed to the rights of the first joint tenant to die, but rather the survivor's rights in joint tenancy property correspond to the rights obtained at the time the joint tenancy was created.  In this case, at the time the joint tenancy was created , the property was not subject to an IRS lien.  NPA Associates, LLC v. Estate of Cunning, 114 A.F.T.R. 2d 2014-____ (D. V.I. Oct. 17, 2014). 


No Profit Motive for Sports Memorabilia Activity.

The petitioner worked full-time as a quality assurance engineer and also had an activity in which he sold sports memorabilia.  On his return for the year in issue, he filed separate Schedule Cs for his engineering business and his sports memorabilia activity.   For the sports activity, he showed no income, no costs of good sold and about $20,000 of expenses.  He had no separate bank account, no inventory system or accounting system or any books and records for the sports memorabilia activity.  The IRS disallowed the losses from the sports memorabilia activity.  The court upheld the disallowance based on the nine-factor analysis contained in Treas. Regs. Sec. 1.183-2(b).  Akey v. Comr., T.C. Memo. 2014-211


No Do-Over For Alternate Value Election Allowed.

Here, the decedent's estate wanted to make an alternate valuation election pursuant to I.R.C. Sec. 2032.  However, the estate didn't file the estate tax return within a year of the due date for the return.  Thus, I.R.C. Sec. 2032(d)(2) was not satisfied and the estate was not eligible for an extension of time to file.  Priv. Ltr. Rul. 201441001 (Jun. 6, 2014). 


No Business Bad Debt If the Debt Is Not Related To Your Business - Capital Loss Treatment Results.

The petitioner, a real estate agent, that didn't customarily make loans and didn't hold himself out as a lender.  Over a 30-year period, the petitioner made loans on less than ten occasions.  The petitioner did not advertise lending services, did not have a separate office for lending services, or maintain separate books and records for loans that he made.  The petitioner made an unsecured loan, made no background check of the borrower and did not seek financial information from the borrower.  Ultimately, the borrower ceased paying on the loan.  The petitioner merely asked for payment and did not take any further action.  The borrower filed bankruptcy, but the petitioner did not file a proof of claim with the court   On his return, the petitioner claimed a deduction for a business bad debt (i.e., ordinary deduction that offsets ordinary income).  IRS disallowed the deduction because they claimed it wasn't incurred in connection with the petitioner's business as a real estate agent.  The court agreed with the IRS, noting that the petitioner was not in the business of lending money and the debt was not a worthless debt incurred in the petitioner's trade or business.  Thus, debt was a nonbusiness bad debt deductible only as a capital loss that is subject to the limitation of $3,000 annually as an offset to ordinary income).  Langert v. Comr., T.C. Memo. 2014-210.


Texas Two-Step Is Listed Transaction That IRS Blows Apart.

The petitioner was into banking and real estate development. He then joined forces with another person, remediated a chemical plant, and began importing ammonia and other chemicals.  The business structure for this venture was a C corporation.  The petitioner ultimately wanted to sell the business, but had large gains trapped inside the C corporation.  The petitioner sold the assets of the business and placed $1 million of the proceeds in his personal bank account.  The corporate stock was sold to an intermediary that was a shell company of the buyer, without any reduction for the BIG tax.  The shell company then sold the stock to a legitimate buyer and transferred the net proceeds of the sale to the petitioner.  The shell company offset the gain on the stock sale with the end result that the tax liability was the petitioner's.  The court noted that the transaction was a listed transaction and that petitioner was fully liable for the tax on sale of the assets and stock.  The petitioner was also found to have violated the state (TX) fraudulent transfer statute.  The court noted that other parties may also be liable for the tax liabilities of the transaction via joint and several liability and that the petitioner could seek contribution from them.  Cullifer v. Comr., T.C. Memo. 2014 T.C. Memo. 208. 


No Deduction for Swimming Pool Cost.

The petitioner installed a swimming pool in his backyard allegedly for medical purposes because his doctors told him he needed to lose weight.  The petitioner deducted the cost of the pool to the extent it increased the value of his home.  The IRS disallowed the deduction and the court agreed.  The court noted that the only substantiation of the medical purpose of the pool was the taxpayer's self-serving testimony that his doctors told him to lose weight.  As such, the pool was not medically required and was not primarily for the treatment of the petitioner's medical ailments.  Le Beau v. Comr., T.C. Memo. 2014-198.


Deductions Allowed To Extent Substantiated.

The petitioner claimed deductions for cost of goods sold.  The petitioner installed flooring by using his own materials and with materials that his customers supplied.  Some receipts had been lost in a flood, and others were simply missing. The IRS disallowed deductions that couldn't be substantiated and the court agreed with the IRS position.  Nguyen v. Comr., T.C. Memo. 2014-199. 


Another Attempted Charitable Donation Gone Wrong.

The petitioner's son died and the petitioner received $75,000 on account of the son's death.  The petitioner (and wife) used the insurance proceeds to establish a scholarship fund in honor of the son.  The fund was set up as in irrevocable trust, except that the petitioner reserved the right to amend the trust if funds would be distributed to students solely for educational purposes.  The trust was not a tax-exempt charity.  The trust made payments to three high school students from its investment income.  The petitioners did not include the investment income in their gross income, but claimed the payments to the students as charitable deductions.  The IRS disallowed the charitable deduction attributable to the amounts that originated in the trust.  The court denied the charitable deduction because the trust was irrevocable.  The petitioner did not need to report the trust income nor was the petitioner entitled to any charitable deduction attributable to payments the trust made.  In any event, no charitable deduction would be allowed because the payments did not qualify as charitable contributions.  The amounts were paid directly to the students who were not charitable donees.  In addition, there was not contemporaneous written acknowledgement of the "charitiable" contributions.  Kalapodis v. Comr., T.C. Memo. 2014-205. 


Trust Treated Same As Taxpayer For Tax Purposes.

The petitioner formed an S corporation for his cabinet business and utilized it for over twenty years until its liquidation.  Later, a "pure trust" was formed with the cabinet shop's land, building, equipment and inventory transferred to it.  A series of transactions ensued with the ultimate result that petitioner did not report any tax from the transactions.  The IRS asserted, and the court agreed, that the trust was a sham and that the petitioner was taxable on lease payments.  Wheeler v. Comr., T.C. Memo. 2014-204.


Treasury Department Must Tell Whether Investigation Into White House Getting Unauthorized Tax Records Exists.

In 2009, President Obama joked about the President having the power to direct IRS audits of particular individuals or groups.  Later, in 2010, a White House Senior advisor told reporters at a press conference that Koch Industries, Inc. paid no taxes.  Based on these developments, various member of the Congress asserted that the advisor's statement was based on illegally obtained confidential tax return information that had been disclosed to the White House.  In response, the Treasury Inspector General for Tax Administration (TIGTA) announced that it was starting an investigation.  Ultimately, TIGTA never released a report and the plaintiff brought a Freedom of Information Act (FOIA) request seeking records relating to any authorized disclosure of tax return information.  However, TIGTA neither confirmed or denied whether they conducted an investigation, asserting certain exemptions from FOIA in a "Glomar" response.  TIGTA claimed that it couldn't acknowledge whether an investigation into the illegal release of taxpayer information to the White House occurred because such acknowledgement would constitute disclosure of tax return information.  The court disagreed, determining that the mere existence of an investigation records of investigations into unlawful disclosures of return information of unnamed parties was not, itself, return information compiled by the IRS in connection with its determination of a taxpayer's liability for a violation of the Internal Revenue Code.  The court also noted that TIGTA had waived reliance on other FOIA exemptions by publicly acknowledging that an investigation existed.  The court remanded the case to TIGTA for a determination of whether the contents of the officially acknowledged records may be protected from disclosure by virtue of a FOIA exemption.  Cause of Action v. Treasury Inspector General for Tax Administration, No. 13-1225 (ABJ), 2014 U.S. Dist. LEXIS 188825 (D. D.C. Sept. 29, 2014).   


State Estate Tax Law Changes Apply To Estate.

Before 2005, the state did not tax transfers at death.  In 2005, however, the legislature enacted a "stand-alone" estate tax on a prospective only basis that mirrored the federal estate tax (where QTIP property is subject to tax in the surviving spouse's estate).  The state then adopted a regulation that taxed QTIP assets when the surviving spouse after the legislative change but where the first spouse had died before the effective date of the 2005 legislative change.  The Washington Supreme Court later invalidated the regulation by interpreting "transfer" narrowly and holding that the only "transfer" subject to tax occurred at the time the QTIP trusts at issue in the case were created.  In re Estate of Bracken, 175 Wash.2d 549, 290 P.3d 99 (2012).  The state of Washington amended its Estate and Transfer Tax Act in 2013 to provide that the tax on QTIP trust assets upon the death of the surviving spouse applies prospectively and retroactively to all estates of decedents dying on or after May 17, 2005.  In the case at issue, the question was whether the 2013 law's retroactive application was permissible insomuch that retroactive application taxed interests that had previously not been taxable.  The court upheld the constitutionality of the law, finding that it did not violate either the separation of powers doctrine, due process clause or the impairment of contracts clause.  In re Estate of Hambleton, No. 89419-1, 2014 Wash. LEXIS 773 (Wash. Sup. Ct. Oct. 2, 2014).        


Starving Artist Engaged in Activity With Profit Intent.

The petitioner, as described by the court, was a well-renown, successful artist that lost money.  The IRS denied the deductibility of her losses on the basis that she was not engaged in the art activity with a profit intent and, alternatively, if she was found to have a profit intent, that the claimed deductions should be disallowed because they weren't necessary business expenses.  However, the court determined that the petitioner was engaged in the art activity with a profit intent based on the nine factors set forth in the I.R.C. Sec. 183 regulations.  The petitioner conducted the activity in a business-like manner, was an expert artist that understood the economics of her business, devoted substantial time to the activity, had some reasonable expectation of appreciation in value of the artwork, had success in a substantially related field that could positively impact her activity, had many years of losses but this factor alone did not outweigh her honest profit intent, had only very occasional profits, but this factor did not weigh much in the favor of the IRS, and did not use her activity to shield income from a primary business or occupation.  Crile v. Comr., T.C. Memo. 2014-202.


Lack of Substantiation and Not Getting Acknowledgement Proper Blows Big Charitable Deduction

The petitioner's mother died and his father asked the petitioner to get all of the personal effects out of the house.  The petitioner did so and donated the items to charity along with some clothing items belonging to himself and his children.  He also donated various electronic equipment to the same charity.  The charity (a qualified charity) gave the petitioner blank tax receipts signed by "Jose" and "Amado."  The taxpayer filled in the amount of the donations and claimed $27,767 in non-cash charitable contributions on his return for the year at issue.  The petitioner claimed that he used Salvation Army guidelines for valuing the donated items, but many of the items he actually valued at amounts exceeding the high-end range of the guidelines for that property.  The court noted that the tax receipts did not contain a description of any of the property and were actually signed before the property was donated.  The court determined that the substantiation requirements had not been satisfied.  The petitioner also never showed his spreadsheet calculations of value to the charity for review.  The court determined that the petitioner had failed the "contemporaneous written acknowledgement" requirement for gifts over $250.00.  The court also imposed a 20 percent accuracy-related penalty.  Smith v. Comr.,  T.C. Memo. 2014-203.


Long-Term Change in Function of Charity May Result in Loss of Exempt Status.

In this technical advice to an IRS agent, the IRS National Office recommended that the taxpayer's exempt status be revoked.  The agent was examining the organization's returns and as part of the examination looked into the conduct of the organization.  The taxpayer was a exempt public charity originally formed to operate a private school.  However, the organization later amended its organizational documents to allow it to own and lease schools in specific parts of the state to non-exempt charter schools.  The IRS agent took the position that the taxpayer's function as a landlord were not exempt purposes under I.R.C. Sec. 501(c)(3) and sought to revoke the taxpayer's exempt status.  The agent sought further review by the IRS National Office.  The National Office suggested revocation of the taxpayer's exempt status.  The National Office noted that the lessees were not exempt entities, and while the rents were below fair market value, they weren't sufficiently low as the taxpayer was able to recover more than costs.  While the taxpayer conducted an educational summer seminar (exempt activity) it was only a minor part of its overall activity.  Tech. Adv. Memo. 201438034 (May 13, 2014).


Farm Not Operated For Profit.

The taxpayer bought land in 2003 and started a farming operation at that time, later setting up a farm checking account and writing a business plan.  The taxpayer originally started raising cattle, but later switched to growing hay and horse boarding, raising and training.  The taxpayer also used some of the property as a vineyard.  Ultimately, the farming operations generated losses that the defendant disallowed the taxpayer's Schedule F deduction.  Based on the nine-factor analysis of I.R.C. Sec. 183, the court determined that the taxpayer was not engaged in the farming activity with the required profit intent.  The defendant also added the 100 percent penalty for willful attempt to evade tax, but the court determined that the penalty did not apply due to lack of purposeful acts beyond mere negligence.  However, the court did impose the substantial understatement penalty.  Deboer v. Department of Revenue, No. TC-MD 140027N, 2014 Ore. Tax LEXIS 168 (Ore. Tax. Ct. Sept. 25, 2014). 


No Innocent Spouse Relief Because Joint Return Not Filed.

The petitioner was an abused spouse in a dysfunctional marriage.  The petitioner divorced in 2008 and didn't file a separate return for 2007.  However, for 2007, a join return was e-filed with only the electronic authorization signature of the petitioner's spouse.  The petitioner also received IRA distributions in 2007 before reaching age 59 and one-half for which a separate return was not filed.  The court determined that the petitioner did not intend to file a joint return for 2007 and the return that was filed was not valid.  Thus, the petitioner was not eligible for innocent spouse relief.  Sorrentino v. Comr., T.C. Sum. Op. 2014-99. 


Judge Not Pleased with IRS Conduct.

On April 17, 2014, the IRS issued a notice of deficiency to the petitioner for tax years 2011 and 2012.  The petitioner timely sent two separate but identical petitions to the U.S. Tax Court in dispute of the notice.  One petition was sent by FedEx First Overnight and was received by the court on Jul. 17, 2014.  The other petition was sent by certified mail and was mailed on Jul. 16, 2014, and received by the court on Jul. 21, 2014.  While the petition mailed by certified mail satisfied the timely mailing rules of I.R.C. Sec. 7502, FedEx First Overnight is not on the IRS list of designated private delivery services providing protection under the timely mailing rules of I.R.C. Sec. 7502.  The IRS filed a motion to close the case assigned a docket number based on the U.S. mailed petition on the grounds that it was duplicative of the petition mailed by FedEx.  The result, had the motion been granted, would have been to dismiss the entire action for lack of jurisdiction because the FedEx petition was not timely mailed under IRS rules.  The court denied the motion and instead dismissed the petition based on the FedEx filed petition.  The court noted that the petitioner should be granted "the greatest protection under section 7502."  Bulakites v. Comr., No. 16719-14 and 16878-14 (filed Sept. 24, 2014). 


Blown NOL Election Leads To Interest Tack-On.

The petitioners, a married couple, incurred a large net operating loss (NOL) that they wanted to carry forward.  However, they didn't timely file the necessary election to do so in accordance with I.R.C. Sec. 172(b)(1) and (3) (forego the two-year carryback to be able to carry forward).  Upon asking IRS what they should do, IRS informed them to amend the return to carryback the NOL and then carry it forward.  The petitioners did so and then wanted the IRS to credit the balance of the NOL forward.  However, the IRS simply refunded the balance of the NOL to the petitioners.  As a result, the petitioners had a tax deficiency for the following year and got assessed interest.  Upon consulting the taxpayer advocate, the petitioners were told that it was their problem and that IRS did not err.  The court noted that taxpayers owe underpayment interest beginning on "the last date prescribed for payment", which is the due date of the return (Apr. 15 of the following year) without regard to whether a return is actually filed.  The court also noted that IRS does not owe interest on an overpayment before the return is filed.  In this case, the court noted that the IRS did not owe interest because the return was deemed untimely filed and the IRS refunded the overpayment within 45 days after the return is filed, citing I.R.C. Sec. 6611(e)(1).  As for the IRS "advice," the court noted that the IRS was not acting in a "ministerial" or "managerial" fashion and, thus, interest abatement was not possible.  Larkin v. Comr., T.C. Memo. 2014-195. 


Royalty Payments Not Treated As Capital Gain

The petitioner transferred several patents to a corporation of which he owned 24 percent.  The balance was owned by a related party and the petitioner's friend.  The petitioner controlled the corporation and reported the royalty income received from the corporation for the patents as capital gain.  The IRS challenged that characterization and the court agreed with the IRS because the petitioner failed to transfer all of the substantial rights associated with the patents due to his control of the transferee corporation.  Cooper v. Comr., 143 T.C. No. 10 (2014).


1031 Exchange Works Even If Unlike Property Acquired First.

The taxpayer was involved in an equipment like-kind exchange program, but property that was acquired in an exchange was not like-kind property to the property that had been given up.  The taxpayer, however, had identified other property during the timeframe for identifying property in a delayed exchange (180 days) and the other property (which was like-kind) was timely acquired.  The IRS noted the I.R.C. Sec. 1031 only requires the like-kind property to be acquired during the replacement period and does not contain any requirement that the taxpayer select which properties will be the replacement property.  The transaction at issue satisfied I.R.C. Sec. 1031.  Tech. Adv. Memo. 201437012 (Apr. 18, 2014).


IRS Details What Is A Timely IRA Contribution.

In this administrative ruling, the IRS said that an IRA (including a Coverdell ESA) contribution is treated as timely made for the current year if the contribution is postmarked on or before the unextended due date for filing the return for that year.  The IRS stated that this is also the case if the payment does not arrive in the custodian's hands by the time of the filing date.  In addition, the IRS said that this would also be the outcome if only a verbal request is made to the IRS custodian that funds be transferred from a non-IRA account.  Priv. Ltr. Rul. 201437023 (Jun. 18, 2014). 


No Cancelled Debt Income When Guaranty Is Conditional.

The petitioners, a married couple, had numerous tax issues at stake in this case.  The husband co-owned a house with his wife's sister in a resort area in Idaho that they rented out as a short-term vacation rental.  The petitioners were also invested in a real estate development project in another Idaho location for which they promised to pay $400,000 in the event that the development project failed and the primary obligor on the project's debt failed to pay.  The project did fail and the petitioner's paid the bulk of the promised $400,000 but had $102,000 forgiven.  The court disallowed some expenses associated with the petitioner/husband's dental practice due to lack of substantiation, but did uphold the vast majority of expenses associated with the rental property.  On the forgiveness issue, the petitioners argued that they did not have $102,000 of cancelled debt income because they were merely guarantors.  The Tax Court noted that it had previously held that a guarantor does not realize cancelled debt income upon the release of a contingent liability - see, Landreth v. Comr., 50 T.C. 803 (1968) and Hunt v. Comr., T.C. Memo. 1990-248, but the IRS argued that those cases were distinguishable because the guaranties in those cases were contingent while the petitioners' guaranty was unconditional and not contingent by its terms.  However, the court noted that the guaranty was an unconditional promise to pay if the primary obligor failed to pay which made the guaranty contingent.  As a result, the petitioners did not have cancelled debt income.  Mylander v. Comr., T.C. Memo. 2014-191. 


Tax Court Disallows Alimony Deduction.

The petitioner and his wife were married in 1975 and divorced in 2006. They agreed to a stipulation of settlement which required the petitioner to make monthly maintenance payments of $1,250 to the ex-wife that would continue until her death or remarriage.  The settlement stated that the payments would be taxable to the ex-wife and deductible to the petitioner.  The stipulation of settlement was incorporated by reference into the divorce decree.  The ex-wife did not receive approximately $39,000 that she should have upon equal division of the couple's retirement accounts, ultimately resulting in a lawsuit with a judgment rendered in 2009 which, in part, resulted in a payment of approximately $50,000 from petitioner's non-IRA accounts.  On his 2009 return, the petitioner deducted over $63,000 for payments to his ex-wife.  The IRS concede that $15,000 was deductible as alimony, but not the balance.  The court agreed with the IRS because the judgment would have to be paid even if the ex-wife had died before payment had been made.  The court noted that the petitioner should have satisfied the judgment via a QDRO by a tax-free transfer from his IRA.  Laremore v. Comr., T.C. Sum. Op. 2014-94.


IRS Gives More Guidance on Section 125 cafeteria plans.

The IRS, in a recent Notice, has expanded the permitted election rules for health coverage under an I.R.C. Sec. 125 cafeteria plan.  The Notice discusses two specific situations and whether a cafeteria plan participant can revoke the election.  The one situation involves a participating employee who has hours of service reduced to get under the 30 hours/week threshold, but the reduced hours don't impact eligibility for coverage under the employer's group health plan.  The other situation concerns an employee that is a participant in the employer's group health plan and wants out of that coverage to be able to buy health insurance in the Obamacare "marketplace."  In both situations, the IRS said the election could be revoked.  IRS Notice 2014-55.


IRS Announces PCORI Fee Amount.

In a recent Notice, the IRS announced the fee that will be imposed under Obamacare on the issuer of a specified health insurance policy for the policy year ending after September 30, 2014 and before October 1, 2015.  The fee will be $2.08 for each life covered by the plan.  The fee is used to fund the executive branch non-physician organizations that will make decisions about the procedures that Medicare will cover - the so-called "death panels."  IRS Notice 2014-56, I.R.B. 2014-41  


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CALT does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. CALT's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.

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