Case Summaries

Payment For Depression and Anxiety Includible In Income.

The petitioner, a waiter at a seafood restaurant, was diagnosed with attention deficit disorder along with a depressive disorder.  Upon being fired from his job, the petitioner sued and received a $35,000 settlement.  $5,000 of the $35,000 was designated as lost wages which are taxable as compensation, and the remaining $30,000 was designated as payment for "pain and suffering and emotional distress."  The IRS took the position that the $30,000 should also be included in income because it was paid to compensate the petitioner for the personal effects on him of being terminated and not because of any personal injury or physical sickness (as required for exclusion under I.R.C. Sec. 104).  The court agreed with the IRS position because the origin of the claim indicated that the payment was made to compensate for the anxiety and depression he sustained as a result of being terminated.  The payments were not made on account of any personal injury or physical sickness.  Smith v. Comr., T.C. Sum. Op. 2014-93.


Lawyer Advice Results in Multi-Million Dollar Gift Tax Liability.

This case involved the merger of two corporations, one owned by the parents and one owned by a son.  The parents' S corporation developed and manufactured a machine that the son had invented.  The son did not patent the invention, and the parents' corporation claimed the research and development credits associated with the machine.  The sons' corporation sold the machine (liquid dispenser) to various users, but the intellectual property rights associated with the machine were never formally received.  The two corporations were merged for estate planning purposes, with the parents' receiving less stock value than their asset ownership value.  The lawyers involved in structuring the transaction "postulated" a technology transfer for significant value from the son to the parents that had occurred in 1987.  The transfer was postulated because there were no documents concerning the alleged transaction executed in 1987.  Instead, the lawyers executed the transfer documents in 1995.  The IRS asserted that no technology transfer had occurred and that the merger resulted in a gift from the parents to the son of $29.6 million for which no gift tax return had been filed and no taxes paid.  The Tax Court agreed with the IRS and the resulting gift tax (at 1995 rates) was $14.8 million.  No penalties were imposed on the taxpayers.  Cavallaro v. Comr., T.C. Memo. 2014-189.


Court Allows 45 Percent Discount For Fractional Interest.

The decedent owned fractional interests in artwork at the time of death that had been placed in a grantor-retained interest trust (GRIT), but had signed an agreement waiving his right to file a partition action.  The decedent survived the 10-year term of the GRIT with the decedent's undivided interest passing equally to the decedent's three children with each child receiving a 16.67 percent interest in the artwork.  The decedent's spouse died before the end of the GRIT with her undivided 50 percent interest in the artwork passing to the decedent.  However, the decedent disclaimed a sufficient amount of interest in the artwork to optimize the use of the unified credit so as to pass the disclaimed portion to his children without estate tax.  The decedent then entered into an agreement with the children giving up his right to partition.  The waiver of his right was disregarded for valuation purposes under I.R.C. Sec. 2703(a)(2) - the provision that states that property value is to be determined without regard to any restriction on the right to sell or use property.  In addition, the Tax Court held that the exception from I.R.C. Sec. 2703(a)(2) contained in I.R.C. Sec. 2703(b) did not apply.  The Tax Court applied a 10 percent discount to the pro-rata value of the artwork due to uncertainties concerning their value associated with childrens' intentions concerning the artwork.  On appeal, the court held that a 45 percent discount should apply because the IRS provided no evidence as to any discount, simply arguing that no discount should apply.  Conversely, the court noted that the estate provided substantial evidence on the discount issue.  Thus, when the Tax Court rejected the IRS position of no discount, the Tax Court should have accepted the estate's evidence that IRS failed to contradict.  Estate of Elkins v. Comr., No. 13-60472, 2014 U.S. App. LEXIS 17882 (5th Cir. Sept. 15, 2014), rev'g., 140 T.C. 86 (2013).   


Partial Income Inclusion For Damage Award Stemming From Bad Tax Advice.

The petitioners, a married couple, had a disabled child that they attempted to provide for via income-producing real estate.  The petitioners engaged in multiple I.R.C. Sec. 1031 exchanges that ultimately, and upon their tax advisor's advice, turned into an abusive tax shelter.  They received $375,000 in settlement of their claims of a lawsuit against their accountants and claimed the sum was not taxable as a return of capital.  In essence, the petitioners claimed that the award represented compensatory damages for losses they suffered due to accountant negligence with respect to the disposition of their real property.  The IRS claimed the amount was fully includible in income as damages for lost profits.  The Court noted that generally such awards represent a return of capital that is not includible in the taxpayer's income.  Under the facts of the case, the petitioners claimed amounts exceeding what they could prove was lost.  Thus, some portion of the $375,000 award will be includible in income and some will be a non-taxable return of capital.  Cosentino v. Comr., T.C. Memo. 2014-186. 


No Long-Term Homeowner Credit For Acquisition of Interest of Former Spouse.

The petitioner and his wife were divorced in 2010 and, as part of the settlement, the petitioner's former wife quitclaimed her 50 percent interest in the former marital home to the petitioner.  The petitioner claimed a long-term homeowner credit on his 2010 return and the IRS denied the credit because he had not "purchased" the home as defined by I.R.C. Sec. 36(c)(3).  The court agreed.  The transfer of the interest in the home was incident to a divorce and the petitioner received a carry-over basis in the home as to that interest which is a prohibited manner in which a home can be acquired and qualify for the credit.  Sullivan v. Comr., T.C. Sum. Op. 2014-89.


Settlement Payment Included In Income.

The petitioner was diagnosed with a degenerative disease that ultimately prevented him from working.  He had a disability policy through his employer and received short-term disability benefits for the last few months of his employment.  He later applied for long-term disability benefits, but was denied because the insurance company determined that he wasn't totally disabled.  The petitioner sued and obtained a settlement amount of $65,000 that would be reported as long-term disability benefits.  The petitioner claimed that the amount was excluded from income under I.R.C. Sec. 104(a)(2) as payment for physical illness, and would also be excludible under I.R.C. Sec. 104(a)(1) as a worker's compensation payment.  The IRS disagreed and the court upheld the IRS determination.  The amount was not paid for any claim of physical injury or sickness, but for a failure to pay disability benefits that the company had contracted to pay.  The court also noted that under California law a settlement had to be approved by the CA Workers' Compensation Appeals Board, and that the petitioner had not submitted the payment for approval.  The court also noted that the amount was paid for sickness on a disability policy that the employer paid for where the premiums were not included in the petitioner's income.  As such, the amount as included in the petitioner's income.  Ktsanes v. Comr., T.C. Sum. Op. 2014-85.


No Deduction For Bonus Paid To Sole Shareholder.

In this case, a personal service C corporation paid an $815,000 bonus to its sole shareholder and attempted to deduct the amount.  The corporation paid the amount in an attempt remove corporate profit and the corporation reported zero taxable income for the year in issue by virtue of the deduction for the bonus paid.  The IRS disallowed the deduction on the basis that the corporate bank account only contained $288,000 at the time the bonus was paid and that the deduction is only allowed when sufficient funds are available to pay the amount.  The Tax Court upheld the IRS position on the basis that the amount of the payment cannot be treated as a distribution when the account has insufficient funds to honor the check.  Thus, the deduction was disallowed.  The court also noted that the sole shareholder's wife kept the corporate books and records and wrote the check at issue thereby subjecting the transaction to "special scrutiny."  Vanney Associates, Inc. v. Comr., T.C. Memo. 2014-184. 


No Deduction For Farmhouse-Related Expenses.

The taxpayer was an architect that used a bonus that he received from his architectural firm in 1975 to buy 420 acres of farmland and an old run-down farmhouse.  The taxpayer continued to live in town until 2010.  From time-to-time, he farmed the tillable ground and rented the pasture ground to neighboring farmers for cash rent.  For the tax years at issue, the taxpayer reported substantial losses as a result of deducting expenses related to the farmhouse in addition to expenses related to the farm ground.  The IRS denied the deductions related to the farmhouse.  The farmhouse had never been rented out for cash and family members occasionally lived in the house over the years in exchange for improvements made to the house.  The Tax Court, ruling for the IRS held that the farmhouse-related deductions were not allowed either under I.R.C. Sec. 212 or Sec. 162 because the taxpayer failed to present evidence that he incurred claimed expenses and because  the taxpayer failed to establish the existence of a real estate rental business.  In addition, the Tax Court determined that the taxpayer had failed to establish that the farmhouse was held for the production of income.  On appeal, the court affirmed. The appellate court noted that the taxpayer had not established a profit motive for any alleged farmhouse rental business and did not establish that he ever treated the farmhouse as part of the farm ground (which did involve a business activity).  The appellate court also held that the farmhouse was not property held for the production of income.  Meinhardt v. Comr., No. 13-2924, 2014 U.S. App. LEXIS 17455 (8th Cir. Sept. 10, 2014), aff'g., T.C. Memo. 2013-85


Partners have No Basis in Unsecured Notes Contributed To LLC Taxed As Partnership.

The petitioner and his company were members of an LLC taxed as a partnership.  The partnership experienced financial issues and the petitioner's company inquired of their attorney whether they could contribute promissory notes to the LLC.  The attorney advised the petitioner that the notes would provide basis to the petitioner equal to the face value of the notes.  Based on that advice, the petitioner contributed unsecured promissory notes without any assumption of the LLC's debt.  The notes contained incorrect dates and incorrect values as to amounts payable. The court held that the petitioner's basis in the notes was zero.  There was no evidence that the petitioner was personally obligated to contribute any fixed amount for a specific, preexisting LLC liability. No accuracy-related penalty was imposed.  VisionMonitor Software, LLC v. Comr., T.C. Memo. 2014-182.


Class of Delivery Drivers Determined To Be Employees For Tax Purposes.

This case involves a class of about 2,300 persons that drive full-time for FedEx delivering packages.  The claimed that they should be classified as "employees" and not as independent contractors for tax purposes and for purposes of the federal Family and Medical Lease Act (FMLA).  The trial court determined that the drivers were independent contractors for tax purposes, and the parties settled on the FMLA issue.  On appeal, the court determined that the drivers were employees based on their relationship with FedEx - FedEx controlled the drivers' appearance, the vehicles that they drove, the time of work and how and when packages were received and moved.  Alexander v. FedEx Ground Package System, Inc., No. 12-17458, 2014 U.S. App. LEXIS 16585 (9th Cir. Aug. 27, 2014). 


IRA Contribution Limits Are Constitutional And Airline Award Points Are Taxable

In this case, the petitioner claimed that the statutory limits on deductibility of IRA contributions were unconstitutional.  The court disagreed, and held that no deduction was allowed for IRA contributions because the petitioner's wife was an active participant in her employer's sponsored retirement plan and the couples combined MAGI was greater than the phaseout ceiling.  While the petitioner claimed that he never received airline "thank you" reward points, the court determined that the value had to be included in income.  Shankar v. Comr., 143 T.C. No. 5 (2014).


No Loving, Touching, Squeezing Means No Tax Exemption.

Under I.R.C. Sec. 501(c)(7), a club organized substantially for pleasure, recreation or another nonprofitable purpose is tax-exempt if no part of the club's earnings inures to the benefit of a private shareholder.  It's under this provision that social clubs (including sororities and fraternities) are tax-exempt.  However, IRS has ruled that an "online sorority" does not qualify to be tax-exempt under the provision.  The IRS said face-to-face interaction was required to achieve tax exemption under the statute.  The sorority did not have any fixed facility where members could meet, and the lack of spending funds for social or recreational purposes was crucial.  IRS said that the face-to-face annual meeting wasn't enough because is was an organizational meeting rather than a social meeting.  Under Rev. Rul. 58-589, commingling of members must be a material part of the organization for the organization to be tax exempt.  In addition, the social organization must simply provide personal growth or other benefits to members - it must focus on social and recreational activities.  Priv. Ltr. Rul. 201434022 (May 29, 2014).


S Corporation Losses Only Deductible To Extent of Basis.

The petitioners were a married couple where the lawyer-wife had died and the husband was an eye doctor.  The husband was the sole shareholder of his S corporation, and both of them had been convicted of willful failure to filed federal income tax returns and were sentenced to prison followed by a supervised release and a fine.  They hired a firm to perform forensic accounting to determine the correct tax liabilities for the years they failed to file returns and deducted the payment to the firm as legal and professional services on Schedule C.  They also deposited funds into the S corporation bank account, claiming that the deposits were loans that increased basis.  The court, agreeing with the IRS, denied any basis increase in the S corporate stock because the petitioners did not establish that the deposits were loans.  But, the court upheld the invoices for forensic accounting services.  Hall v. Comr., T.C. Memo. 2014-171. 


Taxation of Frequent Flyer Miles.

In Announcement 2002-18, the IRS took the position that frequent flyer miles that an are awarded to a taxpayer in exchange for purchases are only taxable if they are converted to cash, or are changed to compensation paid in the form of travel or other promotional benefits (or in situations where such benefits are used for tax avoidance purposes).  In this case, the Tax Court held that the receipt of points that a bank issued to the petitioner which were then redeemed to buy a plane ticket were includible in income.  The court pointed out that the points were a non-cash award for the petitioner opening a bank account with the bank and were really in the nature of interest or money and that Notice 2002-18 didn't apply.  Shankar, et al. v Comr., 143 T.C. No. 5 (2014).


Tax Credit Available to Offset Taxes Paid To Foreign Country.

The Internal Revenue Code (Code) taxes the income of a U.S. taxpayer that is earned in a foreign country.  That foreign country also taxes the same income.  However, the Code allows many taxpayers to either deduct the foreign taxes from gross income for U.S. tax purposes or claim a credit capped at the lesser of the proportion of U.S. tax of the taxpayer's taxable income from foreign sources or the taxpayer's entire taxable income as it bears to the taxpayer's taxable income.  In 2013, the U.S. Supreme court held that foreign paid taxes are creditable under I.R.C. Sec. 901.  The court, affirming the Tax Court, has followed the Supreme Court's guidance.  PPL Corporation and Subsidiaries v. Comr., No. 11-1069, 2014 U.S. App. LEXIS 16479 (3d Cir. Aug. 26, 2014).


First-Time Homebuyer Tax Credit Allowed Because Trailer Was Not a Principal Residence.

The petitioner had a house built in Wichita, Kansas and moved in to it in November of 2009.  She had previously owned a different home in Wichita, but sold it in 2004 due to job issues and moved in with her daughter.  In 2005, the petitioner resumed employment with her prior employer with her post of duty considered to by in California.  In 2007, the petitioner bought a membership in an R.V. park in California and purchased a fifth-wheel (trailer) that was placed on a lot in the R.V. park.  She lived in the trailer while working in California.  On her 2009 return, the petitioner claimed a first-time homebuyer tax credit and IRS denied the credit due to the petitioner's ownership interest in and use of the trailer.  The IRS also imposed an accuracy-related penalty.  However, the court determined that the trailer did not meet the definition of "principal residence" under I.R.C. Sec. 36(c)(2) because the trailer was not "affixed" to the land under state (CA) law and, thus, did not meet the requirement of being a fixture under local law contained in Treas. Reg. Sec. 1.121-1(b)(1) (which governs for purposes of I.R.C. Sec. 36).  Accordingly, the court allowed the first-time homebuyer tax credit.  Oxford v. Comr., T.C. Sum. Op. 2014-80.


Real Estate Professional Requirements Not Met.

In this case, the petitioner had various real estate activities in addition to his day job.  He produced spreadsheets of his time spent in the real estate activities involving single-family homes, but did not produce any contemporaneous log or calendar.  The spreadsheets were created after-the-fact.  The court also determined that the spreadsheet data was excessive, duplicative and counterfactual.  The court determined that the petitioner was not a real estate professional and that losses associated with the real estate activities were not deductible.  The court also imposed a 20  percent accuracy-related penalty.  Graham v. Comr., T.C. Sum. Op. 2014-79.


Lack of Profit Motive Bars Loss Deduction.

The petitioner invested in three partnerships that were created to provide investors with charitable deductions from investments in cemetery plots that were held for over one year and then contributed to charity.  The partnerships failed to hold the plots for longer than a year, but reported that the investors could claim charitable contribution deductions for more than the appraised values, as opposed to basis.  The partnerships also had no income or expense for the tax years at issue other than the charitable deductions.  The petitioner claimed a loss on his investments based on the partnership interests being worthless at year-end.  IRS denied the losses on the basis that the petitioner's investment lacked profit intent.  The court agreed with the IRS and that profit intent was clearly lacking.  The partnerships, the court noted, were not created to realize any income or make a profit.  Just because the Congress allows a deduction for a charitable contribution does not mean that a loss incurred in generating a charitable deduction should be allowed.  The charitable contributions were allowed.  McElroy v. Comr., T.C. Memo. 2014-163.


Pass-Through Loss Allowed Under Facts and Circumstances Test.

The petitioner founded a company of which he turned over day-to-day management to his son and moved to Florida (from company headquarters in Louisiana).  When the business started to fail, he visited the business more often and increased his efforts on research and development, even inventing a new products and securing a new line of credit.  The business carried in excess of a $3 million loss from 2008 to a prior year and received a refund of approximately $1 million.  IRS denied the loss on audit on the basis that the petitioner was passive.  The petitioner claimed that he spent more than 100 hours in the business during the tax year at issue and that his involvement for those hours was regular, continuous and substantial.  The court agreed with the petitioner, based on all of the facts and circumstances, that he was materially participating for purposes of the passive loss rules.  The court noted that.  The court did not require the petitioner to produce a log book or calendar recording his participation.  Wade v. Comr., T.C. Memo. 2014-169.


Rental Loss Disallowed On Home.

Here, the petitioner was a merchant marine that spent much time away from home and rented his home to a friend.  The rental amount was below fair market rental value, and the friend only paid for one month.  The petitioner did not attempt to collect the unpaid rent amounts.  The petitioner claimed a deduction for rental losses which IRS denied on the basis that the petitioner could not prove that he rented the home at market value and made no attempt to collect unpaid rent.  The court upheld the IRS position, noting additionally that the petitioner could not establish his time spent away from home and not at sea.  Hunter v. Comr., T.C. Memo. 2014-164


Bank Is Immediately Liable For Funds in Bank Account When Getting Notice of IRS Levy.

This case points out that the interest of the IRS in a delinquent taxpayer's bank accounts vests immediately on issuance of a levy and the property subject to levy must be immediately surrendered.  If not, the bank is personally liable for the depositor's tax bill.  Here, the taxpayer had an AGI of $21,594 in 2008 but received a tax refund of $78,169 in 2009 attributable to the 2008 tax year.  Instead of notifying the IRS of the obvious error, the taxpayer deposited the funds with the defendant, the taxpayer's bank.  The defendant also did not inform the bank that he was not actually entitled to the funds and that the source of the funds was an obvious IRS error.  An IRS revenue officer assigned to the matter went to the taxpayer's home with a jeopardy levy in hand at 9:30 a.m. on Sept. 9, 2009, and notified the taxpayer that he owed roughly $93,000.  The revenue officer demanded payment, but the taxpayer did not pay the deficiency at that time.  The IRS revenue officer served the taxpayer with the IRS notice to levy his bank accounts.  Ten minutes later, the IRS revenue officer served the jeopardy levy on the defendant.  Less than two hours later, the taxpayer withdrew all of the funds in one of his bank accounts with the defendant, and left less than $8,000 in a different account, which was turned over to the IRS.  Two days later, the defendant froze the bank accounts.  The IRS sought the balance of the taxpayer's tax liability from the defendant.  The court noted that, for a jeopardy levy, IRS need only provide the taxpayer with notice and demand for immediate payment under I.R.C. Sec. 6331 before imposing the levy.  IRS properly followed that procedure and could then levy immediately.  The defendant claimed that it acted reasonably within two hours of receiving the IRS levy and should not be held personally liable for the withdrawn funds.  The court disagreed, noting that I.R.C. Sec. 6332 (the liability provision) does not contain any reasonability requirement.  In addition, the court noted that the government's interest vested immediately upon notifying the bank of the levy and the bank was immediately responsible for preserving the taxpayer's bank accounts for the IRS.  The court also noted that I.R.C. Sec. 6332 contained a reasonability requirement only with respect to an additional 50 percent penalty which could make the defendant liable for 150 percent of the levied property.  United States v. JPMorgan Chase Bank NA, CV 13-3291 GAF (RZx), 2014 U.S. Dist. LEXIS 113896 (C.D. Cal. Aug. 15, 2014).    


ATV Not Tax Exempt For Lack of Being Used Predominantly In Ag Production Activities.

The petitioner, an elderly Iowa farmer, purchased an ATV to use on his farm.  He paid $439.12 in sales tax and sought a refund on the basis that the ATV was exempt from sales tax as farm machinery and equipment.  Iowa Code Sec. 423.1(18) defined "farm machinery and equipment" as equipment used in ag production and exempts it from sales tax if it is directly and primarily used in the production of agricultural products.  The petitioner testified that he used the ATV 25 percent of the time to carry salt and minerals to livestock, 15 percent to carry corn to feed livestock, 25 percent to check cows and calves, 25% to check fence and 10% to check his crops and hay field.  The Iowa Department of Revenue (IDOR) denied the exemption on the basis that only 40 percent of the petitioner's use of the ATV was in direct ag production activities (25 percent to carry salt and minerals to livestock and 15 percent to carry corn to feed livestock) and that the predominant use of the ATV was therefore not in direct ag production activities.  In re Phillips, No. 14DORFC005 (Iowa Dept. of Inspection and Appeals Proposed Decision (Aug. 13, 2014).


Claimed Charitable Deduction of Donated Remainder Interest At Issue.

In this case, the petitioner claimed a $33 million charitable deduction of a remainder interest in the membership interests of an LLC.  The LLC was the landlord of property that was subject to a triple net lease.  At issue was the value of the remainder interest and the application of the IRS tables contained in I.R.C. Sec. 7520.  The court determined that the contribution of the remainder interest (to the University of Mich.) resulted in a deduction that far exceeded the partnership's investment.  After the contribution, the University sold the remainder interest to another entity then resold it and the last purchaser then contributed it to another charity which again triggered a charitable deduction that exceeded the entity's or the donor's investment.  The court denied summary judgment, noting that the entire scheme suggested a tax shelter.  On whether the appraisal of the remainder interest was a qualified appraisal, the court determined that the appraisal barely satisfied the requirements of I.R.C. Sec. 170.  RERI Holdings I, LLC v. Comr., 143 T.C. No. 3 (2014); Zarlengo v. Comr., T.C. Memo. 2014-161. 


Another Property Settlement That Failed To Qualify As Deductible Alimony.

In yet another case, the court held that a property settlement arising in the divorce context was not deductible alimony.  Here, the amount of the settlement, $63,500, was established by the divorce court as a property settlement.  Peery v. Comr., T.C. Memo. 2014-151.


Permanent Conservation Easement Largely Upheld.

The petitioners, a married couple, bought a 40-acre tract within the Pike's Peak viewshed.  They also owned another adjacent 60 acres and sought to plat both tracts as a subdivision with a 2.5 acre size limitation per lot.  Before platting the property, the petitioners  granted a conservation easement on the 40-acre parcel with a development size restriction of one lot of 40 acres.  The pre-easement value as established by the petitioners' appraiser was $1.6 million and the post-easement value was $400,000.  The IRS originally disallowed the entire deduction due to a failure to satisfy I.R.C. Sec. 170, but later conceded that the Code requirements were satisfied and then challenged the appraised values.  The Tax Court determined that the petitioners' appraised values were closer to what the court determined were most accurate.  The result was that the petitioners were entitled to a charitable deduction of over $1.1 million and no penalties or interest.  Schmidt v. Comr., T.C. Memo. 2014-159.


Taxpayer Did Not Materially Participate in Airplane Activity.

The petitioner operated a business in which he trained telephone representatives and also he also practiced law.  He also conducted an airplane rental activity which the court found was unrelated to the telephone activity.  The court, agreeing with the IRS, disallowed the flying deductions against the income from the telephone business activity.  The petitioner also failed to establish that he had devoted sufficient hours to the airplane activity to satisfy the material participation tests under the passive loss rules - either the 500-hour test or the 100-hour test.  The court noted that the petitioner had failed to keep records of the time spent on the airplane activity.  The court also upheld the IRS-imposed negligence penalty and underreporting penalty.  Williams v. Comr., T.C. Memo. 2014-158.


Office In The Home Generates Some Deductions.

The petitioner lived in NYC and worked for a business that was headquartered in L.A.  The petitioner worked from her apartment at the employer's request, and divided her studio apartment into thirds with one-third used for business.  During 2009, the tax year at issue, the petitioner paid for a cleaning service, cable, telephone and internet access, clothing for the employer, and a cell phone for business use.  The IRS disallowed all of the associated deductions that were claimed as unreimbursed employee business expenses.  However, the Tax Court allowed a deduction for one-third of the petitioner's apartment rent and cleaning service charges.  The Tax Court also deductions for telephone and 70 percent of the internet cost.  As for electricity charges, the petitioner's records were insufficient to allow a deduction for any amount.  Cell phone charges were not deductible due to lack of substantiation required (cell phones were listed property in 2009 and subject to strict substantiation rules which were removed by the SMJA of 2010).  The Tax Court did not allow any deduction for clothing expenses because the petitioner admitted that the purchased clothing were also suitable for personal wear.  Miller v. Comr., T.C. Sum. Op. 2014-74.


Divorce-Related Payments By Virtue of Property Settlement Not Deductible.

This case points out, again, that payments in a divorce by means of a property settlement are not deductible.   Here, the petitioner signed a separation agreement that was incorporated into a divorce decree.  The agreement awarded the petitioner's ex-wife $65,000 to be paid within 30 days of the execution of the agreement.  The petitioner deducted the $65,000 as alimony.  Under I.R.C. Sec. 71(b)(1)(B), such payments are generally not deductible.  The court disallowed the deduction the imposed a 20 percent substantial understatement penalty.  Also, numerous scrivenor errors in separation agreement.  Peery v. Comr., T.C. Memo. 2014-151.


Taxpayer Not Engaged In Cattle Business With Profit Intent.

The petitioner was a full time insurance professional and also engaged in various real estate ventures from his home base in North Carolina.  He got involved in cattle breeding with an individual located (at least part of the time) in Indiana.  The cattle breeding venture resulted in numerous breached contracts, unpaid bills and promissory notes and unregistered genetic lines of cattle.   The cattle breeding business was not operated in a business-like manner.  In addition, the cattle breeding venture showed four consecutive years of losses while he was showing a substantial increase in income from this insurance and real estate businesses.  The court determined that IRS prevailed under the I.R.C. Sec. 183 tests and petitioner's cattle breeding venture was deemed to be conducted without a profit intent.  Gardner v. Comr., T.C. Memo. 148.


Businesses Were Separate and Distinct and Could Use Different Accounting Methods.

A corporation's former subsidiary business converted to an LLC with the corporation as it's sole member and the IRS determined that the businesses were separate and distinct trades or businesses under I.R.C. Sec. 446(d) because they were engaged in different activities, had separate books, separate records, were not located near each other and did not share employees except for top-end executives.  Thus, the businesses could use different accounting methods for each of the different businesses.  There was not creation or sharing of profits and losses between the businesses, and income of the businesses was clearly reflected.   This was the case even though the LLC did not elect to be taxed as a corporation and, as a result, was a treated for tax purposes as a division of the corporation.  C.C.A. 201430013 (Mar. 24, 2014).  


State Law Does Not Control For Purposes of Adoption Credit.

The taxpayers adopted a child of mixed ancestry and claimed the I.R.C. Sec. 23(b) credit for associated expenses because the child was not likely to be adopted due to mixed parentage.  To get the credit, the state must make a determination that the child is a special needs child.  The taxpayers claimed that state law specifies that a special needs child is one not likely to be adopted because the child is black or of mixed parentage, and that the statute constituted a determination.  The court held that the statute did not constitute a determination because no individualized decision with respect to the child had been made.  Lahmeyer v. United States, No. 13-23288-CIV-ALTONAGA/O'Sullivan, 2014 U.S. Dist. LEXIS 114896 (S.D. Fla. Jul. 25, 2014). 


Gambling Activity Did Not Rise To Trade or Business Level.

The plaintiff was a Mexican citizen and nonresident of the U.S. that brought a tax refund action exceeding $16 million.  He claimed that he was engaged in the trade or business of slot machine gambling in Las Vegas and, as a result, his taxes should be based on his net income in accordance with I.R.C. Sec. 871(b) (nonresident alien is taxed on taxable income connected with trade or business conducted in the U.S.).  The plaintiff had retired from a Mexican potato farming business in 2001 and began his "betting business" at that time, making numerous trips to Las Vegas annually.  For the years at issue, the plaintiff reported a net loss in some years and profit in other years.  On audit, IRS disallowed wagering costs due to lack of trade or business and issued deficiency notice and assessed tax at 30 percent rate pursuant to I.R.C. Sec. 871(a)(1).  Court determined that test set forth in Comr. v. Groetzinger, 480 U.S. 23 (1987) was to be utilized in determining the existence of a trade or business, and that the test was not satisfied because the plaintiff did not engage in gambling activities on a basis that were continuous and regular.  The court turned to the factors set forth in Treas. Reg. Sec. 1.183-2 to determine whether the plaintiff had the requisite profit intent to be deemed to be in the conduct of a trade or business and determined that: (1) he did not pursue his gambling activity for the purpose of making a profit; (2) he couldn't rely on advisors or gain expertise because playing slots is controlled by a random number generator with the outcome based on pure luck; (3) his time spent on the activity was sporadic and did not consume much of his personal time; (4) he had no expectation that the assets used in the activity would increase in value (because there were none); (5) he didn't participate in any other activities that would enhance his success in playing slot machines; (6) the history of income or loss from the activity was a neutral factor; (7) the amount of occasional profits slightly favored the plaintiff; (8) the taxpayer was very wealthy and didn't need income from slots to support himself, and; (9) there were substantial elements of personal pleasure.  Thus, the plaintiff did not engage in playing slots with the required profit intent.  The court upheld the IRS position.  Free-Pacheco v. United States, No. 12-121T, 2014 U.S. Claims LEXIS 666 (Fed. Cl. Jun. 25, 2014).     


Another Horse Breeding and Training Activity Not Engaged in With Profit Intent.

A married couple operated numerous Steak 'n Shake franchises, but later also began breeding and training Tennessee Walking Horses.  After the husband died in a 2003 house fire, the surviving spouse became President of the corporation that ran the franchises and was very involved in the franchise businesses.  The couple had purchased several hundred acres in TN for slightly under $1 million to operate their horse breeding and training activity.  They ran up substantial losses from the horse activity which they attempted to deduct.  The IRS denied the deductions and the surviving spouse paid the tax and sued for a refund.   The court upheld the IRS determination.  The court noted that under the multi-factor analysis the taxpayers (and later the widow) didn't substantially alter their methods or adopt new procedures to minimize losses, didn't get the advice of experts and continued to operated the activity while incurring the losses.  The court noted that the losses existed long after the expected start-up phase would have expired.  Profits were minimal in comparison and the taxpayers had substantial income from the franchises.  Also, the court noted that the widow had success in other ventures, those ventures were unrelated to horse activities.  Estate of Stuller v. United States, No. 11-3080, 2014 U.S. Dist. LEXIS 100617 (C.D. Ill. Jul. 24, 2014).


Date of "Purchase" Is Key Date For FTHBTC Purposes On Existing Homes.

The petitioner bought an existing home in January of 2009 that needed substantial repairs to make it habitable.  The petitioner began using the house in May of 2009 after making over $10,000 of repairs.  The petitioner claimed the First Time Homebuyer Tax Credit (FTHBTC) based on the purchase price plus the repair cost.  IRS disallowed the part of the credit attributable to the repairs (note - the house was a low-cost home substantially less than the maximum credit allowed).  While I.R.C. Sec. 36(c)(4) bases the credit on the "purchase price" of the home and defines that phrase as the "adjusted basis of the principal residence on the date the residence is purchased", the court determined that "purchase date" is normally the date when the taxpayer takes legal or equitable title with respect to existing housing.  But, the phrase is the date occupancy is established for a constructed residence based on Woods v. Comr., 137 T.C. 159 (2011).  Here, the court determined that the petitioner did not "construct" the house and that, therefore, the credit was to be computed with respect to the purchase price when he took title to the property and the IRS determination was upheld.  Leslie v. Comr., T.C. Sum. Op. 2014-65.


For A Residence Acquired From A 2010 Decedent Gain On Sale Can Be Excluded.

For death's in 2010 an election could be made to opt-out of the federal estate tax.  Such an election resulted in a modified carry over basis rule being applied to assets in the decedent's estate.  Under I.R.C. Sec. 121(d)(11), property acquired from a decedent (or decedent's estate or trust) can take into account the decedent's ownership and use to determine eligibility for the gain exclusion rule.  In this administrative ruling, the IRS determined that the I.R.C. Sec. 121(d)(11) provision is not repealed for 2010 deaths, but is repealed by P.L. 111-312 (the 2010 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010) for deaths before or after 2010.  C.C.M. 201429022 (May 27, 2014).


Self-Rental Rule Applicable With Result That Net Rental Income Not Passive.

The petitioner had substantial income from non-real estate trades or businesses, but tried to qualify as a real estate professional so as to fully deduct substantial rental real estate losses.  The petitioner, however, could not substantiate his activity.  Two commercial rentals were profitable.  The rentals were to two S corporations in which the petitioner was also the president and majority shareholder and an active participant.  While the petitioner claimed that he did not provide any services to the S corporations, the petitioner had also claimed in another lawsuit brought by his children against him (who claimed that the petitioner didn't work enough in the S corporations to justify his large salary) that he was actively involved and was "creating" and "inventing" and was participating in the strategy and growth of the business.  Because the petitioner had taken the position in the other litigation that he was active, the court determined that he was materially participating with the result that the net income from the self-rentals was recharacterized as non-passive.  Schumann v. Comr., T.C. Memo. 2014-138.


No Deduction For Kid Wages Because No Proof That They Provided Services.

The petitioner did consulting and tax prep work out of her home.  She filed a Schedule C on which she claimed deduction for home office expenses.  She said that the percentage of the home used for businesses was 33 percent on Form 8829.  She also paid small amounts of "wages" to three children for work in her business activities that were actually paid to them in the form of credit card purchases for meals and tutoring.  On the percentage issue, the court noted that the petitioner simply took the basement as one of the three levels of her home and took 33 percent as the business use percentage.  The court agreed with IRS and disallowed expenses associated with the home office due to lack of evidence on which the court could base an estimate of the space actually used for business use.  On the deduction for wages, the court noted that two of the children were required to file (their income exceeded the standard deduction) had they not been minors, but that they were compensated for services that were actually household chores.  Thus, no deduction for wages as business expenses was allowed.  Ross v. Comr., T.C. Sum. Op. 2014-68.


Excess Passive Losses Can Still Be Used Even If Gain Previously Excluded.

Under the passive loss rules, in a fully taxable transaction, if all of the gain or loss on the disposition of an activity is realized, then the excess of any loss from that activity over any net income or gain from all other passive activities is treated as a non-passive loss.  Here, IRS reached the conclusion that the use of I.R.C. Sec. 121 does not mean that a transaction is not a "fully taxable transaction."  For instance, if a taxpayer sells a rental property that used to be the taxpayer's principal residence, the possibility exists that when the property is sold that the gain on sale could at least be partially offset by the gain exclusion of I.R.C. Sec. 121 (if the use and occupancy requirements are satisfied).  If the rental activity has unused passive losses, the I.R.C. Sec. 121 exclusion does not bar the ability to release the excess losses under I.R.C. Sec. 469(g)(1).  C.C.A. 201428008 (Apr. 21, 2014).


Bad Debt Deduction Not Allowed.

The petitioner operated a consulting business and upon rehiring a former employee gave the employee $33,000 to help him through some tough times.  The petitioner stated to the employee that it was a loan, but no note or contract was executed.  The employee did not pay back the amount and the petitioner claimed a business bad debt deduction on his return.  The petitioner also sued the employee and the case was resolved two years after the tax year in issue when the deduction was claimed.  The evidence was devoid of any indication of either a business or non-business bad debt.  Court noted that even if the evidence had established that the loan was a bona fide debt, the petitioner would not have been able to establish that the bad debt was a business bad debt.  In addition, even if the debt was found to be a business debt, the petitioner would have failed to establish that the debt became worthless in the year in issue.  Dickenson v. Comr., T.C. Memo. 2014-136.  


No Mortgage Interest Deduction For Rental Property Because No Proof Rental Business Commenced.

Under I.R.C. Sec. 163(h), acquisition debt and home equity debt is deductible with the total of the two together not to exceed $1.1 million.  Here, the petitioner purchased a California residence in 2004 and resided in it with his wife and children.  He moved out in 2006 while his wife and children continued to reside in the home through 2012.  The couple was divorced in 2008.  In 2005, however, the petitioner and wife purchased another home with the intent of renting it out for weekly vacations and similar events.  However, the petitioner and spouse weren't able to rent the property out due to substantial repairs that needed to be done in advance of renting the property.  The petitioner lived in the second home while not traveling for work.  On their joint return, the petitioner deducted amounts for mortgage interest with respect to the second home.   IRS disallowed the deduction and the court agreed.  The property was not a rental property and the petitioner continued to reside in the property.  While mortgage interest was deducted on the aggregate loan exceeded $1.1 million, the court disallowed the excess amount attributable to the second home and noted that had the parties (who were divorced during the years in issue) each paid interest expense, each of them would have been able to deduct up to $1.1 million in qualifying debt.  Hume v. Comr., T.C. Memo. 2014-135. 


When IRS Requires Electronic Depositing of Taxes, Depositing Non-Electronically Results in Penalties.

The plaintiff is a fiduciary of pension plans, IRAs and employee benefit plans for which it is responsible for withholding federal income taxes.  The plaintiff timely and fully deposited all withheld income taxes, but didn't do so electronically as required by IRS regulations when the deposit exceeds $200,000.  IRS assessed failure-to-deposit penalties of over $250,000 by virtue of I.R.C. Sec. 6656(a).  The court upheld the IRS position based on the plain language of the statute and the fact that the Congress had allowed a grace period from the electronic deposit rule at issue from July 1, 1997 to July 1, 1998, and that no grace period any longer applied.  Commonwealth Bank and Trust Company v. United States, No. 3:13-CV-01204-CRS, 2014 U.S. Dist. LEXIS 91489 (W.D. Ky. Jul. 7, 2014).


IRS Says That Status As Real Estate Professional Not Dependent on Aggregation Election.

The taxpayer had multiple real estate rental activities and owned a real property business.  While the taxpayer engaged in the rental activities for more than 750 hours during the tax year, the taxpayer did not participate in each rental activity for at least 750 hours and did not make an election via Treas. Reg. Sec. 1.469-9 to aggregate the activities into a single activity.  The IRS had previously taken the position that a taxpayer, to qualify as a real estate professional, had to put in more than 750 hours in each activity.  But, here, the IRS determined that whether a taxpayer is a real estate professional for purposes of the passive loss rules is not affected by an aggregation election.  Hence, once a taxpayer qualifies as a real estate professional, the requirements for material participation are applied as to each separate activity absent an aggregation election.  C.C.M. 201427016 (Apr. 28, 2014).


To Deduct Vehicle Expenses, Only Logging Odometer Readings Is Not Enough.

In this case, the the petitioner used his personal pickup truck to travel to his employer's customers.  He recorded his odometer reading at the beginning and end of each month in his calendar book, but didn't record any personal travel that he made with his truck and didn't provide any other documentation related to his truck expenses.  However, he claimed that he drove over 40,000 in business miles and claimed over $20,000 in vehicle expenses based on the standard mileage rate.  The court upheld the disallowance of the deduction due to lack of substantiation.  Garza v. Comr., T.C. Memo. 2014-121.


You Have Mail From the IRS and You Cannot Deny It.

This case points out that a taxpayer simply cannot refuse to check their mail and successfully claim that notice of a tax deficiency was not received from the IRS.  Here, the IRS sent a notice of deficiency to the taxpayer on multiple occasions via certified mail, return receipt requested.  Finally, the U.S.P.S. ceased attempting delivery and returned it to the IRS.  The taxpayer claimed that he never got notice of the deficiency.  However, the Tax Court found that the taxpayer was able to get his mail and had multiple opportunities to check and retrieve it, and held that he could not simply refuse to get his mail and claim that he didn't have notice of the deficiency.  The court also determined that the taxpayer could not dispute the underlying tax deficiency related to the notice.  Onyango v. Comr., 142 T.C. No. 24 (2014).


Wife Was Independent Contractor, and Carryforward Losses Not Allowed.

The petitioner, a lawyer, hired his wife to work with an eccentric client that she related well with.  On their MFJ returns for the years in issue, the payments to the wife were reported as contract labor expense and also as gross receipts on Schedule C (subject to s.e. tax).  IRS claimed that the wife was an employee and that payroll taxes should have been paid and disallowed the deduction for the s.e. taxes paid, and reclassified as wage income the amount reported as gross receipts on Schedule C.  Based on all of the common-law factors, the court determined that she was an independent contractor and not an employee.  The IRS also disallowed carryforward losses due to the petitioner's failure to establish the activity that generated the losses and the income in the carryforward years.  Jones v. Comr., T.C. Memo. 2014-125.  


No Deductible Losses Attributable To House Not Held For Income Production Purposes

In this case, the petitioners, a married couple, owned some rental properties.  With respect to the property at issue, the couple had previously rented it.  However, during the years at issue (2007 and 2008) they didn't receive any rent and engaged in only minor attempts to sell the property.  The incurred a loss with respect to the property which they deducted.  The IRS denied the deduction on the basis that the petitioners did not engage hold the house for the years at issue for the purpose of producing income and there was no for-profit activity with respect to the house for the years in issue.  The court agreed with the IRS.  Robinson v. Comr., T.C. Memo. 2014-120. 


Wife Not Estopped from Challenging Husband’s Alleged Divorce-Related Expenses Because She Signed Tax Return Claiming Same Expenses.

In a divorce proceeding, the husband submitted expenses for reimbursement that he incurred in caring for cattle that he owned with his wife before their sale. The trial court awarded him only some of his requested expenses, and the husband appealed. On review, the court affirmed, finding that it was for the trial court to make determinations as to the credibility of the husband’s assertions. The court also declined to adopt a rule of quasi-estoppel and find that since the wife signed a tax return on which the same expenses were claimed by the husband, she should have been estopped from complaining as to the validity of the same expenses in the divorce action. Else v. Else, No. A-13-156, 2014 Neb. App. LEXIS 106 (Neb. Ct. App. Jun. 10, 2014).


No Deduction For Exacted Conservation Easement Because No Proof Of Consideration.

In this case from Colorado, the petitioner sought to develop an historic site into condominiums.  The petitioner sought to build the condos in the parking lot for the historic building  and preserve the historic building in order to get the city to modify existing zoning restrictions, but the city sought conservation easements in return.  Petitioner valued easement at $7 million, but did not indicate on return that it had received anything in return for the easement.  IRS claimed that filing and appraisal requirements were not satisfied with result that easement-related deduction was approximately $400,000.  The court determined that the petitioner was not entitled to any deduction due to the lack of consideration for the easements at issue.    Seventeen Seventy Sherman Street, LLC  v. Comr., T.C. Memo 2014-124.


Taxpayer’s Three-Acre Tract Properly Qualified for Both Homestead Exemption and Open-Space Land Valuation.

A taxpayer owned three contiguous parcels of land: a three-acre tract, a one-acre tract, and a nine-acre tract. He lived in a home located on the one-acre tract.  Before 2010, the taxpayer was granted by the appraisal district a valuation of the three-acre tract as open-space land for purposes of ad valorem taxes. In 2010 and 2011, the appraisal district denied the taxpayer’s application for a residence homestead exemption for the same three-acre tract.  The trial court ruled in favor of the taxpayer in his challenge to the appraisal district’s decision, and the appraisal district appealed. On appeal, the court affirmed the trial court’s ruling, finding that a taxpayer is entitled to a homestead exemption for an entire parcel of property if the contiguous lots total less than 20 acres and they are used as a residence homestead. The court rejected the appraisal district’s argument that the homestead exemption was incompatible with the “agricultural use” requirement necessary for the open-space land valuation. Tex. Tax Code Ann. § 11.13(k) (which provided that the amount of any residence homestead exemption for a qualified residential structure did not apply to the value of that portion of the structure used for other purposes) did not apply to the case at hand because the statute applied only to residential structures, not land. No legal authority provided that land could not be used as a residence homestead and also for agricultural purposes. In fact, Tex. Tax Code Ann. § 23.55(i) did provide that a parcel of land qualifying for open-space valuation did not undergo a change of use when it was claimed as part of a residence homestead.  Parker County Appraisal Dist. v. Francis, No. 02-13-00182-CV, 2014 Tex. App. LEXIS 6690 (Tex. Ct. App. Jun. 19, 2014).


No Tax Deduction For Façade Easement.

In this litigation that has generated multiple court opinions, the petitioner donated a façade conservation easement with respect to the petitioner's row house in an historic district in NYC.  Under the terms of the easement, the petitioner could not alter the façade without the permission of the donee and the petitioner was required to maintain the façade and the balance of the row house.  Under the existing rules of the historic district, the row house was already subject to substantial restrictions on construction and demolition.  In the initial Tax Court decision (T.C. Memo. 2010-151), the Tax Court determined that the petitioner was not entitled to any deduction.  On appeal, the U.S. Court of Appeals for the Second Circuit (682 F.3d 189 (2d Cir. 2012) upheld the charitable deduction of $59,959 because the petitioner's appraiser sufficiently explained how he arrived at valuation numbers before and after easement restriction.  The court determined that it was irrelevant that the IRS believed that the method employed was "sloppy" or haphazardly applied because the pertinent regulation required only that the appraiser identify the valuation method that was used and did not require that the method be reliabale.  The court held that the appraiser sufficiently supplied a basis for the valuation and the approach used was nearly identical to that approved in Simmons v. Comr., T.C. Memo. 2009-208.  In addition, the appraisal provided the IRS with sufficient information to evaluate the claimed deduction.  The petitioner submitted two Form 8283s when combined provided all of the required information and substantially complied with the requirement of the information required to be submitted. The court upheld the charitable deduction for the cash donation to the organization arranging for the donation of the easement (which was required as a condition of facade easement donation).  However, no deduction was allowed for the easement itself because there was no benefit to the taxpayer other than the facilitation of the facade easement.  However, the court remanded the case to the Tax Court to resolve other claims made by IRS.  On remand, the Tax Court (T.C. Memo. 2013-18) held that the petitioner was not entitled to any deduction for the façade easement because the subject property was already subject to substantial restrictions and didn't have any value for purposes of the charitable contribution deduction.  On further review, the appellate court affirmed.  Scheidelman v. Comr., No. 13-2650, 2014 U.S. App. LEXIS 11941 (2d Cir. Jun. 18, 2014).


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