Most individuals put their lease agreements in writing. But not everyone does that. An individual in Maryland leases a bar to a friend with a verbal agreement. He doesn’t tell his accountant about the lease; the accountant believes (wrongly) that the individual is operating the bar. And the individual’s name is on the legal documents as the owner of the bar because his friend had a felony conviction years ago and doesn’t believe he’ll qualify for a Maryland liquor license. The IRS audits the individual. The accountant realizes that there’s an error, and attempts to correct it…but the IRS refuses to accept the corrections. The mess ends up in the Tax Court.
It’s an excellent case to read. “Taxation * * * is eternally lively; it concerns nine-tenths of us more directly than either smallpox or golf, and has just as much drama in it; moreover, it has been mellowed andmade gay by as many gaudy, preposterous theories.” [The quote, from the decision, is actually from H.L. Mencken, “The Dismal Science,” Smart Set, June 1922, at 42.]
Verbal leases are binding. The evidence in the case shows that there truly was a lease between the landlord and the tenant. Their agreement was based on a “swinging door concept”—everything inside was the responsibility of the tenant and everything outside was the responsibility of the landlord and the evidence backed them up.
As to who owned the bar, “Even more telling, however, is that Monk’s [the landlord’s] financial interest–which consisted primarily of his monthly rent payment–wasn’t tied to the profits or losses of Chuck’s Place.” The IRS’ view that the landlord ran the bar ran into some literal evidence, “Maney [the tenant] also testified that he (and not Monk) has the bar’s logo tattooed on his chest. Though the Court did not undertake a visual inspection, we found him credible on this point.”
The Tax Court noted the reality: “In situations like this, where there is written documentation which contradicts the reality of a situation, we disregard the documents to properly tax the person actually earning the income.” So today the petitioner really was the winner. He was just a landlord of a business, not the owner.