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Boston Bruins 2, IRS 0

Monday, June 26th, 2017

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The United States Tax Court today looked at whether pregame road meals for a National Hockey League (NHL) team are “meals and entertainment” expense (which would be deductible at 50% of cost) or a “de minimis fringe” and deductible at 100% of cost. As you might be able to guess from the title of the post, the Bruins shutout the IRS today.

First, if you’re interested in some of all of the background work that must be done for hockey, the opinion is a must-read. For example, I did not know that the road team in hockey does not receive any of the ticket revenue for regular season games. But I digress….

The IRS allowed pregame home meals but did not allow pregame road meals as a de minimis fringe; the IRS claimed that road (away) meals were a meal and entertainment expense. Of course, the meals must also be business-related but both the IRS and the Bruins agreed on that. As you might imagine, diet matters to NHL players:

Each away city hotel prepares pregame meals (i.e., breakfast, lunch, or brunch) and snacks that meet the players’ specific nutritional guidelines to ensure optimal performance for the upcoming game and throughout the remainder of the season. The Bruins contract in advance with each away city hotel for the provision of pregame meals and snacks, and the food is made available to all traveling hockey employees. The Bruins initiate the meal contracting process by providing a custom meal menu to the prospective away city hotel requesting specific types and quantities of food. The Bruins tend to keep food options consistent at each away city hotel to avoid players’ having gastric problems during the game. The Bruins always order the same quantity of food to feed all traveling hockey employees.

The de minimis fringe exception first requires that the eating facility be available to all, and not discriminate in favor of highly compensated employees. NHL teams bring a lot more than just the players on a road trip:

During the years in issue the Bruins traveled to away games with various personnel, which typically included: between 20 and 24 players, the head coach, assistant coaches, medical personnel, athletic trainers, equipment managers, communications personnel, travel logistics managers, public relations/media personnel, and other employees (traveling hockey employees). During the years in issue the Bruins’ traveling hockey employees traveled to every away game.

The Bruins easily passed this first hurdle because the food was provided to all. The major issue was whether these were a de minimis fringe benefit:

Employee meals provided in a nondiscriminatory manner constitute a de minimis fringe under section 132(e) if: (1) the eating facility is owned or leased by the employer; (2) the facility is operated by the employer; (3) the facility is located on or near the business premises of the employer; (4) the meals furnished at the facility are provided during, or immediately before or after, the employee’s workday; and (5) the annual revenue derived from the facility normally equals or exceeds the direct operating costs of the facility (the revenue/operating cost test).

The Bruins lease hotel facilities; that would make it appear that they would pass the first test. “The evidence establishes that the Bruins contract with away city hotels for the right to “use and occupy” meal rooms to conduct team business, and therefore these agreements are substantively leases.” And given that they contract with the hotel to provide the food, they meet the operating test.

It appears (from the opinion) that the IRS vigorously opposed the idea that the Bruins passed the “facility is located near the business premises of the employer” test. But the Court disagreed.

First and foremost, the nature of the Bruins’ business requires the team to travel to various arenas across the United States and Canada, and it is not feasible for the Bruins to be a viable NHL franchise without participating in hockey games outside of Boston. The NHL constitution and bylaws obligate each NHL team to play both home and away games during the regular season and, if the team qualifies, postseason games. Not only does the NHL require teams to participate in away games, but it also requires visiting teams to arrive in an away city at least six hours before the away game commences. The CBA imposes an additional requirement that visiting NHL teams travel to the away city the day before game day, if travel by airplane is greater than 150 minutes. Furthermore, if an NHL team fails to participate in an away game it must forfeit the game, lose playoff points, incur financial penalties imposed by the NHL, and indemnify the home team for loss of revenue and other expenses. Therefore, an integral part of the Bruins’ professional hockey business involves traveling throughout the United States and Canada to play away games as dictated by the NHL schedule. The job of the Bruins’ team includes playing one-half of their regular season games away from their hometown arena, and the financial health of the NHL franchise–not to mention the NHL itself–would be adversely affected if teams refused to play away games.

The Court ruled that staying in away city hotels was essential for the Bruins, and it’s clear that it would be impossible for the Bruins to do all this in Boston. “The evidence at trial also establishes that the Bruins could not perform all these activities at the opponent’s arena because of limited access and insufficient space and facilities.” Thus, the Court held that the road hotels were part of the Bruins’ business premises.

The IRS disagreed:

[T]he traveling hockey employees’ activities at away city hotels are insignificant because: (1) the activities at away city hotels are qualitatively less important than playing in the actual hockey game and (2) the Bruins spend quantitatively less time at each away city hotel than they do at the team’s Boston facilities.

The Court, though, thought that the IRS was offsides on these arguments.

Without the preparatory activities that occur at away city hotels the Bruins’ performance during games would likely be adversely affected. Furthermore, respondent provides no precedent to support the argument that business premises are limited to the location where the most qualitatively significant business activity occurs…Although the Bruins do spend quantitatively less time at each individual away city hotel than they do in Boston, this goes to the unique nature of a professional hockey team that is required to play one-half of its games away from home. It is therefore illogical for respondent to ignore the nature of the Bruins’ business and the NHL and analyze the amount of time spent at each away city hotel in isolation.

The Bruins also passed the revenue/operating cost test. “Meals are excludable to recipient employees under section 119 if they are (1) furnished for the convenience of the employer and (2) furnished on the business premises of the employer.” And the Court agreed with the Bruins here:

The evidence establishes that the pregame meals at away city hotels are provided to the Bruins’ traveling hockey employees for substantial noncompensatory business reasons. The Bruins provide pregame meals to traveling hockey employees at away city hotels first and foremost for nutritional and performance reasons…Providing meals to traveling hockey employees at away city hotels enables the Bruins to effectively manage a hectic schedule by minimizing unproductive time (e.g., finding and obtaining appropriate meals from restaurants in each city) and maximizing time dedicated to activities that help achieve the organization’s goal of winning hockey games. Petitioners have provided credible evidence establishing the business reasons for furnishing pregame meals to traveling hockey employees at away city hotels, and we will not second-guess their business judgment.

The IRS conceded the last part of the test (that the meals were furnished during, before, or after the workday). Thus, it was a shutout: Bruins 2, IRS 0 (the petitioners, the owners of the Bruins, were challenging an IRS audit covering two tax years).

Other professional sports teams may be filing amended returns (if they had only been taking half of the cost of meals) because it’s hard to imagine that the requirements for, say, a traveling NFL or NBA team aren’t similar to those of an NHL team. This is a full decision of the Tax Court, so it is precedential.

Case: Jacobs v. Commissioner, 148 T.C. No. 24

Posted in Massachusetts, Tax Court | Comments Closed

2016 Tax Offender of the Year Gets 34 Months at ClubFed

Sunday, June 25th, 2017

Last April, a husband and wife from Minnesota were indicted on tax evasion charges. There wasn’t anything unusual about what they allegedly did; besides lying to their tax professional and the IRS they deducted personal expenses as business expenses. The reason Diane Kroupa won the award was her profession: She was a judge on the United States Tax Court. She knew better.

Last week Ms. Kroupa received 34 months at ClubFed; her husband received 24 months. Acting United States Attorney Gregory Brooker said,

Over a nearly ten-year period, the defendants engaged in a deliberate and brazen tax fraud scheme…Considering Ms. Kroupa’s position of public trust as a US Tax Court Judge, her crime is particularly egregious. Ms. Kroupa used her knowledge of the tax laws to further their fraud scheme, conceal their criminal conduct and maintain their acquisitive lifestyle. The sentences handed down today show that no one is above the law.

There’s not much to add to that statement.

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Posted in Tax Court, Tax Evasion | Comments Closed

I See $25,000 In Your Future

Thursday, June 8th, 2017

When I start reading a Tax Court decision and see the sentence, “Petitioner and her husband derived considerable income from peddling this scheme to gullible individuals,” you know it’s not going to be a good day for petitioners. But I’m getting ahead of myself.

Three years ago Ms. G had a Tax Court case on their 2004 income taxes which she lost. She appealed that decision and lost. The IRS wanted to collect the money, but the petitioner asked for a Collection Due Process (CDP) hearing with IRS Appeals. She had it, and lost that. She then appealed that result to the Tax Court. Based on income of $235,542 (of which no tax was paid), she owed $99,261 plus penalties and interest.

First, a little background on petitioner:

Petitioner and her husband are well-known tax shelter promoters with a lengthy history of litigation in this and other courts. Their speciality [sic] is the “corporation sole” tax shelter, whereby a taxpayer takes a fictitious “vow of poverty” in connection with a purported “church” and declares herself thenceforth immune from Federal income tax. Petitioner promoted this scheme by writing several books, including How to Protect Everything You Own in This Life and After and Corporation Sole vs. 501(c)(3) Corporation. Petitioner also practiced what she
preached: She and her husband established “Bethel Aram Ministries” in 1993, took fictitious “vows of poverty,” and have not filed a Federal income tax return since. [footnote omitted]

That’s not a good start. I’d like to pay no tax, but you need to be a real minister with a real vow of poverty to do so; imitations don’t work. At the CDP hearing, the IRS Appeals Officer noted that the law had been followed, and shockingly (not) that the taxpayer had still not submitted copies of 2005 to 2014 tax returns.

Well, her streak of non-filing is a bit more lengthy:

Petitioner did not request a collection alternative, and she did not supply the SO with the financial information necessary to enable him to consider one. Far from being in compliance with her ongoing tax filing obligations, she has not filed a Federal income tax return since 1993. The SO did not abuse his discretion in declining to consider a collection alternative under these circumstances…Finding no abuse of discretion in this or in any other respect, we will grant summary judgment for respondent and affirm the proposed collection action.

But the Tax Court wasn’t happy with the petitioner.

It is clear to us that petitioner has maintained this suit “primarily for delay” as part of her 25-year campaign to avoid or defer indefinitely the collection of her Federal income tax liabilities. Because our decision establishing her 2004 income tax liability became final more than three years ago, she had no plausible basis for challenging that liability through the CDP process. Her 30-page response to the motion for summary judgment includes only two paragraphs that bear any rational relationship to the issues this case presents. The vast bulk of that document is directed toward relitigation of the trial court and appellate decisions previously rendered against her. In that connection she advances numerous frivolous arguments, including assertions that the IRS “continues to lie and defame Petitioner” and that the Commissioner and the courts have conspired to deny her First Amendment rights to freedom of speech and religion.

The Tax Court assessed a Frivolous Position Penalty of $10,000.

Petitioner has wasted the resources of respondent’s counsel and this Court. We will accordingly require that she pay to the United States under section 6673(a) a penalty of $10,000. This opinion will serve as a warning that she risks a much larger penalty if she engages in similar tactics in the future.

Tax Court exists so that legitimate disputes between taxpayers and the IRS get resolved. The Tax Court has little sense of humor about frivolity. Given Ms. G’s consistent non-filing and delaying tactics, I suspect we will see her name in a future case with a section 6673(a) penalty of $25,000.

Case: Gardner v. Commissioner, T.C. Memo 2017-107

Posted in Tax Court | Comments Closed

The TurboTax Defense Fails Again

Thursday, May 11th, 2017

A gentleman who is normally an expert witness in trials used TurboTax to prepare his returns. His returns ere reviewed by the IRS; the IRS claimed he took a few too many deductions. The taxpayer felt otherwise, and the dispute ended up in Tax Court. Judge Holmes wrote the opinion, so it’s very readable.

The first issue was alimony payments. Alimony is deductible for the payor but taxable to the recipient. However, one of the requirements is that there be a written order. The taxpayer and his ex-wife had an oral modification of the agreement. That may work for getting the ex-wife more money, but it fails for deducting those extra payments.

The second issue was interest. Interest that’s part of a business can be deducted, but you do have to show you made payments and those payments were interest and not principal. I’ll let Judge Holmes take this:

The evidence does show [he] made payments to his lender, but the amounts do not match those that he claimed on his tax returns, and he did not explain this discrepancy at trial. [He] also did not provide us with any business records regarding the loan, any loan statements, or any loan-repayment schedules. Without this type of documentation we are unable to tell whether these payments were made on the original 2007 loan. Remember that the note for that loan says it should have been paid in full by October 2008. We understand that it might have been his plan to pay the note with proceeds from the sale of his home, and that that sale didn’t happen. The problem is that we can’t figure out what happened to the note–was it refinanced? Was it extended? Without any paperwork (in a situation where there should have been lots of paperwork) we are left only with his testimony about the total amounts of the payments and the allocation of those payments between principal and interest. We do not find his testimony credible on this issue, and so sustain the Commissioner’s determination.

As I tell my clients, document, document, document (and save those records). A paper trail is a very good thing to have when you get to Tax Court.

The third issue was an apparent Net Operating Loss (NOL) carryforward.

A taxpayer substantiates his claim to such a deduction by filing with his return “a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the net operating loss deduction.” During trial he did turn in a tax return for a previous year (though not the one that generated the net operating loss), but even with his testimony, that is not enough to substantiate his entitlement to a loss carryforward.

The taxpayer also received an accuracy-related penalty.

The burden then swings to [him] to show that his mistakes were reasonable and in good faith. See sec. 6664(c)(1). He cannot. He admitted during trial that he deducted items he shouldn’t have, and that he overstated certain losses. He tried to blame TurboTax for his mistakes, but “[t]ax preparation software is only as good as the information one inputs into it.” [citation omitted]

If your tax return has only W-2 income and, say, mortgage interest and property tax, TurboTax will likely do an excellent job. If you have a divroce settlement with a restatement of the amount of alimony due, interest tracing, and a Net Operating Loss carryforward, it might pay to get some expert help.


Case: Bulakites v. Commissioner, T.C. Memo 2017-79

Posted in Tax Court | Comments Closed

Consulting, Gambling; There’s No Difference, Right?

Monday, February 6th, 2017

The Tax Court looked at an individual (call him “Mr. A.”) who looked like a professional poker player, appeared to have an income from poker, but was described on his tax return as a “consultant.” His tax return showed less than half the income that his W-2Gs totaled. The IRS added in a negligence penalty, and the whole dispute ended up in Tax Court.

Before I get into the meat of the case, a comment about gambling and the IRS (and the Tax Court). The IRS does not have a good understanding of the mechanics of poker tournaments. The petitioner today lost some deductions because of this (and that they didn’t explain things point by point). For example, the Court stated (in footnote 4):

The parties also stipulated the authenticity of two receipts showing that Mr. A had paid buy-ins as an “alternate” to participate in “$540 No Limit Hold’em” contests at the Bellagio on July 11 and 17, 2009. As the record does not disclose whether Mr. A in fact played–and if he did not, whether his buy-in was refunded–we conclude that petitioners have not shown that Mr. A paid these buy-ins.

That’s not how alternates in a poker tournament work. Alternates are just the people who get seated when original entrants are eliminated from the tournament. I’ve never seen or heard of an alternate not being seated. But the petitioners didn’t mention this in their briefs or testimony, so the Court used what they thought the term meant, not what really happens in poker tournaments. But I digress….

The problems began with the preparing of their 2009 return.

The return was prepared by petitioners’ accountant…who has a master’s degree in accounting and had previously prepared tax returns for professional poker players. For purposes of preparing the return, Mr. A advised the preparer that his exclusive source of income in 2009 was his poker tournament winnings. He further advised the preparer that he did not have records of the expenses he incurred in order to play in poker tournaments. The preparer concluded that Mr. A was a professional poker player on the basis that poker was his exclusive source of income. Given the absence of expense records, the preparer advised petitioners to report the net income from the gambling activity on Schedule C as gross receipts but not to report any offsetting business expenses.

Let’s look at the problems here. First, the IRS computer system was almost certain to hiccup on this return. If the W-2Gs totaled $42,000 and you report $21,000, there’s a problem. I’m certain that the petitioner received an IRS automated underreporting unit notice on this issue. The second problem deals with the preparer. Tax returns have places for expenses; they aren’t supposed to be lumped with gross receipts. Additionally, there are basic standards in preparing a return. The idea of a preparer putting down, say, $10,000 for expenses when a client says he has no records of those expenses makes no sense.

The taxpayers return showed a Schedule C—the only source of income—with $20,045 of net and gross income. The Schedule C was listed Mr. A’s occupation as “Consultant.” The IRS assumed that was the case, and saw $40,395 of wagering income to be added to the return. That was the first issue. This they won:

On the basis of Mr. A’s and his accountant’s testimony and the entire record, we agree with petitioners. Other than the reference on the Schedule C to Mr. A’s business as a “consultant”, there is no evidence that Mr. A engaged in any consulting activities for compensation during 2009. He denied doing so. When called upon to explain why Mr. A’s business was described as that of a “consultant” on the Schedule C, both he and his accountant dissembled. In the circumstances, we conclude that the business was described this way in a misguided attempt to head off the closer scrutiny of the return that would likely be triggered by a description of Mr. A’s business as “poker” or “gambling”–scrutiny that would likely unearth the inadequacies in the substantiation of Mr. A’s expenses.

The Court included gambling winnings that weren’t on W-2Gs. Yes, all income is taxable no matter if you receive a piece of paper or not. The Court noted, “On this record we find that Mr. A had poker tournament winnings of $48,686 for 2009. Given our conclusion that petitioners reported $20,045 of Mr. A’s gambling income on their return, it follows that they had unreported gains from wagering transactions of $28,641 for 2009.”

The IRS contended that the petitioner wasn’t a professional gambler. Given that the only source of income for the petitioner and his wife was his gambling, the petitioner won this argument. He also was able to deduct his losing poker tournament entries (save the “alternate” entries that the court got wrong).

The taxpayer ran into trouble with his business expenses. “Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to any deduction claimed on a return.” Mr. A. was allowed to deduct those items that he had receipts for. There were almost certainly more expenses, but a line from Tom Clancy comes to mind: If you don’t write it down it never even happened. That’s definitely the case for business expenses: Keep receipts and good records!

The IRS also asserted an accuracy-related penalty for negligence or disregarding IRS rules and regulations.

“‘[N]egligence’ includes any failure to make a reasonable attempt to comply” with the internal revenue laws. Sec. 6662(c). It connotates “a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the
circumstances…This includes “any failure by the taxpayer to keep adequate books and records or to substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax Regs. Disregard of rules or regulations includes any careless, reckless, or intentional disregard of the Internal Revenue Code, the regulations, or certain Internal Revenue Service administrative guidance.”

Respondent contends that petitioners are liable for an accuracy-related penalty on the basis of negligence. We agree. They failed to maintain records of Mr. A’s gambling activities, including the related expenses. Lacking adequate records, they filed a return that reported an estimate of their net income as if it were gross receipts. As a consequence, they significantly understated both gross receipts and net income. They also participated in a misrepresentation of Mr. A’s business as being that of a consultant rather than a professional poker player. The failure to keep records is prima facie evidence of negligence, and the misrepresentation of the nature of Mr. A’s business falls short of a reasonable effort to comply with the internal revenue laws…

Petitioners have not shown reasonable cause and good faith with regard to any portion of the underpayment. While they were advised in the preparation of their return by an accountant, the return as prepared stated a gross receipts figure that Mr. A certainly knew to be inaccurate and further identified the nature of his business in a way that both petitioners knew to be inaccurate. Petitioners have not shown that they acted with reasonable cause and in good faith with respect to any portion of the underpayment. They are liable for the negligence penalty under section 6662(a).

Some helpful hints if you want to fade into the crowd: Accurately report your gross receipts. The IRS matches things reasonably well, and if they have records that show you have $50,000 of income and your report $20,000, there’s going to be a notice sent to you. If you’re a consultant, would you note your occupation as “professional gambler?” I assume not. The converse is also true; if you’re a professional gambler, you’re not a consultant.

Second, you sign your return, and you’re expected to review it. If you’re gross income is $50,000 and you report $20,000, that you used a tax professional will not absolve you from the accuracy-related penalty.

Finally, keep good records! Every time I get a new client I emphasize with them the importance of keeping good records. An audit is an inconvenience if you have records that substantiate what’s on your tax return. If you don’t, it will be a very painful, very expensive inconvenience.

Case: Alabsi v. Commissioner, T.C. Summary Opinion 2017-5

Posted in Gambling, Tax Court | Comments Closed

No Gambling Log, No Problem, Right?

Tuesday, November 8th, 2016

Two married poker players worked as house players (commonly called “proposition players” or “props”) in California. They were paid wages for their work, but they had gambling winnings that they didn’t include on their tax return. They state they lost money (more than their winnings) each month with their poker playing so the winnings needn’t be included on their returns. The IRS disagreed. The dispute made its way to Tax Court.

The petitioners worked at the Hustler Casino in Gardena, California (south of downtown Los Angeles), one of the card rooms (poker clubs) in the Los Angeles metropolitan region. They were hired by the Hustler to start poker games, and fill those games until other customers came. Such house players are common, and are used at off hours or to start games.

One of the petitioners happened to be at the right place at the right time and shared in a “Bad Beat” jackpot worth $16,800 (noted on a W-2G). Because their losses exceeded their wins, the petitioners simply ignored the W-2G. Although not specified in the Tax Court’s opinion, petitioners likely received an Automated Underreporting Unit Notice (probably a CP2000) noting the missing income. Eventually a Notice of Deficiency was issued, and the case made it to Tax Court.

Petitioners didn’t note what they won or lost. From the Opinion:

Petitioners assert that initially they tried to keep track of their poker winnings and losses by writing down the amount won or lost at the end of each day, but after a while they gave up that practice because it is “bad for your psyche * * * you need to be strong mentally” when playing cards.

The Opinion goes into how gambling losses for a proposition player should be noted (whether it’s an unreimbursed employee expense or a gambling loss), but the Court first had to determine the losses.

Regardless of whether petitioners were employees or independent contractors, they were engaged in a gambling activity and are required to substantiate their reported gambling losses. Accordingly we first look to the issue of whether petitioners substantiated their reported gambling losses.

Deductions and credits are a matter of legislative grace, and taxpayers must prove entitlement to the deductions and credits claimed. Taxpayers are required to identify each deduction, show that they have met all requirements, and keep books or records to substantiate items underlying all claimed deductions. To establish entitlement to a deduction for gambling losses the taxpayer must prove the losses sustained during the taxable year. The Commissioner has suggested that gamblers regularly maintain a diary, supplemented by verifiable documentation, of gambling winnings and losses. A taxpayer’s “contention that it was too difficult for him to maintain contemporaneous records of his gambling activities is without merit.”[citations omitted]

The “bad for your psyche” defense isn’t a good one at Tax Court. The petitioners didn’t provide any evidence of their losses. They could have used a phone app to note their gambling results or pen and paper. They provided no confirmation to the Court, so the Court was left with little choice but to affirm the Notice of Deficiency.

A helpful hint for props: Keep a gambling log! It’s not hard (there are even phone apps you can use). Yes, your psyche may be damaged by a bad day at the poker table but you won’t suffer a second loss in Tax Court if you keep that log.

Case: Pham v. Commissioner, T.C. Summary 216-73

Posted in Gambling, Tax Court | Comments Closed

Substance Over Form

Thursday, January 7th, 2016

The Tax Court looked today at a worker in Hollywood. He thought he was a contractor; the IRS felt he was an employee. Who was correct?

Our favorite judge of the Tax Court, Judge Mark Holmes, authored the opinion so it’s very readable. The petitioner today was upset about three things that the IRS had changed with has 2009 and 2010 tax returns. First, he filed as an independent contractor in 2008 and the IRS didn’t do anything so his 2009 and 2010 returns shouldn’t be looked at. Second, he feels he was an independent contractor. Third, if he wasn’t an independent contractor he was a statutory employee. The IRS disagrees with all of these.

Judge Holmes quickly disposes of the first issue.

Each tax year stands alone, and the Commissioner may challenge in a later year what he permitted in an earlier one. The Commissioner’s failure to challenge Quintanilla’s status for the 2008 tax year doesn’t disable him from challenging that status for 2009 and 2010.

The second issue has easy law but is difficult in application. “We’ll start with the easy part: An independent contractor is one who works for another but according to his own manner and method, free from direction or right of direction in matters relating to performance of work save as to results.” The key is what did the petitioner really do, not how did he get paid.

We find that the production companies that hired Quintanilla hired him to build sets. They expected him to provide any tools he needed to complete the job. Quintanilla has an enormous collection of tools–which he stores in two 40-foot steel containers–that travels with him to jobsites. These containers are also packed with machinery that Quintanilla uses to fabricate pieces of sets on the spot…Thus, Quintanilla might be paid by the same payroll company for six months, but actually be working on 20 or more projects run by many different production companies.

But Mr. Quantanilla received some W-2s, so he must be an employee, right?

When a production company hired Quintanilla as an individual, it would generally issue him a Form W-2, Wage and Tax Statement. And the company listed on the Form W-2 as the employer was usually a payroll company. Even a tiny bit of questioning showed that his situation is much different from most taxpayers who get a W-2 from their employer, and nobody involved in this case thinks the payroll company had any control whatsoever over how Quintanilla did his work. Indeed, Quintanilla often performed different jobs for different production companies while being paid by the same payroll company. He was hired for more than 80 different jobs by production companies in 2009, but some of these production companies hired him for multiple jobs at different times throughout the year. The same was true in 2010…

We conclude that almost all these facts favor finding that Quintanilla was an independent contractor and not an employee. The most important is that Quintanilla had a large degree of control as to how to accomplish the tasks he had to do throughout the year.

That the petitioner provided his own tools was another factor in his favor. He had a risk of economic loss, another factor in his favor. The IRS tried to argue that he was employed by various payroll companies, and that was clearly not the case. The final argument that the IRS made was that the petitioner was a union member.

Quintanilla credibly explained that he and many of his peers in the industry join unions mainly to obtain health insurance and to a lesser extent to appear on call boards. His experience was typical–he was a member of a union and received his health insurance from it. That union required Quintanilla to show a minimum number of hours to receive this insurance. But neither the union contracts nor the production companies gave him vacation days or sick time. As Quintanilla credibly explained, if he wanted a vacation he would just not answer his phone. And the union contracts even excluded fixed wages and working conditions from their coverage–they expressly reserved the power of employees to cut better deals if they could. Quintanilla testified that all of his jobs came from personal connections and not one came from a union call board…

Quintanilla credibly testified that everything in Hollywood is a negotiation, and contracts are discussed daily. At times a studio even uses another studio’s stage if the price is lower than the rate for its own stage. Continual negotiations and ever-changing contracts are evidence that the studios didn’t intend to make a permanent relationship. Employers don’t negotiate with their employees daily.

So today’s petitioner, who represented himself in Tax Court, won that he was an independent contractor, not an employee. (The statutory employee issue wasn’t reached, as the petitioner won as an independent contractor.) He’s able to take his business expenses on Schedule C rather than Schedule A as he did on his tax returns.

This case was an example of a major issue in dealing with the IRS: substance versus form. I have an ongoing issue with a client who received an information return (a 1099) in error, but the IRS refuses to believe the client. All we can provide are negatives–there was no money paid to him in the year in issue. This case is going to head to Appeals soon, and we may prevail there (Appeals now looks at the chance of prevailing in Tax Court, and with information returns the burden of proof is on the IRS, and there’s no proof other than the erroneous 1099).

Here, had the IRS actually looked at what actually was happening with the petitioner, it should have realized what he was saying was true. Unfortunately, that’s a bit too much to ask for when dealing with the IRS today.

Case: Quintanilla v. Commissioner, T.C. Memo 2016-5

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Posted in Tax Court | Comments Closed

If a Professional Prepares Your Return, Are You Exempt from the Accuracy-Related Penalty?

Monday, December 14th, 2015

An attorney’s tax return had two major errors: $450,000 of gross receipts were left off the return and $505,417 of Contract Labor expenses were deducted as not only Contract Labor but also as Cost of Goods Sold. The return was audited, and the taxpayer agreed with the additional income and that the labor was double-deducted and pays the tax. However, he disputed the 20% accuracy-related penalty. The dispute ends up in Tax Court.

The amount of income underreported is enough where the penalty would apply if an exception doesn’t exist.

The section 6662 penalty does not apply to any portion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to * * * [it]…” Reasonable cause has been found when a taxpayer selects a competent tax adviser, supplies the adviser with all the relevant information, and consistent with ordinary business care and prudence, relies on the adviser’s professional judgment as to the taxpayer’s tax obligations.

Put simply, the Court didn’t believe that the attorney used sufficient care in reviewing his return.

Petitioners contend that they reasonably and in good faith relied on their C.P.A.’s advice in the preparation of their 2010 return. We disagree. On the basis of Mr. Ogden’s testimony at trial, we find that his cursory review of petitioners’ return did not constitute proper review…

A reasonable inspection of the return by petitioners would have uncovered both the unreported gross receipts and the improperly claimed deduction. Although petitioners’ C.P.A. [firm] testified that the portion of contract labor expenses treated as COGS on petitioners’ return was hard to spot, we believe Mr. Ogden had sufficient knowledge to detect the error on the return. Because Mr. Ogden prepared the Forms 1099-MISC for the attorneys at his firm, he should have known the total amount of contract labor expenses. Even so, the amount of contract labor expenses reported on petitioners’ return did not remotely match the amount of total contract labor expenses reported on Mr. Ogden’s law firm’s Form 1096. This, combined with the fact that petitioners did not report $450,000 of income on their return, shows that more diligence was needed on their part to reasonably assess their proper tax liability. [citations omitted]

There are a couple of lessons from this decision. First, have everyone you need at the trial. While the CPA who represented the taxpayer in the audit testified at the trial, the CPA who prepared the return did not. “Petitioners did not call the C.P.A. who prepared their 2010 return as a witness, and they presented no evidence that this C.P.A. gave “advice” that they could rely on.” This didn’t sit well with the Court.

More importantly, if you’re an attorney, a CPA, or an Enrolled Agent, the Tax Court is going to expect you to know tax law. You will also be held to a higher standard on any financial disputes. (The same will be true of other financial officers, such as a controller, CFO, etc.) When you’re reviewing a tax return, do not simply take a cursory look at the return. You should want to make sure it’s accurate. If you’re signing a return with $1 million of income, isn’t it worth more than a few seconds to review it? I would certainly think so. The Tax Court definitely did.

Case: Ogden v. Commissioner, T.C. Memo 2015-241

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Not a Pigg or a Turkey of a Decision

Monday, December 14th, 2015

Clarence Leland is an attorney in Mississippi. However, he bought a farm in Turkey, Texas. He entered into a crop share agreement with a Mr. Pigg. The farm didn’t make money, and Mr. Leland claimed the losses on his 2009 and 2010 tax returns stating he materially participated in the activity. The IRS didn’t allow the loss, claiming the passive activity rules prevented Mr. Leland from claiming the loss. They also added an accuracy-related penalties. The dispute made its way to Tax Court.

The passive activity rules prevent taxpayers from taking losses if they’re not materially participating in an activity. Mr. Leland didn’t maintain contemporaneous logs, but he was able to reconstruct logs that showed he worked 359.9 hours in 2009 and 209.5 hours in 2010. There was plenty of activity to be done on the farm:

Maintaining the 1,276-acre farm requires petitioner to perform a lot of long, hard work. Petitioner performs most of these tasks himself, but he sometimes has assistance from his son or a friend, Steve Coke. Aside from petitioner, Mr. Pigg, Mr. Coke, and petitioners’ son, no individuals perform any tasks on the farm. Petitioner visits the farm several times each year in order to perform necessary tasks, commuting approximately 13-16 hours each way, including the time it takes to load equipment onto his trailer. The farm has approximately 6-8 miles of perimeter roads and 18-20 miles of interior roads that must be bush hogged and disced regularly in order to remain passable. A Bush Hog is a device that is pulled behind a tractor to cut vegetation and clear land. Discing involves churning and plowing soil to uproot any existing vegetation. Trees and brush that grow near the roads must be controlled through spraying and chopping down limbs that protrude onto the roadways. Because high winds can erode soil on the roads, wheat must be planted each fall to prevent erosion on the roads and on acreage that is not part of the 130 acres planted and harvested by Mr. Pigg. Almost all of the roads have fences running parallel that must be maintained…In a year before the tax years 2009 and 2010, wild hogs ate 250,000 pounds of peanuts that petitioner and Mr. Pigg had grown on the farm. As a result, petitioner has to spend significant time controlling the wild hog population, which he accomplishes through hunting and trapping.

There are seven tests that allow one to qualify as materially participating in an activity, including “the individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.” Mr. Pigg spent about 30 hours on the farm in 2009 and a lesser amount in 2010.

Petitioner’s reconstructed logs, his receipts and invoices related to farm expenses, and his credible testimony are all reasonable means of calculating time spent on the farming activity during tax years 2009 and 2010…We are satisfied that petitioner’s participation was not less than the participation of any other individual, including Mr. Pigg, Mr. Coke, and petitioners’ son, during tax years 2009 and 2010…Accordingly, petitioner materially participated in the farming activity during tax years 2009 and 2010, and the deductions attributable to that activity are not limited by section 469.

From a footnote, we discover that the IRS objected to the logs was that they were not contemporaneous. But that’s not required:

Respondent’s main objection to petitioner’s reconstructed logs was that they were not prepared contemporaneously with the activity. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), does not require contemporaneous records, and we are satisfied that petitioner has established material participation through other reasonable means. Respondent did not dispute petitioner’s inclusion of travel time in his reconstructed logs. The facts of this case establish that petitioner’s travel time was integral to the operation of the farming activity rather than incidental.

So the decision is anything but a turkey for Mr. Leland, and the farming isn’t a passive activity. Mr. Leland also wins on the accuracy-related penalties, as the returns were accurate. It’s nice to see a plaintiff win at Tax Court on passive activities; I expect we’ll be seeing a lot more cases in this area in the future (because of the new net investment tax).

Case: Leland v. Commissioner, T.C. Memo 2015-240

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The 14th Time Wasn’t the Charm

Tuesday, November 24th, 2015

For most of us the saying “If you don’t succeed at first, try, try again,” is good advice. However, it’s not good to try to deduct personal expenses as business expenses on your tax return. It’s an especially bad idea to then try justifying that at Tax Court repeatedly. Of course, that happened today.

Petitioners are no strangers to this Court. This case constitutes, at the minimum, their 14th case, involving at least one of petitioners, spanning almost 30 taxable years from 1981 to 2010. Most recently they litigated the consolidated cases at docket Nos. 16195-12S, 26201-12S, and 1070-13S, which were decided by this Court’s T.C. Summary Opinion 2014-105. Those cases, like this one, addressed similar continuing issues arising primarily from petitioners’ efforts to substantiate and deduct expenses which they attribute to Mr. Boring’s Schedule C sole proprietorship d.b.a. Rambor Technology (Rambor) or his partnership Board Automation. The substantive tax disputes emanate from petitioners’ misunderstanding of the terms “ordinary” and “necessary” as used in defining deductible business expenses pursuant to section 162 and the interrelationship of that section with section 262, defining nondeductible personal expenses. [footnotes omitted]

The issues in this case were deducting expenses without backup, including what appear to be numerous personal expenses. In order to deduct business expenses, they must be both ordinary and necessary for the business.

An expense is ordinary for purposes of this section if it is normal or customary within a particular trade, business, or industry…An expense is necessary if it is appropriate and helpful for the development of the business…Section 262, in contrast, generally precludes deduction of “personal, living, or family expenses.”

The breadth of section 162(a) is tempered by the requirement that any amount reported as a business expense must be substantiated, and taxpayers are required to maintain records sufficient therefor.[citations omitted]

Put simply, almost all of the expenses that were deducted on the return were either nondeductible personal expenses or had no substantiation.

The Court goes through great detail in this case. The reason is that the Court doesn’t want to hear the 15th case dealing with the same issues.

We warn petitioners, however, that their conduct is in material noncompliance with Federal tax law. Our opinions here and in T.C. Summary Opinion 2014-105 are tailored to explain what the law requires. Petitioners have been fairly warned; consequently, any further conduct in the same vein as that considered here and in our previous cases addressing their tax liabilities and tax payments may well, under present law, result in the application of a section 6673 penalty in an amount of up to $25,000.

Section 6673 is the penalty for filing a frivolous Tax Court case. The Court ruled that the case wasn’t entirely frivolous because of one issue. On the tax return, the petitioners took the home office deduction (including mortgage interest). That deduction was denied, but the mortgage interest taken on the home office deduction should have been moved to be an itemized deduction on Schedule A. If not for that, the petitioners might not only owe the tax, penalties (they were hit with the accuracy-related penalty), and interest, but the frivolous penalty too. They somehow avoided the late filing penalty (this was noted in a footnote on the return), so they should consider themselves lucky.

Case: Boring v. Commissioner, T.C. Summary Opinion 2015-68

Posted in Tax Court | Comments Closed

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