Taxable Talk

There’s a time to be a protester and there’s a time not to be. In Tax Court, it’s imperative you have legitimate arguments; you can pay a very high price for frivolity. Today’s petitioner learned that…perhaps.

The petitioner neglected to file tax returns from 1999 through 2007. (I suspect this might continue to future years at it does take some time for a case to get to trial at Tax Court.) He faced the Failure to File Penalty, the Failure to Pay Penalty, the Underpayment of Estimated Tax Penalty, and the Fraudulent Failure to File Penalty. That’s the first time I’ve ever seen a Fraudulent Failure to File Penalty. He timely filed a Tax Court petition.

The petitioner didn’t show up for trial, and something else I hadn’t seen before:

We hold petitioner in default. He has failed to comply with the Rules of the Court. He has not cooperated in the preparation of these cases for trial, he has failed to comply with Court orders, and he did not appear for trial. His responses are filled with tax-protester rhetoric. Such conduct provides ample basis for holding him in default.

So what is the Fraudulent Failure to File Penalty?

Section 6651(f) imposes an addition to tax of up to 75% of the amount of tax required to be shown on the return where the failure to file a Federal income tax return is due to fraud. “[R]espondent must prove by clear and convincing evidence that petitioner underpaid his income tax and that some part of the underpayment was due to fraud.” There is no question that petitioner’s failure to file a return for each of the years in issue resulted in underpayments for each year. To establish fraudulent intent, the Commissioner must prove that a taxpayer intended to evade a tax known or believed to be owed by conduct intended to conceal, mislead, or otherwise prevent the collection of tax. Not only do respondent’s averments show such intent, but petitioner is deemed to have admitted that his failure to file returns for the years in issue “was not due to mistake” and “was due to * * * [his] fraudulent intent to evade taxes”. We have adequate grounds on which to sustain respondent’s section 6651(f) additions to tax for all years in issue. [Internal citations omitted.]

All of the other penalties were upheld, too. Rubbing salt into the wounds the IRS asked for a penalty for filing a frivolous tax court petition.

Among his frivolous arguments, petitioner claims that he is not subject to Federal income tax, that the only persons required to pay Federal income tax are those people working directly for the Federal Government or the U.S. military, and that the Internal Revenue Code does not establish any liability for the payment of Federal income tax. A position maintained by a taxpayer is frivolous where it is “contrary to established law and unsupported by a reasoned, colorable argument for change in the law.”

But the Tax Court didn’t give him a penalty. Rather, there were two Tax Court cases filed, so the Court assessed two penalties of $25,000 each–the maximum–for wasting the court’s time. That’s also the first time I’ve ever seen that done.

A helpful hint to anyone considering preparing a frivolous Tax Court case: Don’t! Other than making tax bloggers laugh, you will find that Tax Court judges will have a somewhat different reaction…a reaction that could separate substantial sums of money from your wallet.

Case: Jones v. Commissioner, T.C. Memo 2014-101

The Tax Court had a routine decision today in a collection matter. The case itself (Best v. Commissioner) isn’t particularly interesting; the Court upheld the IRS’s collection efforts. It’s the last page and a half of the decision that caught my attention.

The petitioners in the case had filed a previous Tax Court case which they settled back in 2009.

We sustained substantial portions of the deficiencies in tax that respondent determined along with additions to tax for both failure to timely file a return and failure to timely pay tax and for failure to pay estimated tax. We entered decision in docket No. 22241-07 on January 2, 2009. Petitioners were represented in that case by their present counsel, Donald W. MacPherson.

The petitioners lost today, and they also were sanctioned $5,000 for frivolous arguments.

The interesting part is at the end of the decision.

Section 6673(a)(2)(A) empowers us to impose on a taxpayer’s counsel who multiplies the proceedings in any case unreasonably and vexatiously the excessive costs reasonably incurred on account of such conduct. We may sua sponte impose such costs. See Edwards v. Commissioner, T.C. Memo. 2002-169, aff’d, 119 Fed. Appx. 293 (D.C. Cir. 2005); Leach v. Commissioner, T.C. Memo. 1993-215.

As to what Judge Halpern saw that led him to this extreme, the opinion notes,

Although we have found petitioners deserving of a section 6673(a)(1) penalty, we believe that Mr. MacPherson’s conduct may be deserving of a sanction for unreasonably and unnecessarily bringing and prolonging these proceedings. Indeed, in his declaration in support of petitioners’ response to respondent’s motion to impose a sanction on petitioners, he acknowledges that, following the earlier deficiency proceeding in this case, petitioners “had a major collection problem and * * * I decided to try the assessment issue believing there is some chance of lack of proper assessment which will result in voiding the assessment and causing the clients to be free of the debt as a result of the statute of limitations”. He concedes, however: “I concluded many years ago that the ’23C issue’ was a ‘dead letter’ in so far as obtaining the 23C.”

The goal of the Tax Court is for the two sides, whenever possible, to settle their cases and to move expeditiously. The only time I can remember an attorney being sanctioned was when an attorney filed a pro se action in his mother’s estate. The Tax Court was not amused by what appeared to be delaying tactics of the probate case in King County (Washington) Superior Court and the Tax Court. In that previous case, the attorney filed a probate action in 1995; he filed a Tax Court action in 2000. Come 2008 and both actions were still ongoing. As I wrote back in 2008, the thirteenth time wasn’t the charm.

In this case, the Court sees an attorney take years on a collection matter, when he (the attorney) admits that his clients have a collection issue, and that the main issue being argued wouldn’t work. I do want to point out that the Court has not sanctioned the attorney today; he is being given an opportunity to show cause as why the Tax Court should not impose a sanction.

Case: Best v. Commissioner, T.C. Memo 2014-72

The cliche goes, if you don’t succeed at first, try, try again. Of course, where you and I would never go, the Bozo side of the tax world loves to venture. The Tax Court today got the chance to look at a two-time Tax Court loser. Would his third chance at Tax Court give a better result?

The first case was for the 1991 tax year. I’ll let the Tax Court describe the issue (the quote is from today’s ruling):

The principal issue arose from a dispute between petitioner and his brokerage house, which eventually liquidated his account by selling the securities in it. Petitioner failed to report on his 1991 tax return the capital gain realized on the sale of these securities, contending that his brokerage house had engaged in a “tortious conversion” of his account and that it, rather than he, was taxable on gains realized when the stock was sold. Golub I, 78 T.C.M. at 373. We determined that petitioner in effect was attempting to relitigate in this Court securities law claims that were subject to an arbitration proceeding in which he had refused to participate. See id. at 373, 378. We concluded that petitioner “received substantial amounts of income in 1991,” that he “failed to pay tax on those amounts,” and that “[h]is defense to that failure is frivolous and wholly without merit.” Id. at 378.

He lost, and also had to pay a $10,000 penalty for taking a frivolous position at Tax Court.

The second case involved an appeal of a Collections Due Process (CDP) hearing; the IRS was attempting to collect the tax debt from 1991.

The IRS Appeals Office sustained the tax lien, and we upheld that determination…We concluded that the IRS had followed all appropriate procedures in filing the notice of tax lien, and we specifically rejected petitioner’s argument that the IRS had “improperly offset his income tax refund for tax year 2004 against his outstanding tax liability for tax year 1991.” As we explained, section 6402 of the Code explicitly authorizes the IRS “to credit an overpayment to offset an outstanding income tax liability.”

On to the present. Here, the petitioner was having a problem with the IRS regarding 2008. He thought there was an overpayment of $24,627 (so he should receive a refund of that amount); the IRS thought he owed $17,373. The difference was $42,000 that allegedly was, “‘2008 estimated tax payments and amount applied from 2007 return.'” The matter went to another CDP hearing. I’ll let the Court describe that hearing:

Although petitioner’s position at the hearing was not entirely clear, he appeared to argue (once again) that the Tax Court decision sustaining deficiencies and penalties for 1991 was unconstitutional and should be vacated; that the IRS’ application to his 1991 tax liability of overpayments and credits from other tax years was thus erroneous; and that these overpayments and credits should have been applied instead to his tax liability for 2008. Petitioner failed to provide any evidence at the hearing that he had made quarterly estimated tax payments for 2008 or that the IRS had misapplied any overpayments or credits.

He lost at the CDP and appealed to Tax Court.

When you go to Tax Court, you need proof–evidence that the IRS erred. This could be arguing that the IRS is interpreting some part of the Tax Code or a regulation incorrectly. It could be that you have evidence showing payments made that the IRS refused to honor. It could be that the IRS’s position on a payment plan (installment agreement) or an offer in compromise is unreasonable. All those are good arguments at Tax Court. However:

We operate at a disadvantage in assessing petitioner’s arguments because the summary judgment papers he filed, some 90 pages in toto, are devoted almost exclusively to rehashing arguments about his 1991 tax liability and the legitimacy of this Court’s (long since final) decision sustaining the IRS determinations of deficiencies and penalties for that year. To discern from petitioner’s papers anything relevant to the actual controversy before us is to search for needles in a haystack. However, his position appears grounded on an assertion that the IRS improperly failed to credit his 2008 account with $42,000 in payments comprising “2008 estimated tax payments and amount applied from 2007 return,” as claimed on his 2008 Form 1040, line 63. Petitioner submitted no evidence, to the IRS or this Court, that he made any quarterly estimated tax payments toward his 2008 tax liability.

The Court goes on to note that the IRS is specifically authorized by both statute (the Tax Code) and regulations to offset overpayments and apply them to outstanding tax.

…[P]etitioner’s argument reduces to the contention that he has no 1991 tax liability because our decision sustaining the 1991 deficiencies and penalties was unconstitutional. This argument is frivolous. We accordingly grant summary judgment for respondent.

The Court then looked at whether the petitioner should get another penalty for being frivolous. Not only had he been sanctioned once previously by the Tax Court, “…[T]wo U.S. District Courts and the Court of Appeals for the Second Circuit had previously imposed sanctions against petitioner, prohibiting him from using their resources to advance frivolous attacks against his former brokerage house and other securities defendants.”

I think you know where this is headed:

Petitioner’s filings in this summary judgment proceeding consist mainly of incoherent verbiage that he has cut and pasted from previous filings in this and other courts…At the end of the day, petitioner’s position is that he has no tax liability for 1991 because the IRS and the judicial system have conspired to deprive him of his constitutional rights. That is a frivolous position that has been rejected repeatedly, and sanctions are once again appropriate.

We take petitioner at his word when he avers that he “will never cease” litigating his 1991 tax liability. He should understand, however, that this persistence will come at an ever-increasing price. We therefore impose a penalty in the amount of $15,000 under section 6673(a)(1).

I should point out (for the record) that not only did the IRS make a motion for summary judgment (which was granted), the petitioner had also done so. “We have also considered petitioner’s cross-motion for summary judgment. We find it wholly without merit and entirely frivolous….”

Case: Golub v. Commissioner, T.C. Memo 2013-196

I vaguely remember a video game with the character Leisure Suit Larry. I’ve never played video games (well, perhaps some online poker) so my knowledge of the games is minimal. From Wikipedia, we find that Larry is,

…though still somewhat lovable, …a balding, dorky, double entendre-speaking, leisure suit-wearing “loser” in his 40s. The games follow him as he spends much of his life trying (usually unsuccessfully) to seduce attractive women.

No, the makers of Leisure Suit Larry didn’t have Larry going through a federal courthouse looking for ladies. Instead, we have the former CFO of Sierra Entertainment (the creator of Leisure Suit Larry) heading to Tax Court on a case involving an airplane, grapes, lending, and lady’s clothing.

First, a word of warning. While I thoroughly enjoyed reading Judge Holmes’s decision, it is long. It runs 76 pages. That said, it is eminently readable by a layman.

Ed Heinbockel is the former CFO. After leaving Sierra Entertainment he ended up running a training simulation company (quite successfully). However, he also had some other businesses that weren’t as successful. He bought an airplane and rented it to others. He decided to add a vineyard near his home. There was a family loan that went bad. And his wife had a successful personal shopping business with plenty of deductions.

An issue that I’ve stressed over and over to my clients is to document, document, and document. If you have good records of your business expenses, an audit will usually go well. The Heinbockel’s didn’t (generally), and their audits for 2005 – 2007 didn’t go well. The case ended up in Tax Court.

Airplanes are expensive. One way of making them less expensive is to rent them out when you’re not using them. However, a key is to keep records of expenses. Additionally, it helps in a court case if the loan when you’re buying the plane doesn’t have the reason for the purchase stamped as “personal.”

Unfortunately for the petitioner, he didn’t keep good records. He didn’t run the operation in a business-like manner. In fact, when the Court looked at the factors (to see if the activity was run for profit), all of them weighed against the activity being for profit.

Next was a lending activity. However, it really wasn’t according to the Court.

They provided no books or records, showed no separate accounts, and proved no active solicitation of business…We find instead an ordinary family deal: They loaned Lydia’s brother money when he said he needed some.

However, the Heinbockels do get to deduct the proven amount of legal fees they incurred in recovering the bad debt as a miscellaneous itemized deduction (so on this issue it wasn’t a total loss).

The Heinbockels looked at starting a vineyard. Unfortunately, the NIMBY crowd didn’t like the idea of a vineyard so the grapes were never planted. The problem for the petitioners was that since they never incurred income from the grapes, the expenses can’t be currently deducted. Instead, they’re start-up expenses that are deductible when the first dollar of income is taken in.

There’s an obvious issue here: What happens when there is never income?

Thus, all of the expenses the Commissioner has disallowed (including those for 2007 on which he had the burden of proof) should have been deferred under section 195 until an active trade or business began. And, since the Heinbockels sold the property in 2007 without ever beginning business, those costs should have been capitalized and added to the basis of the property for computing their gain or loss upon sale.

So the expenses will decrease their gain when they sold the land that they wanted to become a vineyard.

Finally, there was the personal shopping business. The first issue was that this was claimed on the tax returns as Mr. Heinbockel’s business rather than Mrs. Heinbockel’s. The Court rejected that:

With a business named Lydia’s World, it wouldn’t seem to be a stretch to conclude that this was, in fact, Lydia’s business. It certainly wasn’t Ed’s. Throughout trial, Lydia testified that this was her business. When asked to describe Lydia’s World, she described it as “my business;” and her testimony was threaded throughout with the first-person singular….

Then the case meandered into documenting expenses. Unfortunately, there was no written mileage log. The purported business trips had lots of elements of personal pleasure (e.g. a trip to Sea World).

The absence of contemporaneous logs combined with Lydia’s often inconsistent testimony, and the numerous occasions where these alleged business trips appeared to be draped with personal pleasure, cause us to find that none of the travel and meals and entertainment expenses met the business purpose requirement of section 274.

There’s also the records–or lack thereof. “The records for Lydia’s World rivaled Fibber McGee’s closet for their organization.” Luckily for the Heinbockel’s, the Court is allowed to use the Cohan rules for some items (such as Cost of Goods Sold); the court allowed 50% of gross sales. Elsewhere, they weren’t so lucky:

Even when they provided an invoice, the Heinbockels kept such incomplete and disorganized records as to ensure that we can’t tell whether those amounts were already allowed as deductions elsewhere. We therefore find that the Heinbockels have not met their burden to substantiate any deductions that the Commissioner didn’t already allow for 2005. And to the extent that the Heinbockels conceded amounts lower than those reported on Lydia’s World’s 2005 Schedule C, we accept those concessions.

The Heinbockels did win some other deductions for Lydia’s World where there were receipts and records.

The moral of the story is simple: Keep good records! If you have organized records, documenting your expenses, and you run your businesses in a business-like manner, not only will an audit likely go far better, but your Tax Court case (if you head to Tax Court) will go far better than Leisure Suit Larry’s day at Tax Court.

Case: Heinbockel v. Commissioner, T.C. Memo 2013-125