Taxable Talk

The Tax Court today looked at the case of a man who deducted in vitro fertilization (IVF) expenses. There was just a few problems: he wasn’t married, had no medical conditions, and the IRS objected.

So why did the petitioner want to deduct IVF expenses? And why did the IRS object?

“Petitioner argues that it was his civil right to reproduce, that he should have the freedom to choose the method of reproduction, and that it is sex discrimination to allow women but not men to choose how they will reproduce…“Although respondent believes that amounts paid for procedures to mitigate infertility may qualify as deductible medical care”, respondent argues that “Petitioner had no physical or mental defect or illness which prohibited him from procreating naturally”, as he in fact has, and that “the procedures were not medically indicated.” Respondent’s position is that the expenses at issue are nondeductible under section 262 because “Petitioner’s choice to undertake these procedures was an entirely personal/nonmedical decision.”

The court first examined whether the expenses were medical expenses or nondeductible personal expenses.

None of the expenses at issue was “incurred primarily for the prevention or alleviation of a physical or mental defect or illness.” Sec. 1.213-1(e)(1)(ii), Income Tax Regs. In other words, petitioner had no medical condition or defect, such as, for example, infertility, that required treatment or mitigation through IVF procedures.

The petitioner also alleged constitutional questions (discrimination) based on him being a man. He had used IVF to father children through unrelated surrogate mothers and alleged that to not allow him the ‘choice’ of doing so was discriminatory. The court’s conclusion answers that issue:

Although petitioner at times attempts to frame the deductibility of the relevant expenses as an issue of constitutional dimensions, under the facts and circumstances of his case, it does not rise to that level. Petitioner’s gender, marital status, and sexual orientation do not bear on whether he can deduct the expenses at issue. He cannot deduct those expenses because he has no medical condition or defect to which those expenses relate and because they did not affect a structure or function of his body. Expenses incurred in the absence of the requisite underlying medical condition or defect and that do not affect a structure or function of the taxpayer’s body are nondeductible personal expenses within the meaning of section 262.

Can a couple having trouble conceiving use IVF and deduct those expenses? If it’s medically indicated, almost certainly. Can a man deduct IVF just to have more children? No.

Case: Magdalin v. Commissioner, T.C. Memo 2008-293

No, not that Custer.

Earlier this month the Tax Court looked at the case of Richard Custer. Mr. Custer, a pilot, hadn’t filed his 2004 tax return. The IRS sent him a notice of deficiency. Mr. Custer then filed a petition with the Tax Court, “…containing numerous frivolous and groundless “tax defier” arguments.” And this wasn’t Mr. Custer’s first appearance before the Tax Court. As the IRS noted, “Petitioner has made frivolous arguments in a past Tax Court case and continues to maintain these arguments in the current case. In his previous Tax Court Case, Docket No. 21335-05L, the Court imposed a § 6673 penalty in the amount of $5,000.”

The Tax Court doesn’t look kindly at “…shopworn arguments characteristic of tax-protester/tax defier rhetoric that has been universally rejected by this and other courts.” And the court has a stick they can use against petitioners who make such arguments. “Section 6673(a)(1) authorizes this Court to penalize up to $25,000 a taxpayer who institutes or maintains a proceeding primarily for delay or pursues a position in this Court which is frivolous or groundless.” Mr. Custer was penalized $10,000 for his frivolity.

So if you think that you don’t have to pay the income tax it’s time to change your view. Those frivolous arguments aren’t worth the paper they’re printed on.

Case: Custer v. Commissioner, T.C. Memo 2008-266

Most of us have mortgages on our homes. Joe Kristan has an excellent write-up on a Tax Court case decided yesterday, where the petitioners had a mortgage, but:
– They recorded the mortgage the morning of the trial;
– They submitted a phony copy of the promissory note as evidence at their trial; and
– The note was full of typographical errors and didn’t appear to be truly notarized.

There’s lots more, and as Joe said, “If you want to deduct mortgage interest, get down to the county courthouse to record the mortgage when you make the loan; don’t wait until the Tax Court trial date.”

Sometimes when you deal with the government you get the runaround. Agency “A” will tell you need to talk with Agency “B” while Agency “B” says only Agency “A” can handle the problem. It’s enough to give you gray hair.

One enterprising (albeit Bozo) attorney had an interesting idea of how to apply this in reverse. He had just filed his mother’s estate into probate in King County (Seattle), Washington. He decided to file a Tax Court case on the estate, and tell the Probate Court there was a problem resolving the Tax Court case while telling the Tax Court there was a problem resolving the Probate Court case.

He did this quite successfully for twelve years. Unfortunately, he wasn’t so successful in the thirteenth year. The Tax Court caught on to his scheme and has sanctioned the attorney:

Mr. Allison’s education and legal experience, not to mention his admission to the Tax Court bar, underscore the egregiousness of his conduct. The issues in both cases before us are fairly simple and should have been resolved long ago. Instead, the cases before us have dragged on for over eight years, and the probate case has lingered for more than a decade. We therefore find that he used procedures of our Court primarily for delay, and in doing so was repeatedly dishonest. Mr. Allison’s persistence in the face of warnings from both courts thus warrants a penalty under section 6673(a)(2). That section requires a determination of the costs imposed on the Commissioner, and we will order the Commissioner to file evidence of what those costs were.

Because Mr. Allison is an attorney currently admitted to practice before the Tax Court, other sanctions may be appropriate. We will also send this opinion (and the order to show cause dated March 7, 2008) to the King County Superior Court for their consideration in In re Estate of Allison, No. 95-4-03740-0.

I guess the old saying, fool me once, shame on you, fool me twice, shame on me, needs to be lengthened.

Other Coverage: Roth Tax Updates, TaxProf Blog

Today the Tax Court looked at the case of a police officer who used an unnamed Bozo tax preparer. The officer didn’t have receipts, records, or other documentation to back-up his itemized deductions, yet the tax preparer put down lots of itemized deductions: “[P]etitioner claimed deductions totaling $26,829 comprising $13,737 in unreimbursed job-related expenses, $6,545 of charitable contributions, $3,023 of medical and dental expenses, and $3,494 of State and local income taxes.”

The Court did allow some of the deductions: deductions for dry cleaning of the uniform at $20/week, ammunition of $65, and state and local taxes of $3,494.

The Court did not allow deductions for black Nike boots (these could be worn while off work), private target practice (not proven to be “necessary and ordinary”), commuting (commuting is never deductible), parking (no receipts/back-up records), charitable contributions (no documentation), and medical expenses (he admitted he had no medical expenses). Given that the standard deduction of $4,750 was greater than the itemized deductions (they total $4,559), the IRS was the winner.

But that wasn’t all. The IRS asked for an accuracy-related penalty of 20%. The Court noted:

Petitioner contends that he is not liable for the penalty because he relied on erroneous expert advice given by his tax preparer. However, petitioner did not take reasonable steps to report the correct tax liability. Petitioner did not provide the preparer with any documents or receipts to substantiate any of his claimed deductions, nor did he scrutinize any of the figures that the preparer reported on the return. Further, petitioner failed to question any of the inflated figures. Thus, petitioner did not exercise the due care of a reasonable and ordinarily prudent person. The understatement is due to negligence within the meaning of section 6662(c), and petitioner is liable for the accuracy-related penalty under section 6662(a).

Whether you’re a policeman or an insurance agent, there’s one rule to live by when figuring your itemized deductions: document, document, and document. This cop didn’t, and he paid the price.

Case: Snead v. Commissioner, T.C. Summary 2008-57

We constantly hear “if you don’t succeed at first, try, try again.” Of course, if you’re a Bozo taxpayer, that should be changed to, “If you fail once, and you fail again, you’re probably going to fail a third time.”

Take the case of John Green. Mr. Green is in Tax Court for the third time. Back in 1993, he attempted (without success) to escape paying taxes on money he embezzled because he’s a Native American. As I’ve written before, illegal income is just as taxable as legal income. And Native Americans must pay taxes, too. Next, he fought a deficiency on his 2001 tax return claiming it wasn’t based on his 2001 return. Well, he never filed a 2001 tax return; the deficiency and the penalties were sustained. Today he reappears: “In this case, he challenges with hydraheaded interpretations of settled law the deficiencies which the Commissioner determined for his 1997, 1999, and 2000 tax years.”

I’ll start with Mr. Green’s arguments:

“Green now admits that his status as a tribal Potawatomi doesn’t relieve him of the obligation to pay income taxes. He does, however, argue that his “treaty-based return position disclosures” (we’ll call them the “disclosure” documents) were tax returns and so triggered the running of the statute of limitations. If that doesn’t work, he argues that the Commissioner is collaterally estopped from raising the issue of whether his disability-retirement pay is taxable. If that fails, he claims that his disability-retirement pay is nontaxable income under sections 104 and 105. If it isn’t, then he claims that the Commissioner should have included the lump-sum payments in his 1998 deficiency, not his 1997 deficiency. And, finally, he argues against the imposition of any penalties for any of the years at issue.”

The first issue is whether or not Mr. Green filed returns. The IRS contended that he didn’t file anything; however, Mr. Green had certified mail receipts. “Of course, this establishes only that Green filed his “disclosure” documents with the IRS Service Centers, and not that the documents were sufficient as tax returns to begin the running of the statute of limitations.”

However, the Court finds that Mr. Green’s documents weren’t returns, that they weren’t signed under the full penalty of perjury (Mr. Green modified the language), and he didn’t provide enough data for the IRS to calculate his tax liability. There’s a fourth test, but the Court notes, “We are leery of finding ourselves in this titanomachy. And we can scurry away from the dispute till another day. Green submitted self-made documents that did not objectively permit the assessment of his tax liability…Enough–Green wasn’t being honest or reasonable” The Court found that there is no statute of limitations because the returns weren’t filed.

Next, Mr. Green uses a collateral estoppel argument. “We’re not biting–the test remains whether the issue was actually litigated and necessary to the judgment. And whether tagged “abandonment” or “concession”, the Commissioner’s decision for the 1993 tax year doesn’t estop him from contesting the exclusion of Green’s disability-retirement pay from his taxable income in this case.”

Next, Mr. Green argues that his disability pay is exempt from tax. He argues that sections 104 or 105 exempt his disability pay. You’ll have to read the case to see that each of his arguments is demolished by the Court—his disability income is taxable.

Finally, Mr. Green argues that the doctrine of “Constructive Receipt” means that the income is not taxable to him in the years in dispute. Mr. Green was to receive $1 of $93,905 of disability pay; the other $93,904 was sent to pay child support and back taxes. The question the Court had to decide was when does constructive receipt occur?

“That occurred no later than December 16, 1997 in the OPM records–by that time, Green had filed the required paperwork and OPM recognized him as entitled to the money and reinstated him as eligible for future payments. It was Green himself who sent the court-ordered garnishment instructions to OPM, informing the agency that it should withhold part of his retroactive disability-retirement pay to satisfy his child support obligations.”

There is one last issue for the Court to decide:

“We therefore hold in this case that the Commissioner is right to allocate $93,304 to Green’s 1997 income. That leaves a bit of a puzzle as to the remaining $1…That suggests there might be another $1 check left over from the lumpsum payment. If such a check had also been sent to Green in January 1998, its taxability would be governed by the general rule that a check is treated as income when received. Kahler v. Commissioner, 18 T.C. 31, 34-35 (1952). But because we have no clear evidence as to when he received that possible $1 payment, we find that Green fails to meet his burden of proof that the $1 should be taxed in 1998, so he is taxable on $93,305 and not just $93,304, in 1997.”

So the third time definitely wasn’t the charm for Mr. Green. The Court ruled that he owes the taxes and penalties assessed.

Case: Green v. Commissioner, T.C. Memo 2008-130

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.

Case: Monk v. Commissioner, T.C. Memo 2008-64

Today the Tax Court looked at a case that showed what happens when you use a tax preparer who (a) doesn’t understand the software, (b) has little knowledge about your primary sources of income, and (c) has little tax knowledge. As you might expect the petitioners didn’t fare well.

Our petitioners had their return audited for 2002, and a deficiency resulted from disallowing “(1) $12,000 deducted as an other miscellaneous deduction for “home winterization” on Schedule A, Itemized Deductions, and (2) the following expenses claimed on Schedule E, Supplemental Income and Loss, for rental Property B (identified as an “apartment building” located at 8314 South Green Street):

• Advertising $350
• Auto and travel 4,500
• Cleaning and maintenance 3,000
• Repairs 12,000
• Supplies 900
• Utilities 3,000″

When the parties met for the pre-trial conference the petitioners’ accountant, when informed that it was required by the Tax Court that everything not in dispute be stipulated, made a remark that set the tone for the case: “Rules are made to be broken.” I’m sure the Court appreciated that.

Things didn’t get much better. “During the above meeting, [petitioner’s accountant] redefined the properties listed on petitioners’ Schedule E….” Why wasn’t this done before the audit? But I digress. These changes, which included one rental property included on the original return which shouldn’t have, and another property that wasn’t included suddenly appeared, resulted in additional deficiencies and an accuracy-related penalty:

“(1) Unreported rental income; (2) disallowance of five dependency exemption deductions; (3) unreported income from a State income tax refund; (4) disallowance, in total, of itemized Schedule A deductions for (a) medical and dental expenses, (b) real estate taxes, (c) personal property taxes, (d) home mortgage interest, (e) gifts to charity, and (f) unreimbursed employee business expenses; (5) disallowance in total of all Schedule E deductions; and (6) disallowance of rental and real estate loss because of passive activity loss limitations.”

As for the actual case, just a few lines from the decision note the most important point of all.

“Petitioners provided no receipts to substantiate any of the expenses claimed for either Property A or B. For example, [Petitioner] admits that they did not spend $350 to advertise either Property A or B for rent and that, in the case of Property A, no advertising of any kind was necessary since their daughter took possession of that property immediately after they moved to Property B. [Petitioner] acknowledged that $700 claimed for auto and travel expenses was arbitrarily arrived at. [Petitioner] testified that the $2,000 claimed for cleaning expenses for Property A was paid to clean out the basement of that property in anticipation of their move.

“Our examination of the record convinces us that petitioners failed to maintain any records whatsoever with respect to the items claimed on the Schedule E attached to their 2002 return. Moreover, [petitioner] and their tax preparer…admit that some of the figures claimed for deductions taken on their 2002 return, including all of their Schedule E deductions, were false and/or arbitrarily contrived.”

I could go on and on, but I think you get the flavor.

There are some morals to this story. First, not all tax preparers are equal. Obviously the petitioner’s tax preparer comes from the Bozo side of tax preparation. He was unlicensed, untrained, and, had little knowledge of the tax software he was using. That’s a problem with software—it will put the numbers exactly where you tell it to. As the cliche goes, garbage in, garbage out.

Second, get a tax preparer who understands your major areas of tax concern. For example, I had a potential client approach me about doing his return. I sent him to another professional I know because his return had a large amount of oil, gas, and mineral rights income, and that’s an area I don’t know well. He’s much better off going to someone who understands that well as it’s a specialized area. Sure, I could learn it, but he’d have to pay me to relearn the wheel, so to speak (and I have enough areas that I specialize in already).

Third, choose your preparer wisely. You are ultimately responsible for what’s on your tax return, not your accountant. As the Tax Court noted,

“We further conclude that petitioners have failed to show that their reliance on Mr. Ingram’s tax return preparation was reasonable. Mr. Ingram admitted that he was not an accountant, that he was unfamiliar with the computer software that he used to prepare petitioners’ return, that he had made many errors with respect to petitioners’ 2002 return, and that his rush to complete the return also resulted in errors. Petitioners’ reliance on Mr. Ingram as their tax return preparer was clearly unreasonable.”

And finally, keep your receipts! Today’s petitioners invented numbers out of thin air and got the results they deserved. If you have rental property, you’re supposed to treat it as a business. You can purchase a filing cabinet for under $100.

Case: Burkley v. Commissioner, T.C. Summary 2008-20