We’re on vacation for the next week. If something earth-shattering in the tax world happens while I’m relaxing, I’ll take time out to post on it. Otherwise, enjoy the fine bloggers listed in the blogroll on the right.
I’ll be back on Monday, August 2nd.
Last week I complained about the IRS taking more than 5 ½ months to process an amended return. Well, I may have some clarity now on IRS processing time and it ain’t pretty.
On February 4th clients of mine mailed their 2018 tax return to the IRS. This particular return could not be electronically filed. They mailed it certified mail. It took nearly a full month to get from Las Vegas to Ogden, Utah. On March 1st it was received.
And then nothing…until today.
The IRS shows the return was processed today, November 23rd. That’s more than 8 ½ months from the date it was received (and more than 9 months after it was sent). Yes, we’re dealing with Covid but this is really unacceptable. These clients have been waiting to set up a payment plan (installment agreement) but couldn’t because the return was “in limbo.”
Per IRS Commissioner Rettig, there are 1 million unprocessed tax returns, 6.8 million returns “in process,” and 3 million pieces of unopened mail. Or a child could be conceived and born faster than whatever it is you’re sending to the IRS is responded to.
So, what’s the solution? I honestly don’t see much improvement until next summer (when I think we’ll be able to put Covid in the rear-view mirror). Until that happens, it’s just going to be a slog.
Long-term, the IRS really needs to have its funding increased. The main IRS computer is older than I am (to give a hint of my age, I watched “The Play” in-person as a college student 38 years ago). The IRS is (as far as I know) the only place where money spent at the federal level brings back more money (Commissioner Rettig said that for every dollar spent, the IRS brings in $7). Let’s spend some money and move the IRS into the 21st Century!
Two marijuana dispensaries were audited by the IRS. Because of Internal Revenue Code § 280E (which prohibits all deductions for carrying on a business of trafficking in a controlled substance, which marijuana is), the first dispensary was looking at a tax bill of $1,129,276 with penalties of $225,855; the second was “only” faced with additional taxes of $531,707 and penalties of $106,341. The dispensaries received Notices of Deficiency, and they petitioned the Tax Court. The attorneys sent the petitions by Federal Express First Overnight. But they made mistakes:
The petitions were received, but the IRS filed motions to have them dismissed for “Lack of Jurisdiction.” This happens when you file late–the Tax Court is a court of limited jurisdiction, and you must follow the rules in order to have a case heard there. The IRS prevailed at the Tax Court (the case was dismissed for lack of jurisdiction), and the dispensaries appealed to the Ninth Circuit Court of Appeals.
In today’s ruling of the Ninth Circuit in Organic Cannabis Foundation, LLC v. Commissioner, the Court begins:
This unhappy case presents a cautionary tale about the need for lawyers to ensure that they have done exactly what is statutorily required to invoke a court’s jurisdiction. The unusual Internal Revenue Code (“I.R.C.”) provision at issue here allows taxpayers to benefit from a “mailbox” rule—i.e., that a document will be deemed filed when dispatched—only if the taxpayer uses one of the particular delivery services that the Internal Revenue Service (“IRS”) has specifically designated for that purpose in a published notice.
Read the rules! It’s not hard; the IRS maintains a list of such services. The attorneys used a faster service than what was then on the list. The problem is the plain language of the statute, as the Court notes:
Unlike Federal Rule of Appellate Procedure 25(a)(2)(ii), which applies a mailbox rule to the timely delivery of a brief to “a third-party commercial carrier,” § 7502 does not allow taxpayers to use the services of any bona fide commercial courier. Instead, the statute specifies that a particular “delivery service provided by a trade or business” will count as a “designated delivery service” only “if such service is designated by the Secretary for purposes of this section.” I.R.C. § 7502(f)(2). The term “Secretary” means “the Secretary of the Treasury or his delegate,” id. § 7701(a)(11)(B), and here that delegate is the Commissioner (or his further delegate). In addition to requiring a formal designation, the statute states that the IRS may designate a delivery service “only if [it] determines that such service” meets four enumerated statutory criteria designed to ensure that the delivery service is at least as adequate as the U.S. mail…
Congress did not merely require that a private delivery service meet certain functional criteria concerning the operation of that delivery service; it also pointedly insisted that the service must be “designated by the Secretary for purposes of this section.” I.R.C. § 7502(f)(2) (emphasis added). Given the wide range of documents that are eligible for § 7502(f)’s mailbox rule and the need for clear-cut rules on questions of timeliness, Congress understandably elected to establish a quality-control regime in which the IRS would vet each such service in advance and then issue bright-line designations as to which services are subject to the mailbox rule and which are not. The statutory language also makes clear that there must be separate designations for each “service” offered by a private courier—and not merely a designation of the courier itself—because § 7502(f) expressly distinguishes between the “trade or business” that engages in delivery of packages (e.g., FedEx) and the various “delivery service[s]” by which it does so (e.g., FedEx Priority Overnight).
So what can Organic Cannabis Foundation do? They can appeal this decision, though their chance of success is near zero. (They can try for either an en banc ruling of the Ninth Circuit or petition the Supreme Court.) They can pay the tax, file a claim for refund, and then after six months file a lawsuit in District Court. And given that every court that has looked at § 280E has come to the same conclusion (that Congress must act to change the law and that the IRS is correctly interpreting current law), their chance of success isn’t good. But that’s what they’re left with.
Sometimes faster isn’t better. Had the petitions been mailed certified mail at the post office, they would have been considered timely filed even if it took a month to reach the Tax Court. Had the petitions been sent with a slightly slower service (FedEx Priority Overnight), they would have been considered timely filed. Had they been sent three days earlier, they would have been received by the deadline and been timely filed. This is a Tax Court case where $1,993,179 is in dispute and the rules weren’t followed. Needless to say, it pays to follow the rules.
Hat Tip: How Appealing
When last we left the bankruptcy of Caesars Entertainment Operating Company (CEOC) (nearly four months ago), a complete reorganization wasn’t ruled out but Caesars was still in control of the bankruptcy. Over the last four months:
The principal question being investigated was whether in structuring and implementing these transactions assets were removed from CEOC to the detriment of CEOC and its creditors.
The simple answer to this question is “yes.” As a result, claims of varying strength arise out of these transactions for constructive fraudulent transfers, actual fraudulent transfers (based on intent to hinder or delay creditors) and breaches of fiduciary duty by CEOC directors and officers and CEC. Aiding and abetting breach of fiduciary duty claims, again of varying strength, exist against the Sponsors and certain of CEC’s directors. None of these claims involve criminal or common law fraud.
I am not an attorney, so my speculation is just that: speculation. That said, Caesars’ goal of creating a bad Caesars and a good Caesars and having just the bad Caesars go through Chapter 11 doesn’t look like a good bet to succeed.
Perhaps I should call this Bozo Tax Tip “Forming a California Trust.” Why? Let me explain.
Let’s assume John and Jane, two California residents, form a trust to benefit their children, Ann and Bob. Ann lives in Florida; Bob resides in California. The trust is an irrevocable trust, so it files its own tax return (a Form 1041). The income to the beneficiaries is reported on Schedule K-1s. Ann is surprised and calls her accountant when she receives both a federal K-1 and a California K-1.
The issue is simple: The trust is a California trust, so the income is California-source. California requires that a Schedule K-1 for Form 541 (California’s trust tax return) be included. Yes, Ann must pay California tax on the income. Ann’s CPA called me and asked me why I included the K-1 from California. My response was succinct: I have to and Ann has to pay the tax.
California’s desire to have anyone and everyone pay California tax has led to many trusts relocating to Nevada (which has no state income tax) and other trust-friendly states. California isn’t one of those states. Ann’s parents, John and Jane, could have formed the trust in Nevada but because they didn’t Ann is stuck in the Hotel California. You can check out any time but you can never leave.
Ignoring the California K-1 is a Bozo idea. Instead of just paying tax, you will get the joy of paying tax, penalties, and interest. If your parents are in California and thinking of forming a trust to benefit you, it may be worth your time to talk about Nevada to them. Otherwise, welcome to the Hotel California.
The Tax Court doesn’t like frivolous arguments by petitioners. Indeed, if you bring a frivolous argument to Tax Court you can be fined up to $25,000. But what happens when an attorney deliberately pushes a frivolous argument for his clients? That’s what the Tax Court had to decide today.
The underlying case was a collection matter relating to 1993 and 1994 taxes (there’s no typographical error there). The petitioners made two arguments, but the Court didn’t think much of them. As I wrote last year when this case first came to the Tax Court, the case itself wasn’t particularly interesting. But Judge Halpern didn’t like the delaying tactics used by the petitioners’ attorney. The Court then wondered if a sanction to the attorney was warranted.
We found substantial authority rebutting petitioners’ claim that Ms. Hernandez could not rely on computer transcripts to verify that their unpaid tax had been properly assessed. We stated: “Nothing in evidence indicates any irregularity in the assessment procedure that would raise a question that the assessments were not validly made in accordance with the requirements of section 301.6203-1, Proced. & Admin. Regs.”…
We likewise found substantial authority that respondent had satisfied his obligation under section 6203 to furnish petitioners with the records of assessments of their unpaid tax. We stated that the information in the account transcripts furnished to petitioners by Ms. Hernandez “constitutes all of ‘the pertinent parts of the assessment’, which, pursuant to section 301.6203-1, Proced. & Admin. Regs., on their request, respondent must furnish to them.”
The words “substantial authority” are key here. This means (to us laypeople) that the attorney should have known these were bad arguments, and shouldn’t have moved forward with them. The petitioners received a $5,000 penalty their frivolity. The petitioners’ attorney was told,
We contemplated levying excess costs on Mr. MacPherson for unreasonably and unnecessarily bringing and prolonging the proceedings. We said that we would accord him the opportunity to respond to that charge.
So what’s needed for such an award to occur:
Section 6673(a)(2) plainly imposes three prerequisites to an award of excess costs. First, the attorney or other practitioner (without distinction, attorney) must engage in “unreasonable and vexatious” conduct. Second, that “unreasonable and vexatious” conduct must be conduct that “multiplies the proceedings.” Finally, the dollar amount of the sanction must bear a financial nexus to the excess proceedings; i.e., the sanction may not exceed the costs, expenses, and attorneys’ fees reasonably incurred because of such conduct…The purpose of section 6673(a)(2) is to penalize an attorney for his misconduct in unreasonably and vexatiously multiplying the proceedings.
It gets worse for the attorney:
We have already found that petitioners’ assignments of error are frivolous and groundless and were raised primarily for delay…We believe that Mr. MacPherson intentionally abused the judicial process by bringing and continuing this case on behalf of petitioners knowing their claims to be without merit…
Moreover, as to petitioners’ remaining assignments of error, months before respondent made his motion for summary judgment respondent’s counsel put Mr. MacPherson on notice that respondent considered those arguments frivolous and contrary to established law. At Mr. MacPherson’s request, respondent’s counsel provided to him the authority on which counsel relied. And so Mr. MacPherson had further knowledge that his claims were without merit…
Mr. MacPherson further multiplied the proceedings and vexatiously impeded the resolution of this case by objecting to respondent’s motion for summary judgment on the grounds that there was a genuine dispute as to material facts and then, in less than a week, reversing course and suggesting that the parties submit the case to the Court fully stipulated under Rule 122 or make crossmotions for summary judgment…
Finally, we find Mr. MacPherson to have multiplied proceedings in his response to our order to show cause. He submitted over 400 pages purporting to support his claim that sanctions are not appropriate, but much of it consists of Mr. MacPherson’s persistence with arguments we have already told him are frivolous.
And the attorney, in the view of the Tax Court, violated American Bar Association rules that state, “A lawyer shall not bring or defend a proceeding, or assert or controvert an issue therein, unless there is a basis in law and fact for doing so that is not frivolous, which includes a good faith argument for an extension, modification or reversal of existing law.”
So the Tax Court took the number of hours worked by the two attorneys in the IRS Office of Chief Counsel by their hourly rates and came to $19,837.50. And he’s lucky with that number,
Mr. MacPherson knew or should have known that this case should never have been commenced. And for that reason, we are inclined to hold that Mr. MacPherson is liable for all of the time spent by respondent, not to mention time expended by the Court in processing and reviewing all of Mr. MacPherson’s submissions. [emphasis in original]
The only case I remember that an attorney committed alleged misconduct was where an attorney filed a probate action on his mother’s estate and then filed a Tax Court action on the same estate. He told the probate court he was waiting on the Tax Court; he told the Tax Court he was waiting on the probate court. He did this successfully for twelve years. The 13th time didn’t go so well.
The goal of Tax Court is to bring the two sides together. Sure, if the IRS has erred, and no satisfaction could be reached before Court, then Tax Court is absolutely appropriate. However, when an attorney brings a case with no legs to stand on and where he knows there are no legs to stand on the attorney has a problem.
A bit of humor to start the day. Courtesy of Spidell’s Tax Season Tribune, I discover that a video game has decided to emulate the Internal Revenue Service. Now, it’s been years since I played video games. Apparently the game Witcher 3 is quite successful. And in this game is the Deputy Tax Enumerator for Revenue and Customs for Occupied Temeria, Dorian Branch. Here’s a YouTube excerpt:
I’m going to start the new year with a few reposts of essential information. Yes, you do need to keep a mileage log:
Monday is the first business day of the new year for many. You may have resolved to keep good records this year (at least, we hope you have). Start with keeping an accurate, contemporaneous written mileage log (or use a smart phone app–with periodic sending of the information to yourself to prove that the log is contemporaneous).
Why, you ask? Because if you want to deduct all of your business mileage, you must do this! IRS regulations and Tax Court rulings require this. Written is defined as ink, so that means you need a paper log or must be able to prove your smart phone log is contemporaneous.
The first step is to go out to your car, and note the starting mileage for the new year. So go out to your car, and jot down that number (mine was 40,315). That should be the first entry in your mileage log. I use a small memo book for my mileage log; it conveniently fits in the center console of my car.
Here’s the other things you should do:
On the cover of your log, write “2016 Mileage Log for [Your Name].”
Each time you drive for business, note the date, the starting and ending mileage, where you went, and the business purpose. Let’s say you drive to meet a new client, and meet him at his business. The entry might look like:
1/5 40315-40350 Office-Acme Products (1234 Main St, Las Vegas)-Office,
Discuss requirements for preparing tax return, year-end journal entries
It takes just a few seconds to do this after each trip, and with the standard mileage rate being $0.54/mile, the 35 miles in this hypothetical trip would be worth a deduction of $19. That deduction does add up.
Some gotchas and questions:
1. Why not use a smartphone app? Actually, you can but the current regulations require you to also keep a written mileage log. You can transfer your computer app nightly to paper, and that way you can have the best of both worlds. Unfortunately, current regulations do not guarantee that a phone app will be accepted by the IRS in an audit.
That said, if you backup (or transfer) your phone app on a regular basis, and can then print out those backups, that should work. The regular backups should have identical historical information; the information can then be printed and will function as a written mileage log. I do need to point out that the Tax Court has not specifically looked at mileage logs maintained on a phone. A written mileage log (pen and paper) will be accepted; a phone app with backups should be accepted.
2. I have a second car that I use just for my business. I don’t need a mileage log. Wrong. First, IRS regulations require documentation for your business miles; an auditor will not accept that 100% of the mileage is for business–you must prove it. Second, there will always be non-business miles. When you drive your car in for service, that’s not business miles; when you fill it up with gasoline, that’s not necessarily business miles. I’ve represented taxpayers in examinations without a written mileage log; trust me, it goes far, far easier when you have one.
3. Why do I need to record the starting miles for the year? There are two reasons. First, the IRS requires you to note the total miles driven for the year. The easiest way is to note the mileage at the beginning of the year. Second, if you want to deduct your mileage using actual expenses (rather than the standard mileage deduction), the calculation involves taking a ratio of business miles to actual miles.
4. Can I use actual expenses? Yes. You would need to record all of your expenses for your car: gas, oil, maintenance, repairs, insurance, registration, lease fees (or interest and depreciation), etc., and the deduction is figured by taking the sum of your expenses and multiplying by the percentage use of your car for business (business mileage to total mileage driven). Note that once you start using actual expenses for your car, you generally must continue with actual expenses for the life of the car.
So start that mileage log today. And yes, your trip to the office supply store to buy a small memo pad is business miles that can be deducted.
My favorite Tax Court judge, Mark Holmes, is out with an opinion where Ghostbusters makes an appearance. And once again keeping records would win the day but perhaps that would take a supernatural effort from today’s petitioner.
David Laudon is a chiropractor licensed in Minnesota. He made nearly $290,000 in bank deposits from 2007 to 2009 yet reported only a bit less than $210,000 in gross receipts on his returns. He deducted as business expenses for his chiropractic home office a Microsoft Xbox 360, Nintendo Wii, and numerous pieces of hair-salon equipment. He also claimed deductions for driving tens of thousands of miles throughout Minnesota and the Dakotas–both to treat patients and to perform an assortment of other services. The Commissioner thought this was a stretch and urges us to support his adjustments.
This doesn’t look good, especially when I see the words,
Some of Laudon’s stated reasons for making these trips strain credibility: for example, driving to a “schizophrenic” patient who was–on more than one occasion–“running scared of demons” down a rural Minnesota highway, or driving to a patient’s home in a Minneapolis suburb– expensing 261 miles–because he had received a call from police that she had overdosed on OxyContin prescribed by her physician. Laudon claimed to have driven hundreds of miles per day–sometimes without a valid license–to see patients, but several of these trips were for medical procedures he was not licensed to perform. Even his testimony about multiple entries in the logs where he wrote “DUI” was not credible: He claimed that these were not references to being stopped by police while under the influence, or driving while his license was suspended, but instead were his misspellings of a patient named “Dewey”–a supposed patient of his. [emphasis in original]
That’s just a taste of the decision. I won’t go into the minutiae, but I think you’ve got a taste of what’s going on. The details include unreported income (“But because he didn’t produce any evidence verifying that these amounts were deposited into the relevant accounts, Laudon hasn’t met his burden of proof.”), an automobile log that was “‘not a complete itemized thing'” led to those deductions being denied, and a home office that wasn’t exclusive (“We particularly disbelieve his claim that the Xbox, Wii, big-screen TVs, and other electronics in his basement were used exclusively for chiropractic purposes since this claim conflicts with his much more plausible admission to the IRS examiner during audit that his daughter and his girlfriend’s son would play these video games while he was on the phone.”) and had no substantiation led to that being denied.
As I’ve said in the past, keep a mileage log. Keep records of your deductions. Ask your tax professional about the rules to have a home office. And keep good records.
There are two deadlines today. First, individuals outside the United States must make file their tax returns (or an extension) today. Second, today is the due date for second quarter estimated payments (both for individuals and corporations). These are both postmark deadlines, so as long as your estimated payment is posted today (and I strongly recommend certified mail, return receipt requested so you have proof), it’s considered timely.
