Monday, April 12, 2021
Income tax (as well as other forms of taxes) has been an element of life for over a century in the United States. Tax issues seemingly permeate just about everything a person does and shapes one’s behavior. In today’s article I summarize several recent tax-related cases to illustrate my point of how pervasive tax issues are.
Tax issues in various contexts in recent court cases – it’s the topic of today’s post.
Taxpayer Unable to Establish Funds Used to Cover Expenses as Loans or Gifts
Oss v. Dep’t. of Revenue, No. TC-MD 190304N, 2020 Ore. Tax LEXIS 47 (Ore. T.C. Jul. 30, 2020)
An issue that presents itself more than we would like to admit is the proper characterization of financial assistance provided to a child by a parent or parents. The issue sometimes comes up when a parent dies without clear specification in a will or a trust of the nature of the transfer. This often flares up when other children are present, and their inheritance would be diminished if the transfer were considered to be a gift.
This matter came up in a recent Oregon case. In the case, the plaintiff operated a recreational marijuana business as a single-member limited liability company. The plaintiff’s business and personal expenses were largely cash-based. Under the cash accounting method, the plaintiff reported on his 2015 Schedule C: gross receipts of $1,153,466; cost of goods sold of $1,100,217; and gross income of $53,249. After reviewing the plaintiff’s 2015 tax return and analyzing the plaintiff’s gross receipts using an indirect analysis, the defendant determined the plaintiff had $1,144,181 in purchases and had substantiated $287,414 in nondeductible expenses, resulting in $1,431,595 in outgoing cash. As a result, the defendant increased the plaintiff’s 2015 gross receipts by $278,129, which was the amount outgoing cash exceeded the plaintiff’s gross receipts.
The plaintiff argued that the additional funds used to cover expenses were attributable to a combination of loans, gifts, and savings. Specifically, the plaintiff claimed that he received $120,000 from his father as a result of four nontaxable loans and $150,000 in nontaxable gifts from his grandfather over six years. The plaintiff also claimed to have built up a reserve of cash savings by spending less on living expenses than the defendant had determined in its indirect income analysis.
The state tax court noted that taxpayers are required to keep adequate records in order to determine their correct tax liability. The court determined that the plaintiff was unable to establish that he received a loan from his father, gifts from inheritance funds, or cash savings. The plaintiff only had a handwritten note from his father and no bank statements or testimony to establish the loans or gifts existed. The court also noted that the plaintiff likely understated his annual living expenses by relying on bankruptcy standards to estimate living expenses. As a result, the court held that the defendant had properly adjusted the plaintiff’s gross receipts for 2015.
Settlement Proceeds Are Taxable Income
Blum v. Comr., T.C. Memo. 2021-18
On this blog, I have published a couple of detailed articles on the tax treatment of court settlements and judgments. You may read those here:https://lawprofessors.typepad.com/agriculturallaw/2019/07/tax-treatment-of-settlements-and-court-judgments.html and here https://lawprofessors.typepad.com/agriculturallaw/2020/12/taxation-of-settlements-and-court-judgments.html The issue came up again in a recent case involving a lawsuit against a law firm for malpractice.
In the case, the petitioner was involved in a personal injury lawsuit and received a payment of $125,000 to settle a malpractice suit against her attorneys. She did not report the amount on her tax return for 2015 and the IRS determined a tax deficiency of $27,418, plus an accuracy-related penalty. The IRS later conceded the penalty, but maintained that the amount received was not on account of personal physical injuries or personal sickness under I.R.C. §104(a)(2). The Tax Court agreed with the IRS because the petitioner’s claims against the law firm did not involve any allegation that the firm’s conduct had caused her any physical injuries or sickness, but merely involved allegations that the firm had acted negligently in representing her against a hospital.
IRS Listing of Taxpayers With Significant Tax Debt Constitutional
Rowen v. Comr., 156 T.C. No. 8 (2021)
Currently, a push is being made in D.C. for an “infrastructure” bill. I guess the massive one in 2015 didn’t do the trick. The current proposal, just like the one in 2015, has a bunch of “stuff” in it that has little to nothing to do with infrastructure. In the 2015 legislation, one of those non-infrastructure provisions was an IRS “travel ban.” That “travel ban” provision came up in a recent case when a taxpayer claimed it was unconstitutional.
Section 32101, subsection (a) of the “Fixing America’s Surface Transportation” (FAST) Act created I.R.C. §7345 which authorizes the IRS to certify lists of seriously delinquent taxpayers to the Treasury Department that will then send those lists to the State Department for denial or revocation of a listed taxpayer’s passport. In the recent case, the petitioner had unpaid tax debt of nearly $500,000 and the IRS certified to the Treasury Department that the petitioner had a “seriously delinquent tax debt” within the meaning of I.R.C. §7345(b), giving the U.S. Secretary of State the ability to deny or revoke the petitioner’s passport. The petitioner sued for a determination that the certification was erroneous under I.R.C. §7345(e)(1) and moved for summary judgment on the basis that I.RC. §7345 violated the Due Process Clause of the Constitution and illegally infringed his right to travel internationally. The petitioner also claimed that I.R.C. §7345 violated his human rights under the Universal Declaration of Human Rights.
The Tax Court held that I.R.C. §7345 is not constitutionally defective because it doesn’t restrict the right to international travel and that the IRS was entitled to judgment as a matter of law. The Tax Court noted that all passport-related decisions are left to the Secretary of State and that the authority of the Secretary of State to revoke a passport doesn’t derive from I.R.C. §7345. The Tax Court noted that the constitutionality of the authority granted to the Secretary of State by FAST Act section 32101(e) was not an issue in the case and, therefore, the Court expressed no view on that issue.
Failure to Substantiate Eliminates Charitable Deduction
Chiarelli v. Comr., T.C. Memo. 2021-27
If there is one thing that is certain about tax law, it is that deductions are a matter of “legislative grace” and a taxpayer must be able to substantiate them if challenged. Recently, the U.S. Tax Court dealt with yet another case involving the substantiation of deductions.
Under the facts of this case, the petitioner made numerous charitable donations of clothing, furniture and antiques that he inherited. However, the petitioner didn’t maintain any proper receipts from the charitable donees, he didn’t keep reliable records in lieu of receipts. The petitioner also didn’t have contemporaneous written acknowledgements for his contributions exceeding $250, and didn’t satisfy the heightened record keeping and return statement requirements for contribution exceeding $5,000. Appraisals of the donated items didn’t account for the items’ physical condition and age, and didn’t include any mention of the appraiser’s qualifications or a statement that the each appraisal was prepared for income tax purposes. The petitioner also did not complete the appraisal summary on Form 8283.
The Tax Court rejected the petitioner’s substantial compliance argument noting that while the petitioner provided supplemental information, the supplemental information was also incomplete. The Tax Court also rejected the petitioner’s claim that he cured his defective submissions by responding to IRS's request for additional documentation within 90 days in accord with Treas. Reg. §1.170A-13(c)(4).
Conservation Easement Deduction Allowed for Donated Façade Easement
C.C.M. AM 2021-001 (Mar. 8, 2021)
Conservation easement deduction cases are everywhere. The IRS is all over taxpayers engaged in donating permanent conservation easement to a qualified charity and claiming a charitable deduction for the loss of value to their land caused by the easement. Recently the IRS put out more guidance on donated conservation easements in the form of a Memo from the IRS Chief Counsel’s Office.
The taxpayer in the Memo donated an easement on a building in a registered historic district on which the taxpayer had installed an accessibility ramp to comply with the Americans With Disabilities Act (ADA). The IRS determined that the installation of the ramp would not disqualify the taxpayer’s deduction. The IRS viewer the ramp as “upkeep” essential to the preservation of the structure. Such upkeep, if required to comply with the ADA, does not jeopardize the donor’s eligibility for a charitable deduction under I.R.C. §170(h)(4)(B) with respect to a building in a registered historic district.
The manner in which taxation impacts daily life is staggering. The cases discussed in today’s post illustrate just some of the ways that a taxpayer can get crosswise with the IRS. Take heed!