Tax Court Caselaw Update

Overview

It’s been a while since I did a post on tax developments from the Tax Court.  Today is the day to provide that update on some recent Tax Court decisions that bear on various aspects of taxation that impact tax planning and tax preparation.  I will do this again soon because there have been many important Tax Court decisions recently – too many to summarize in a single post.

An update of recent tax cases – it’s the topic of today’s post.

S Election Must Be Revoked To Be a C Corporation. 

Chan v. Comr., T.C. Memo. 2021-136

The petitioners operated a restaurant via their S corporation.  They failed to file tax returns for two years and didn’t report the business income on their personal returns.  The IRS audited, reconstructed their income using the bank deposits method and disallowed all expenses.  The petitioners claimed that they operated the restaurant via a C corporation.  The IRS rejected that claim, noting that the petitioners had not affirmatively revoked the S election.  The Tax Court upheld the IRS position with respect to the petitioners’ type of entity.  However, the Tax Court determined that material facts existed concerning other issues and gave the petitioners a chance to demonstrate the expenses associated with the business. 

Lesson:  Pay attention to the rules for forming as well as changing an entity type.  There are formal elections that must be made or revoked. 

Penalties Imposed on Donated Conservation Easement Transaction. 

Plateau Holdings, LLC, Waterfall Development Manager, LLC, Tax Matters Partner, T.C. Memo. 2021-133

The petitioner donated a conservation easement to a qualified charity and claimed a $25.5 million charitable donation deduction. The IRS challenged the valuation of the easement and its validity in an earlier decision, the Tax Court agreed, disallowed the deduction and imposed a 40 percent penalty for gross overvaluation of the easements.  In an earlier case, the Tax Court determined that the correct value of the easement donation was $2.7 million and imposed a 40 percent penalty for gross valuation misstatement, resulting in an additional tax of $9,103,120.  The Tax Court also disallowed the charitable deduction because the easements were not protected in perpetuity due to a provision in the deeds granting the easements to the charity that reduced the charity’s proportionate share of the sale proceeds by in impermissible carve-out for donor improvements upon a judicial extinguishment of the easements.  In the present case, the IRS sought an additional 20 percent penalty for negligence due to the petitioner’s substantial understatement of tax under I.R.C. §6662(a) and (b)(1)-(2).  The 20 percent penalty would apply to the portion of the underpayment resulting from the Tax Court’s decision in the prior case that the petitioner was not entitled to a charitable deduction.  The Tax Court did not allow the 20 percent accuracy-related penalty because the petitioner had reasonable cause and acted in good faith with respect to the claimed charitable deduction corresponding to the correct valuation of the easements. 

Lesson:  The IRS closely examines conservation easement donation transactions, but must clearly establish the elements for imposing a negligence penalty.  Precise deed drafting and good valuations are essential.    

IRS Properly Denied Installment Agreement

Roberts v. Comr., T.C. Memo. 2021-131

The IRS may consider a taxpayer as qualified for an installment agreement to pay an outstanding tax obligation upon the satisfaction of six requirements: 1) the taxpayer files any delinquent returns; 2) if applicable, the taxpayer files any outstanding employment tax returns; 3) if applicable, the taxpayer makes all current payroll tax deposits; 4) the taxpayer completes Form 433-B with the financial information (supported by documentation) needed to negotiate a payment arrangement to satisfy the delinquent taxes; 5) the taxpayer provided the financial information to the IRS agent working the case and requests and installment agreement in writing specifying the amount per month intended to be paid, the date the payments will begin and the tax periods the installment agreement covers; and 6) the taxpayer must comply with IRS deadlines for providing additional documentation or information.  In this case, the IRS denied the petitioner’s request for an installment agreement because the petitioner was not current on her Federal tax filings and didn’t supply financial information on Form 433-A.  The petitioner also didn’t provide the IRS with a specific proposal for the installment payments.  The Tax Court upheld the denial by the IRS.

Lesson:  If you are seeking an installment agreement payment plan with IRS, make sure to have your records in place along with a well-thought-out plan to present to the IRS. 

Company Founder Was Employee

REDI Foundation, Inc. v. Comr., T.C. Memo. 2022-34

The petitioner was formed in 1980 to serve as a vehicle for one of its officers to conduct seminars on real estate development.  The petitioner was granted I.R.C. §501(c)(3) status.  The officer in question also was a member of the petitioner’s board of directors.  The petitioner was inactive for almost all years from 1980 to 2010 and offered the officer’s seminars only in 1980 and 1990.  In 2010, the petitioner offered an online course to the public.  The office exercised complete control over the petitioner’s online course, often working 60 hours per week with the course and its students.  The petitioner’s sole source of income was derived from tuition associated with the online course, and the officer was paid by the petitioner based on enrollment from the course.  For the petitioner’s 2015 tax year, the petitioner reported total revenue of $255,605 on Form 990 and salaries, other compensation and employee benefits of $91,918.  The petitioner issued the officer a Form 1099-Misc. for the $91,918 and did not file Form 941 for any of the periods at issue.  No employer tax returns reporting payments to the officer as salary or wages were filed.  Upon audit, the IRS sought additional information concerning the treatment of the officer as an independent contractor, and information on whether the petitioner met the requirements for Section 530 employment tax relief.  In response, the petitioner claimed that the officer was never an employee and Section 530 relief was inapplicable.  IRS determined the officer to be an employee for employment tax purposes and that the petitioner was not entitled to Section 530 relief.  The IRS assessed employment tax liabilities and penalties under I.R.C. §6656.  The Tax Court agreed with the IRS, noting that the officer had a hand in every aspect of the petitioner’s business and that, as a result, his work as a corporate officer was more than minor.  In particular, the Tax Court pointed out that the only exception from employee status for a corporate officer is for an officer that performs only minor services and does not and is not entitled to receive remuneration for services.  The Tax Court noted that the officer provided services that constituted the corporation’s entire income and was paid for those services.  As such, the Tax Court concluded, it was a “fair inference” that he did so as an office and as a statutory employee.  The fact that he described what he paid himself as “royalties” did not make them so, and the Form 1099-Misc. that he issued to himself was self-serving.  As a statutory employee, Section 530 relief did not apply.  Penalties were also imposed for failure to file Form 941s and for failure to pay.  

Lesson:  You are an employee if you direct the business of the corporation and the corporation’s sole income comes from the services you provide. 

Value of Airline Tickets Included in Gross Income

Mihalik v. Comr., T.C. Memo. 2022-36

The petitioner is a retired airline pilot that participated in United Airline’s Retiree Pass Travel Program (RPTP). In 2016, United, through the RPTP, provided free airline tickets to the petitioner, his wife, daughter, and two adult relatives. The petitioner did not include the value of the free tickets two “enrolled friends” (likely relatives) in income on their 2016 tax return on the basis that it was a de minimis fringe benefit.   United Airlines issued Form 1099-Misc. to the petitioner for the relatives’ ticket values and the IRS determined that the value of the tickets provided to the two adult relatives was required to be included and issued a notice of deficiency containing an adjustment for the omitted income. Total tax due was $2,862.00.  The Tax Court agreed with the IRS’ position and granted summary judgment.  The Tax Court noted that the petitioner failed to allege any facts or legal argument to counter the IRS position.  The Tax Court determined that the value of the relatives’ tickets was not excludible under I.R.C. §132(a)(1) as a “no-additional-cost services” because the relatives were not the petitioner’s dependent children.  The tickets were also not excludible under I.R.C. §132(a)(4) as a “de minimis fringe” because the tickets had a value high enough that accounting for their provision was not unreasonable or administratively impracticable.

Lesson:  Some fringes are excludible (coffee; tea; doughnuts and pastries; soft drinks; local telephone calls; use of employer’s office equipment for occasional personal use, etc.) and some things are not (season tickets; employer-provided automobiles other than very limited use, etc).

Evidentiary Issues Sink Taxpayer 

Kohout v. Comr., T.C. Memo. 2022-37

The petitioners, a married couple, operated a medical funding and real estate business through a wholly-owned S corporation. Inc.  The husband was the sole shareholder.  On its 2013 Form 1120S, the S Corporation reported gross receipts of $1,829,524.  For the 2013 tax year, the IRS determined a $923,280 deficiency and accuracy-related penalties, under section I.R.C. §6662(a), in the amount of $184,676. The petitioners claimed that they overstated the S corporation’s gross receipts for the 2013 taxable year by $955,599, and that there was sufficient basis in one of the S corporation’s subsidiaries to deduct pro rata shares of a loss for the 2013 taxable year. None of the agreements related to the S corporation’s operations were presented to the IRS, and the record was void of any evidence of income that the S corporation received from the operations. The petitioner testified that he altered the QuickBooks computer files on multiple occasions after the S corporation returns were prepared, including during the IRS audit, and due to a computer crash, computer files for the S corporation and its subsidiaries were destroyed. However, the evidence did show that the S corporation made and received money transfers to and from its many disregarded subsidiaries, and those transfers—and evidence of the many bank accounts used by the S corporation for the transfers—were at issue.  But, the petitioners, after engaging an accountant to reconstruct the S corporation’s books, believed that the S corporation’s income was overstated when he signed and filed the S corporation’s return and their personal returns. The reconstruction expert prepared and sought to admit summaries of the S corporation’s bank statements, some of which were near 60 pages in length.  The Tax Court held the petitioners liable for $923,000.  They failed to prove they had overreported their income or that they were entitled to a deduction for pass-through losses.  The petitioners did not provide rental statements and invoices that would have corroborated the recalculation of their 2013 gross receipts.  The pass-through loss deduction was denied due to lack of proof of sufficient basis in the S corporation. 

Lesson:  Be careful with summarizing client tax information.  The Tax Court approves of summaries, but only if they comport with Rule 1006.  Under that rule, “[t]he proponent [of evidence] may use a summary, chart, or calculation to prove the content of voluminous writings, recordings, or photographs that cannot be conveniently examined in court.”  To comply with Rule 1006, a summary must be “an accurate compilation of the voluminous records sought to be summarized.”