Sunday, December 4, 2011

IRS To Stop Lousing Up Short Sales

PMTA 2010-058

This was originally published on PAOO on November 29th, 2010.

For the latest on this see my follow-up post

When I was a kid, my father worked on Wall Street. He was a Senior Order Clerk. I'm not sure whether his job still exists. It was not particularly lucrative, but I got these insights into high finance through the jokes that he used to tell me. Most of them I didn't "get" until I was in my thirties. One of my favorites is the little ditty "He who sells what isn't hissen, buys it back or goes to prison." That was about short sales as the term relates to securities.

The term means something else in real estate. If a property has a fair market value lesser than the mortgage, the secured party might let the property be sold for an amount lesser than the mortgage. This avoids the need for foreclosure. The owner may or may not remain liable for the balance, the discharge of which may or may not be a taxable event. Such is not the topic of this post.

When I was buying a condo, I found that buying property on a short sale tended to be fraught with delay. You would think that the pressure to sell would create pressure to move things along, but the pressure is not sufficient to overcome bureaucratic inertia. Not surprisingly people who have trouble paying their mortgages frequently have trouble paying their taxes. So it is not unusual for a property with an upside down mortgage to have IRS liens against it. In order for the property to transfer the IRS must release its lien.

Typically the first mortgage will have been in place before the IRS filed its liens. So the value of the lien is the lesser of the tax obligation or the taxpayers equity in the property. In the case of a short sale the latter amount is 0. So the IRS should release its worthless lien and let life go on. That is not what has happened though. Even though the IRS is behind the first mortgage, they are, or at least, believe they are ahead of everybody else :

Applications for Discharge Which Include Requests for Payment of Real Estate Transfer Tax....In cases where a filed notice of federal tax lien has perfected the interest of the United States in such property, the Service is asked to issue a certificate of discharge of federal tax lien to allow payment of the state's claim at closing. It is the Service's position that such taxes have no priority status under I.R.C. §6323(b)(6) against the filed notice of federal tax lien. ... Priority of the federal tax lien is defined exclusively in I.R.C. §6323. Under no circumstances will a discharge of federal tax lien be issued for less than the full value of the Service's claim on the equity in the subject property. The transfer tax will not be accorded priority status or treated as an expense of sale. Applications that include such provisions will be rejected.

Under this interpretation, the taxpayer/property owner has to come up with the transfer taxes in order to move the transaction on.

PMTA 2010-058 finds the above interpretation to be erroneous:

We disagree with the conclusion that the designation by the senior lienholder of some of its proceeds to be used to pay real estate transfer taxes in connection with short sales of real property somehow creates an equity interest in the property on the part of the taxpayer. Rather, these are expenses that the senior lienholder agrees to carve out of its priority lien claim as a matter of business prudence in order to facilitate the sale. Because this does not create an equity interest on behalf of the taxpayer that is subject to the federal tax lien, the authority of the Service to issue a certificate of discharge is under section 6325(b)(2)(B), where the interest in the United States is valueless. The Service has no authority under section 6325(b)(2)(B) to require payment of the sum that otherwise would be applied to junior real estate transfer taxes as a condition of discharge. Because the interest of the United States is valueless, the result would be the same even if the senior lienholder was choosing to use a portion of its mortgage proceeds to pay a junior creditor of the taxpayer (such as payment of homeowner's association fees).

Essentially they are saying that the carve-out for transfer taxes is coming out of the banks secured interest and does not create some sort of equity that makes the IRS lien worth something. This document a letter to the director of collection policy (PMTA stands for Program Manager Technical Assistance) was dated September 17, 2010, but only recently came up on RIA. I haven't seen anything else on this so I am making this a bonus post in the interest of timeliness. If you are involved in a short sale that is hanging because of the IRS, it might be a useful reference.

The letter was sent to the Director of Collection Policy for Small Business/ Self Employed. It was copied to Special Counsel of the National Taxpayer Advocate Program, Assistant Division Counsel (SBSE) and Associate Area Counsels for Ft. Lauderdale and Jacksonville. So this may be a problem that is peculiar to Florida although the principle is of general interest.

In the comments below you will see feedback from Richard Zaretsky, an attorney specializing in short sales and related matters. He indicated to me that he has had shouting matches with the IRS on this issue. He has a blog dedicated to short sales. I've seen some misinformation on websites that would lead you to believe that an IRS lien will kill the possibility of a short sale. The relevant section of the Code is 6325(b)(2)(B) which indicates a lien with no value can be released and that in determining the lien's value other liens with priority will be taken into account.

Another Round of Miscellany

This was originally published on PAOO on November 29th, 2010.

Original source documents appear in RIA and beg to be shared with my vast readership, Repeatedly they are pulled up and labored on. Time passes and more interesting matters easily transform themselves into full length posts as the promising material slowly begins to wither. Finally it comes to the time to fish or get off the pot. (Pardon my love of deliberately mangling common expressions.) Here are some brief summaries of the posts that go to oblivion unless one of my readers demand that they get the full treatment :

FOUNDATION FOR HUMAN UNDERSTANDING v. U.S., Cite as 106 AFTR 2d 2010-5862, 08/16/2010

This was shaping into a maudlin reminiscence of my father who used to go though this sequence with his hands that started with "This is the church" and ended with "Look inside and see all the people" as he turned his hands over and wiggled his fingers. The point being that the Foundation For Human Understanding failed to qualify as a church, because it didn't have a regular group getting together to worship as a body. It gets into the 14 factors that make a church a church for income tax purposes. It's a little troubling that Jesus and the Apostles would probably have had a hard time passing the test.

UNITED ENERGY CORPORATION v. COMM., Cite as 106 AFTR 2d 2010-6056, 08/27/2010

I was going to title this "The Trouble with S Corps". Probably the biggest deficiency to the S corp form compared to that of partnerships (which includes most LLC's) is that the liabilities of the S corp are not allocated to the shareholders even if they have guaranteed them.

S corps.—income and losses—basis— loans—guarantees—economic outlay—S corp. indebtedness to shareholders. Tax Court decision that shareholders in S corp. and other entities weren't entitled for passthrough loss deduction purposes to increase their bases in S corp. by amount of any of its debt, other than by amount of shareholder ledger debts, was affirmed, based on Court's reasoning that other debt, comprising bank loans or loans with related entities, wasn't “indebtedness of S corp. to shareholders” within meaning of Code Sec. 1366(d)(1)(B) because shareholders made no actual economic outlay in respect to same.

Consolidated returns—interco. transactions and obligations—deemed satisfaction—transfers to controlled corps.—basis—gain—discharge of indebtedness—S corp. indebtedness. Tax Court supplemental decision that new corp. realized taxable gain as result of deemed satisfaction of affiliated S corp.'s shareholder ledger debts, when those debts were contributed to corp. in Code Sec. 351 transaction, was affirmed, based on Court's reasoning regarding operative reg regime/former Reg. §1.1502-13(g)(4) and finding that corp. acquired ledger debts with built-in gain.

MAES v. U.S., Cite as 106 AFTR 2d 2010-6752, 10/13/2010

In this case taxpayer tried to argue that amounts she had reported as alimony were actually disguised child support or alternatively a property settlement. The first argument was based on the fact that amount ran until the year that children turned 20. The agreement did not explicitly reference the children and other evidence argued for alimony. The second argument was based on the fact that agreement did not explicitly state that payments terminated in the event of her death. The requirement was, however, fulfilled because of state law provision which terminates support obligations on death. This case reinforces the point that it is important to have good tax advice in the structuring of alimony.

These two are tax nerd tests. If they seem at all interesting, you are a tax nerd. I sometimes get the impression that in the Chief Counsel's office they spend half their time being confused about TEFRA.

CCA 201034021
A partnership cannot have an affected item in itself. Each partnership year is a separate cause of action whose partnership items are not computationally affected by adjustments to other partnership years. Thus, an amortization for one year will not keep the statute open for other partnership years as “affected items“.
CCA 201033037
That's up to Exam. But its probably unnecessary since we would have to conduct a TEFRA partnership proceeding for any year in which they took excessive deductions to determine the amount, character and allocation of partnership debt, and whether it was guaranteed by each respective partner in that year. These determinations would then be binding for purposes of generating any affected item notices of deficiency limiting loss to basis or at risk for that particular year.

Well that leaves me with enough material to finish out the year. I should be confident that more good stuff will be coming, but you never know.

Smart Grid Experiment Participants Qualify For Income Exclusion

Private Letter Ruling 201046013, 11/19/2010

This was originally published on PAOO on November 27th, 2010.

This merits a brief bonus post. A utility company is engaging in a controlled experiment to determine the effectiveness of a variety of energy saving techniques. They are dividing the sample into four groups:

The first group will be the control group. They will have fixed rate electricity pricing and receive information from monthly electricity bills only. The second group will receive an Advanced Metering Infrastructure (“AMI”) meter. The AMI meter will give hourly electricity pricing and will provide web- based electricity consumption and pricing information. The third group will receive an AMI meter and a PV system. The PV system will allow the home to use electricity that it produces, not through the traditional electricity distribution grid. The forth group will have the AMI meter, the PV system, and a battery back-up energy storage for critical load panel. The panel will allow the home to produce energy with the PV system and store it for use at other times. The PV system and related property provided to customers will be owned wholly by them, and may give rise to increased value to customer's homes.

Under the most general rule of Code Section 61, the installation of the systems at no charge would constitute gross income to the homeowners and in addition to whatever else they were getting they would be receiving a 1099. Code Section 136, however, provides an income exclusion for energy conservation subsidies provided by public utilities. The ruling provides that this particular program qualifies so the participants will not have their sunny savings clouded by a tax bill.

Think Before Filing Joint Returns

Eileen L. Pugsley v. Commissioner, TC Memo 2010-255

This was originally published on PAOO on November 26th, 2010.

I've written before on not reflexively filing joint returns. This case may be a particularly good illustration of the point. It is also one of those stories that illustrates the point that tax problems are frequently the tip of the iceberg of more serious problems. Eileen Pugsley put up with a lot before she divorced her dentist husband, Daniel. She was asking the tax court if she has to put up with being saddled with 6 years worth of unpaid tax liabilities. The tax court indicated that she will.

Doctor Pugsley had been on a long slide due to alcoholism. In 2005, he lost his dental license, because of failure to fulfill his CPE requirement. He continued to practice without a license until 2007 when his practice was shut down by the Ohio State Dental Board. He continued dressing for work and leaving the house each day, but spent the day drinking.

Finally he entered a rehabilitation program. While he was there Mrs. Pugsley found unfiled joint tax returns for the years 1999 to 2003 in a dresser drawer. She called the family accountant who advised her to file them right away. Prior to filing the returns she applied for innocent spouse relief. The IRS turned her down because the returns hadn't been filed. Several months later the returns were filed. She applied again for innocent spouse relief and was denied again. The factors considered were as follow:

(1) is separated or divorced from the nonrequesting spouse,
(2) had knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability,
(3) would suffer economic hardship if relief were denied,
(4) complied with income tax laws in years after the year at issue,
(5) received significant economic benefit from the unpaid income tax liability,
(6) was abused by the nonrequesting spouse,
(7) was in poor health when signing the return or requesting relief,
(8) whether the nonrequesting spouse had a legal obligation to pay the outstanding

The first factor that she was divorced when filing with the tax court was the only factor in her favor. The second factor weighed against her since she should have known that her husband was not capable of paying the tax. The third factor weighed against her :

Petitioner receives $58,000 per year in salary, $1,500 in monthly spousal support, $484.17 in monthly marital asset payments and $240 per month for health insurance payments for her children. Petitioner testified that her monthly expenses are minimal. Petitioner has no dependents though she provides some financial support to her youngest child. Respondent determined that, based on petitioner's spousal support and salary, petitioner had monthly disposable income of $461 that could be applied to the tax liabilities.

The fourth factor also weighed against her :

Respondent's Appeals Office determined that petitioner was compliant with tax laws as of 2008. Petitioner failed, however, to report spousal alimony as taxable income after her separation agreement was executed in September 2009. She also claimed a $5,000 deduction for contributing to an IRA but failed to make the requisite contribution. She alleges to have filed an amended return only after the issue was brought to her attorney's attention, though no amended return was submitted into evidence.

She also lost on the fifth factor, although I have a little trouble understanding this one:

Petitioner spent $300 a month to belong to a tony athletic club and purchased a home for over $500,000. Petitioner also sent her children to expensive private colleges. The facts and circumstances presented strongly suggest that petitioner received a significant benefit from the failure to pay the tax liabilities. This factor also weighs against relief.

I mean what is so great about having Tony in your health club ?

The remaining factors were neutral. She tried to argue that Dr. Pugsley's financial irresponsibility constituted abuse, but that isn't the type of abuse they mean. The Court found his agreement under the divorce decree to pay the taxes of no account since he clearly couldn't pay them in full. He was paying the IRS $1,000 per month.

The final score was 1 favorable factor, 4 unfavorable and 3 neutral. So Mrs. Pugsley has to keep paying the IRS monthly on the debt her husband is responsible for according to the divorce decree.

I don't have all the facts, but I am going to go out on a limb here. I believe it is likely that the decision to file joint returns was a mistake. If I had gotten the panicked call from Mrs. Pugsley, I would certainly not have told her to just go ahead and file the returns. There is a good chance that I would have concluded that she should have sent in Married Filing Separate returns even if they were not required. (This is because a non-signing spouse can be deemed to have consented to a joint return, an issue I previously discussed.)

The problem is that there are really two fairly distinct areas of tax practice. The one that is most familiar and where I spend most of my time involves determining the correct tax and planning the legitimate ways of minimizing it. Included in this is elections such as the election to file a joint return. The other area is collection. In collection matters, the correct amount of the tax is often only of academic interest, if that. What is important in this area is how much they think they can get from you and whether you are acting like a good doobie. Presumably if Dr. Pugsley had filed separately his correct tax would be even higher. However, the benefit of joint filing reduced the tax to an amount that was still higher than what he could conceivably pay. There is a sense in which all tax amounts that can never be fully paid are equal. The joint filing created another source that IRS could collect from namely Mrs. Pugsley's post divorce salary.

It may be that I am being unfair to Mrs. Pugsley's advisers. They may have duly considered separate filing and rejected it for some reason that does not appear in the record of the case. I have practiced enough in this area to know, however, that the decision to file jointly is often made reflexively or is just viewed in terms of tax minimizing. Requesting innocent spouse relief on unfiled returns indicates that there was a fundamental misunderstanding of the two different systems.

Making A List And Checking It Twice

U.S. v. BRIER, Cite as 106 AFTR 2d 2010-5459, 11/05/2010
U.S. v. VAZQUEZ, Cite as 106 AFTR 2d 2010-6970, 11/08/2010

This was originally published on PAOO on November 21st, 2010.

There has been quite quite a bit in the tax blogosphere about the new registration requirements for tax preparers. I have not been weighing in on it. There is some grumbling about CPA's being exempt from the explicit continuing professional education requirements. Frankly, I think that enrolled agents don't get enough respect, so I really don't mind a few brick brats thrown our way. In our defense though I will say we have a 40 hour CPE requirement. My firm provides this to all staff whether they are licensed or not. Much to my chagrin, we are now specialized so tax people will have most of their CPE in tax (I agree with Robert Heinlein that specialization is for insects. On the other hand there wasn't as much to GAAP back in the good old days). I just paid my $64.50 and am awaiting my PTIN. I'm wild and crazy and reckless and figure that anybody who gets a hold of my client's returns is going to want to steal their identity rather than mine, so I never bothered with it before.

I'm talking about this now, because a fairly juicy case has come out. I'm sure some people will argue that it proves we need the new regulations and others will argue that it proves the IRS already has the tools it need. As with many of the things I choose to blog on, I mainly think it is a good story. I doubt there is much crossover between my blog readership and Mr. Brier's customers, but one never knows. They need to be on the alert and perhaps this post will serve as a heads up to some of them.

I don't think I'll ever get over my working stiff attitudes. It doesn't make much sense to over withhold and get yourself a big refund check. It really didn't make any sense at all back in the good old days when money earned interest (I'm sorry anything less than 4% does not deserve to be called interest). Nonetheless, I miss those days. Being a partner in a partnership, I have to make estimated payments and go on extension. I always wrap my first quarter estimate into my extension payment meaning my refund is always applied. The joy of awaiting that envelope in the mail is a thing of the past. Totally irrational financial planning, but it still had a certain satisfaction. One of my disciplines back then was to always put any check other than regular pay in savings. Which is why the attraction of refund anticipation loans totally escapes me.

Nonetheless they became a big business. Refund anticipation loans are a natural outgrowth of certain types of tax preparation businesses, once you get past the underlying financial irrationality. Somebody has, in effect, made a series of small non-interest bearing loans to the federal government. They then pay a usurious rate to get paid back a couple of weeks sooner. I think there is a sub-branch of microeconomics that studies phenomena like this. I'm sure it's not called stupinomics, but that would be a good name for it. Getting seriously into the refund anticipation loan business compounds a problem faced by preparers who are not working in the high end of the business. This problem can be illustrated by a little story.

One Easter I had just gotten off the phone with a client who needed to put together six figures to pay his extension payment. Next I went over my mother's return with her. She was very upset that she owed $150. Explaining to her that she would owe a lot more if she had been 50 and had a salary equal to the state pension and social security that she had received was fruitless. Probably when she was 50 she had gotten a refund. A balance due was a new experience for her. I solved my problem with this "client" quite elegantly. The following year I asked her if it would be OK if I put her return on extension. In her capacity as my mother, she had always had an exaggerated sense of how difficult my life was so she was fine with that. Along with the extension, which I being a CPA,could sign myself, I sent my own check for $300. So when I prepared the extended return there was a refund. I thought the strategy was pretty clever, but don't think you could make a business plan around it. Which brings us to Mr. Brier and Refunds Now Inc.

Mr. Brier started Refunds Now in 2001 preparing approximately 250 returns that year. In 2009 the count was in the vicinity of 8,000. He was hands on in preparing returns early in the business, but has shifted to marketing for the last several years. He seems to have found his niche, given the impressive growth. The court describes some difficulty he had finding himself as a financial professional:

Brier received his undergraduate degree from the University of Rochester and a master's degree in business administration from the University of Rhode Island. Brier began practicing as an accountant in 1987. Brier received his certification as a certified public accountant (“C.P.A.”) in 1991. That certification, however, was suspended in 1999, after Brier entered into a consent order with the State of Rhode Island Board of Accountancy (“Board”). In that consent order, Brier accepted the Board's findings of “unlawful practice of accounting, unlawful use and disclosure of confidential information, and dishonesty, fraud or negligence in the practice of accounting.” His certification has not been reinstated. Brier has also held the designation as a certified financial planner, however that credential was revoked. In June 2003, the IRS notified Brier that he was no longer eligible to practice before the IRS. In 2005, the Rhode Island Department of Business Regulation issued an order barring Brier from associating with a licensed broker/dealer or an investment advisor in the state of Rhode Island. That order was based on Brier's falsification of his application to apply for a license as a broker/dealer. In his application, Brier failed to disclose that his C.P.A. license had been suspended.

You screw up with one board and they're all out to get you. So it goes.

In 2007 the IRS began examining returns prepared by Refunds Now. At trial Agent Christine Stone testified that they found 309 returns where additional tax was due and 2 where the tax was overstated. This was from a sample of 350. You have to have a little perspective here. I imagine that if most returns I have signed were intensively audited, there would be some sort of adjustment if nothing else because of some sort of substantiation problem. We used to have a joke that if you got a no change on an audit that it meant you hadn't been aggressive enough, but the environment has changed. Returns that I sign tend to have a lot of moving parts to them and enough complexity that there will always be something debatable. Knock on wood,I've had mostly no changes the last few years. The "errors" on the Refund Now returns were of a different nature:

(1) the use of incorrect filing statuses to reduce tax liabilities and maximize the earned income tax credit;
(2) the failure to apply the tests to determine whether an individual qualified as a taxpayer's dependent;
(3) the fabrication or manipulation of Schedule C gross receipts for the purpose of maximizing the earned income tax credit or minimizing net taxable income subject to self-employment taxes;
(4) the fabrication or inflation of various Schedule A deductions, such as charitable contributions and/or employee business expenses; and
(5) the fabrication or manipulation of income and expenses on Schedule E.

On examining returns the IRS encountered people who had no idea how items such as charitable contributions ended up on their returns. They also found that returns prepared by Refunds Now were filed under the electronic ID's of other firms, because Refunds Now number had been suspended. There was a pattern of rapidly changing ID numbers. Mr. Brier indicated that this was to keep his competition from getting statistics on his various offices. The IRS and the court seem to have inferred other motives.

The bottom line of this decision is a preliminary injunction against Mr. Brier and several of his minions from preparing returns. More ominous for their clients is the following:

Defendants Michael Brier, Jeffrey Sroufe, Esther Santiago, and Refunds Now, Inc., individually, and doing business under the names RNTS, Inc., FTIRS, Inc., POTIRS, Inc., and IHIRS, Inc., or under any other name or using any other entity, are ordered to provide counsel for the United States, on or before December 15, 2010, a list of names, addresses, e-mail addresses, telephone numbers, and social security numbers of all clients for whom they prepared or helped prepare any tax-related documents, including claims for refunds or tax returns, since January 1, 2004.

They are not done with Mr. Brier. It will be interesting to see how this develops. There is a lot less detail to the case of Marie Vazquez who's operation may have been more modest than Mr. Brier's. She is agreeing that it would be better if she pursued a trade other than tax preparer and will be notifying her former clients of that conclusion. She will also be providing the IRS with a list.

Does Cohan Still Rule ?

This was originally published on PAOO on November 24th, 2010.


If you have been here before you might note that a case from 1930 does not quite qualify as a recent development. I was in Manhattan for a seminar, though, and one of my rituals is to visit the statue of George M. Cohan, the inspiration for the "Cohan rule". The Court gave an excellent rationale for the rule:

In the production of his plays Cohan was obliged to be free-handed in entertaining actors, employees,and, as he naively adds, dramatic critics. He had also to travel much, at times with his attorney. These expenses amounted to substantial sums, but he kept no account and probably could not have done so. At the trial before the Board he estimated that he had spent eleven thousand dollars in this fashion during the first six months of 1921, twenty-two thousand dollars, between July first, 1921, and June thirtieth, 1922, and as much for his following fiscal year, fifty-five thousand dollars in all. The Board refused to allow him any part of this, on the ground that it was impossible to tell how much he had in fact spent, in the absence of any items or details. The question is how far this refusal is justified, in view of the finding that he had spent much and that the sums were allowable expenses. Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making. But to allow nothing at all appears to us inconsistent with saying that something was spent. True, we do not know how many trips Cohan made, nor how large his entertainments were; yet there was obviously some basis for computation, if necessary by drawing upon the Board's personal estimates of the minimum of such expenses. The amount may be trivial and unsatisfactory, but there was basis for some allowance, and it was wrong to refuse any, even though it were the traveling expenses of a single trip. It is not fatal that the result will inevitably be speculative; many important decisions must be such. We think that the Board was in error as to this and must reconsider the evidence.

I have a special attachment to the Cohan rule, because I am the last person to become a partner in the firm of Joseph B. Cohan and Associates. As young staff when we learned about the Cohan rule we thought it had been named after Joe or perhaps his son Herb. Well it is possible that we had our own variation. Legislation and perhaps technology have eroded the Cohan rule. My visit to the shrine, though, made me want to see how the rule has done in the last year.

Constantine Sakkis, et al. v. Commissioner, TC Memo 2010-256

Both of these deductions are typical of the type of expenses usually incurred with rental property, and are subject to the Cohan rule allowing us to estimate. We must, however, have some basis upon which to make the estimate. Vanicek v. Commissioner, 85 T.C. 731, 742-43 (1985). There is nothing in this record to help us estimate these “triple-net” expenses, so we disallow them. For the interest expense, however, we have a copy of the all- inclusive note which indicates equal ownership of the property by the Sakkises and Tsakoyiases as well as repayment terms for the loan. We find Sakkis credible that the interest rate was kept at 10 percent after the first 10-year period. We therefore allow the entire $11,149.50 as a rental expense on Schedule E.

Sharon L. Griffin v. Commissioner, TC Memo 2010-252

Sharon Louise Griffin worked part time as a videotape operator and technician. But, if her returns are to be believed, she operated nine businesses in her spare time, grossing $2,876,957 during 2001-2003, but ending up in the red each year. She doesn't contest her receipt of income, but disputes the Commissioner's disallowance of her claimed expenses and other deductions.

We need not apply the Cohan rule at all if the evidence presented by the taxpayer is insufficient to identify the nature of or estimate the extent of the expense.

Keith J. Fessey v. Commissioner, TC Memo 2010-191

Section 274(d) overrides the Cohan rule with respect to section 280F(d)(4) “listed property” and thus specifically precludes the Court from allowing automobile expenses on the basis of any approximation or the taxpayer's uncorroborated testimony.

Myrtis Stewart v. Commissioner, TC Memo 2010-184
Taxpayer/longtime IRS examiner/real estate investor was denied claim to deduct as bad debt 2 years of mortgage payments she made on property that co-investor sold without her knowledge in year before those at issue: taxpayer, whose testimony and records were confused and unclear, didn't show that debt became worthless during years at issue, that she sustained some other loss on property, or what her basis was.

Neither the items' fair market values nor their bases can be determined from the record with any degree of certainty. Therefore, we cannot apply the Cohan rule to determine a reasonable allowance for the theft losses. Consequently, petitioner is not entitled to her claimed theft losses, and [pg. 1095] respondent's determinations in that respect are sustained.

Sandra L. Bennett v. Commissioner, TC Memo 2010-114

The documents Ms. Bennett did keep were largely insufficient—even under the Cohan rule, and all the more under section 274(d), where it applies—to substantiate most of the deductions she claims.

Theodore M. Green, et ux. v. Commissioner, TC Memo 2010-109

The record provides no satisfactory basis for estimating the amounts of petitioners' transportation costs that may have been used for trips to the doctor's office as opposed to the hair stylist. Consequently, the Court will not apply the Cohan rule to estimate the amounts of petitioners' transportation costs that may constitute medical expenses.

Mahmoud M. Soltan, et ux. v. Commissioner, TC Memo 2010-91

If a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount, we may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making (the “Cohan rule”). Cohan v. Commissioner, 39 F.2d 540, 543-544 [8 AFTR 10552] (2d Cir. 1930). The taxpayer must present sufficient evidence for the Court to form an estimate because without such a basis, any allowance would amount to “unguided largesse.” Williams v. United States, 245 F.2d 559, 560-561 [51 AFTR 594] (5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).

Section 165(a) allows a deduction for “any loss sustained during the taxable year and not compensated for by insurance or otherwise.” The Soltans have failed to substantiate the amount or character of any loss. Under these circumstances the Soltans are not entitled to a deduction under section 165(a). Accordingly, we allow no net operating loss deduction to either petitioner for any tax year at issue. We sustain the IRS's deficiency determinations in the notices of deficiency for all of the tax years at issue.

Philip A. Lehman, et ux. v. Commissioner, TC Memo 2010-74

Married couple was denied carryover deductions for NOLs husband purportedly sustained in connection with his tavern-restaurant: taxpayers didn't show that husband actually sustained NOLs in years stated or that such carried over to and were available in years at issue/ weren't absorbed in intervening years. Taxpayers' claims, that husband operated tavern at loss through certain years but that records regarding same were later destroyed by flood, and that as result, their deductions should be allowed pursuant to Cohan rule for estimating deductions despite missing records, were rejected; even Cohan rule required some basis for reasonably estimating taxpayers' claims, which basis was wholly lacking here given foregoing and that only things taxpayers submitted in support of their position were returns, which themselves couldn't establish losses, or self-serving testimony.

Kristine J. Wolfgram v. Commissioner, TC Memo 2010-69

Testimony alone, without corroborative evidence, does not satisfy the requirements of section 274(d), and thus the Cohan rule is inapplicable.

Edralin A. Pagarigan v. Commissioner, TC Summary Opinion 2010-167

An expenditure of $726 seems reasonable for completing a course of study. Nonetheless, the lack of substantiation and the inexactitude are of petitioner's own making. Therefore, to avoid unguided largesse, we hold that under the Cohan rule petitioner is entitled to deduct $363 for the course in 2005, which is one- half of the amount that she claimed

Kelly L. Madsen v. Commissioner, TC Summary Opinion 2010-151

Madsen provided the Court only with worksheets that listed the amounts of work clothes expenses; she did not include any receipts. Her worksheets fail to identify the particular type of each item of work clothing she purchased, and at trial she was able to identify only two items of work clothing as purchased during the tax years at issue. Her testimony thus did not clarify what the items of work clothing listed in the log actually were. But we find her worksheets contain reasonable figures for work clothes expenses and also find her records for the other expense items “more readily lending themselves to detailed record-keeping” to be reliable and accurate within the meaning of the regulation. Therefore, applying the Cohan rule as reflected in the regulation, we hold that she is entitled to a deduction for work clothes under section 162 in the amounts reflected on her worksheets, $797 for 2004 and $1,442 for 2005.

David R. Holland v. Commissioner, TC Summary Opinion 2010-132

At trial, petitioner succinctly set forth his position as well as his understanding of what this case is all about: *** I did run construction. I did have expenses. I don't have records of them expenses, but I did work this construction all year long, and I had the expenses. I don't know of any job that you have no expenses for. Just because I don't have the records of it is what this is all about.

Like petitioner, we are not aware of “any job that you have no expenses for.” But that truism does not abide, because a taxpayer is required to maintain records sufficient to substantiate deductions claimed by the taxpayer on his or her return

Although we found petitioner to be a credible individual, his testimony, standing alone, is no substitute for what section 274(d) demands. Thus, except for the allowance described in the immediately preceding paragraph, we are obliged to sustain respondent's determination disallowing the deduction claimed by petitioner for “Form 2106” and cellular phone expenses.

Expenses Subject to the Cohan Standard

Finally, the deduction in issue includes expenses for work gloves ($550) and safety boots ($150). Neither of these items is subject to strict substantiation; rather, both are subject to the more liberal Cohan standard.

Given petitioner's profession, we can well appreciate that safety boots are a necessity, as are work gloves. But while we understand that work gloves wear out or are misplaced and need to be replaced, $550 strikes us as a bit much, at least in the absence of any documentary evidence. Accordingly, without regard to the 2-percent floor on miscellaneous itemized deductions, see sec. 67(a), we allow $150 for safety boots and $300 for work gloves. See Cohan v. Commissioner, 39 F.2d at 543-544. Respondent's determination to the contrary is not sustained

Asif Hafeez v. Commissioner, TC Summary Opinion 2010-109

A passenger vehicle is listed property under section 280F(d)(4) subject to strict substantiation under section 274(d). The rule in Cohan does not apply to expenses relating to listed property, which generally includes any passenger automobile. Secs. 274(d)(4), 280F(d)(4)(A)(i); Sanford v. Commissioner, supra at 827-828; Seidel v. Commissioner, T.C. Memo. 2005-67 [TC Memo 2005-67]. However, the term “passenger automobile” does not include any vehicle used by the taxpayer directly in the trade or business of transporting persons for compensation or hire. Sec. 280F(d)(5)(B)(ii); sec. 1.280F-6(c)(3)(ii), Income Tax Regs. Therefore the town car that petitioner purchased is not listed property, and the expenses related thereto are subject to the Cohan rule.

Willie J. Moore, et ux. v. Commissioner, TC Summary Opinion 2010-102

I gave Mr. Moore the full treatment in a previous post. Suffice it to say he did not breathe new life into the Cohan rule.

Ian Menzies, et ux. v. Commissioner, TC Summary Opinion 2009-196

The Court believes petitioner incurred unreimbursed vehicle expenses related to his work for Porter and Titan during 2005. However, the Court may not estimate vehicle expenses under Cohan. See Sanford v. Commissioner, supra; Rodriguez v. Commissioner, T.C. Memo. 2009-22 [TC Memo 2009-22] (the strict substantiation requirement of section 274(d) precludes the Court and taxpayers from approximating expenses); sec. 1.274-5T(a), Temporary Income Tax Therefore, we must sustain respondent's Regs., supra. determination.

In Conclusion

The Cohan rule is not dead, but it is of limited use. Ironically, it is in the area that Cohan had difficulty with, travel and entertainment, that it is of no use. It's fine to give your regards to Broadway, but it would be wiser if you kept better records than the famous producer. Perhaps the photo below gives you a more complete picture:


Not surprisingly I'm not the first tax blogger to pay a tribute to George. Here is one done a little while ago by Robert Flach of The Wandering Tax Pro.

A Tisket A Tasket - Your Hedge Fund's in a Basket

AM 2010-005

This was originally published on PAOO on November 18th, 2010.

So today we get to introduce a new acronym. What is an "AM" you ask. Well it is Legal Advice Issued by Associate Chief Counsel. I suppose that doesn't explain the acronym. I'm going to guess Associate Memo. Regardless, it is one of those things that the IRS would just as soon keep to itself, but that you can get in RIA because of that nasty Freedom of Information Act. This particular one gives us advance notice that there is a very clever plan that the IRS does not like one little bit.

The taxpayer a partnership entered into an option to purchase a basket of securities. Nothing too exciting about that. Here is where it starts getting interesting. The basket is being held offshore. They don't give actual numbers, but for the sake of ease I'm going to say that the partnership put up $1,000,000 and a foreign bank put up $9,000,000. The foreign bank then bought the securities that are supposed to be in the basket. When the contract terminates the partnership is entitled to receive $1,000,000 plus the basket gain or less the basket loss. The gain or loss is inclusive of dividends, appreciation, depreciation, interest, expenses etc. If at any point the basket value goes below $9,000,000 the partnership is "knocked out".

Here is the really clever part. What is in the basket ? Whatever the general partner of the partnership says. So the basket is an actively traded portfolio. I would dearly love it if this thing actually worked because it would be a way to avoid having hedge fund K-1's that run into scores of pages. The portfolio manager decides on the amount of leverage transfers the appropriate amount to the foreign bank, issues trading instructions and nothing need be reported till the contract is settled up.

The associate chief counsel does not think that this thing is really an option :

..... it is clear that the Basket Contract, despite its option terminology, lacks the requisite characteristics of an option. In particular, two elements of the agreements between HF and FB are contrary to the typical functioning of an option: (a) the interplay between the Basket Contract's premium, Cash Settlement Amount, and Knock-Out provision, which imposed upon HF costs similar to an obligated buyer and preclude any possibility of lapse; and (b) HF's ability to alter the Reference Basket, through GP, while the Basket Contract remained open, which is inconsistent with the notion that an option on property must reference specific property at a defined price.

The partnership was deemed to be the owner of the "Reference Basket"

Upon application of the factors set forth by the authorities discussed above to the terms of the agreements between HF and FB, it is clear that HF should be treated as the tax owner of the Reference Basket because HF had: (a) opportunity for full trading gain and current income; (b) substantially all of the risk of loss related to the Reference Basket, and (c) complete dominion and control over the Reference Basket.

A memo from the Associate Chief is a long way from definite authority, but it is a head's up that this structure has a target stenciled on its back.