Originally published on Passive Activities and Other Oxymorons on June 17th, 2011.
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Betty L Klebanoff v. Commissioner, TC Summary Opinion 2011-46
I've been going back and forth whether to make much of this one or not. Taxpayer entered into a business venture, whether as a partner or not is a little unclear. They received a $51,000 "draw" against profits that never materialized. When her return was due it wasn't clear what she was supposed to report so she didn't report anything. Then they gave her a K-1 which said she had received a guaranteed payment. The venture had by then fizzled. Soon after the IRS audited her. Her position was that the $51,000 was not reportable. IRS said it was ordinary income subject to SE tax.
The Tax Court ended up with short term capital gain - distribution from a partnership in excess of basis. Not only was there no SE tax, there was also no penalty, which I think was on the generous side :
Petitioner was aware that she received $51,000 in payments from Mirus during 2007. She did not understand the legal or technical ramifications of those payments. She made attempts to contact Mirus and Messrs. Buck and Colson, but she did not receive any response regarding the $51,000 in payments. Petitioner did not receive any notification from Mirus before her 2007 income tax return was due and was filed. At the time her 2007 income tax return was due and being filed in 2008, petitioner's lawyer was engaged in negotiations in an attempt to work out some settlement of her interest in Mirus. There was uncertainty about whether petitioner would receive additional amounts from Mirus and/or Messrs. Buck and Colson and as to the nature of the payments already received. Petitioner decided to wait and file an amended return for 2007 after she was able to better address the taxability of the $51,000 in payments.
The events that culminated in the filing of the first Mirus partnership return and petitioner's income tax return were followed in relatively short order by respondent's audit of petitioner's return and the issuance of a notice of deficiency. Petitioner consulted tax professionals who advised her and caused her to file an amended partnership return for Mirus reflecting that the $51,000 in payment was a draw and that Hospice and Rock were the partners of Mirus.
It was therefore reasonable for petitioner to take the position that the $51,000 was not taxable in her 2007 tax year. Under those circumstances, petitioner's actions were reasonable and she is not liable for an accuracy-related penalty.
I really don't see a defensible argument for not reporting the $51,000 somehow or other, but it was a confusing mess, so I'm glad she got a break on the penalty.
Tuwana J. Anthony v. Commissioner, TC Summary Opinion 2011-50
If you have a business that involves selling various items, inventory is likely to enter into your tax computations. You can't just deduct what you spent on the stuff from what you got paid for stuff in each year. You have to consider stuff that is bought in one year and sold in a different year. If you are talking about big items you might specifically identify them, but if its a lot of small stuff you need to take a short cut. The short cut is this. To figure your cost of goods sold you take the amount that you spent on stuff during the year ("purchases") and add the cost of stuff you had on hand at the beginning of the year "opening inventory". That is your cost of goods available for sale. To get your "cost of goods sold" (which is the number that you get to reduce your income by) you need to subtract the cost of stuff you didn't sell, "ending inventory". Getting that number can be a bit of production. It's one thing if you have an auto dealership with paper work on each vehicle from the factory. If you have a retail store with all sorts of little tchotchkes it can be more of a production. One way to approach it is to list out all the items with their selling prices and then reduce the total by your mark-up.
Ms. Anthony apparently forgot that last step. She was audited for 2004 and was able to convince the Tax Court that her ending inventory was overvalued because it was at retail selling price.
During settlement negotiations in docket No. 5791-07S, petitioner affirmatively raised, inter alia, the issue of whether the $41,097 reported ending inventory on petitioner's 2004 Federal income tax return should have been reported as $20,548. Specifically, petitioner took the position that she erroneously reported her 2004 ending inventory using her retail selling price—rather than her cost—for the inventory.
The 2004 case was settled in 2009. There was a little problem though. The incorrect 2004 closing inventory was used as the 2005 opening inventory. This could have been a gotcha on the IRS, since the statute was closed on 2005, but that is not the way it worked out:
In Tuwana J. Anthony v. Commissioner, Docket No. 5791- "07S”, based on representations made by you, the Tax Court made a determination that your ending inventory for 2004 was $20,548, instead of $41,097 as reported by you. Under section 1311, the same adjustment is required to be made to your beginning inventory for 2005. *** This results in an increase to your [2005] income of [$20,549]. On the basis of the above inventory adjustment and other adjustments that petitioner and respondent agreed to, respondent determined a $5,516 deficiency in petitioner's 2005 Federal income tax. Although the section 6501 3-year period of limitations for 2005 had expired at the time respondent issued the notice of deficiency on January 7, 2010, respondent relied on the mitigation provisions of sections 1311 through 1314 to issue the notice of deficiency to petitioner.
On the basis of the foregoing, we find that all requirements of the applicable mitigation provisions have been met and that respondent properly relied thereon in issuing petitioner the notice of deficiency for 2005. Petitioner's opening inventory for 2005 is reduced from $41,097 to $20,548 consistent with the adjustment made to her 2004 ending inventory.
Jose B. Magno, et al. v. Commissioner, TC Summary Opinion 2011-43
This was another case about the real estate trade or business exception to the passive activity loss rules. The taxpayer hadn't made the aggregation election and his testimony about time spent was not persuasive:
During the audit stage of this proceeding, Mr. Magno told respondent's revenue agent that he worked approximately 25 to 30 hours per week on his financial planning and services business. That conversation was documented in the revenue agent's notes, and the revenue agent testified credibly to its contents at trial. At trial, however, Mr. Magno testified that he worked principally as a financial consultant from January through August 2005. He also testified that he became a full-time manager of the first and second residences in 2006 and 2007 and that he reduced the number of hours which he devoted to his financial consulting services business to “about” 500 hours per year.
We credit the testimony of respondent's revenue agent and therefore conclude that Mr. Magno must have worked more than 1,250 hours during each subject year in real property trades or businesses to qualify as a real estate professional under section 469(c)(7)(B)(i). 6 Mr. Magno was not able to corroborate with written documentation his assertions that more than one-half of the personal services he performed in trades or businesses during the subject years were performed in real property trades or businesses. Accordingly, we find that Mr. Magno has not proven that he meets the requirements of section 469(c)(7)(B)(i).
I'm starting to find these cases a little tedious, but I'm going to continue to report on them.
Timothy O. Micek v. Commissioner, TC Summary Opinion 2011-45
In 1999 petitioner and Ms. Micek orally agreed that petitioner would help support Ms. Micek by paying her $1,250 every 2 weeks. To memorialize this agreement, on November 10, 1999, petitioner signed a spousal support affidavit, stating that he promised to pay Ms. Micek $1,250 biweekly via direct deposit. A notary public of the State of New Jersey notarized the spousal support affidavit. Throughout the years at issue, petitioner made payments to Ms. Micek pursuant to the spousal support affidavit.
While petitioner was making payments, he was diagnosed with multiple sclerosis and was forced to stop working. As a result, in 2003 petitioner stopped making the required payments. On April 21, 2003, petitioner's attorney received a letter from Ms. Micek's attorney inquiring why petitioner had terminated the “alimony/expense payments”.
The issue before us is whether the spousal support affidavit qualifies as a written separation instrument as defined by section 71(b)(2). The spousal support affidavit is a written instrument, signed by petitioner, promising to pay Ms. Micek $1,250 every 2 weeks. As discussed above, a separation instrument does not require a specific medium or form and does not have to be signed by both husband and wife. Further, even though Ms. Micek did not sign the spousal support affidavit, petitioner testified that he reached an oral agreement with Ms. Micek with respect to support payments during their separation. This meeting of the minds not only is memorialized by the spousal support affidavit, but also is supported by the letter from Ms. Micek's attorney received by petitioner's attorney on April 21, 2003, describing the payments she had been receiving from petitioner as alimony payments. Accordingly, the spousal support affidavit qualifies as a written separation instrument as defined by section 71(b)(2), and petitioner is entitled to his claimed alimony deductions for the years at issue.
It looks like the IRS may have been whipsawed by this decision. If not I would not like to be in the shoes of Ms. Micek's attorney since his use of the word "alimony" was an important element in the decision. He should have been aware of whether his client was reporting the payments as taxable income.
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