Let That Whistle Blow

Originally published on Passive Activities and Other Oxymorons on June 27th, 2011.
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CCA 201117033

The IRS is very careful about disclosing confidential information but if you insist that they correspond with you in prison, it's on you that the warden gets to see your tax troubles.  Chances are you are not a prime candidate for identity theft.

Subject: RE: ———————-You could continue to send mail to his home address, since it obviously is forwarded to his current “residence.” You could also ask him, in a letter, where he would prefer that you send mail to him. If he lists his current abode, then send it there. We can assume that he knows that some, if not all, of his mail is opened by the authorities. There would be no disclosure violation for using the address that he requests. ————————


COLEBROOK?EL v. IRS, Cite as 107 AFTR 2d 2011-XXXX

The Plaintiff, Noble Roderick Colebrook–El, alleges that Defendants, Internal Revenue Service's (“IRS”) and its agents, Debra Hurst and Beth Jones's, attempt to collect his federal tax debt violated his Constitutional rights, the Moroccan Treaty, and several other Acts of Congress. The factual allegations contained in the Complaint, titled “Affidavit and Petition and Injunction and Order of Protection,” are at times indiscernible and largely irrelevant to the issues in this case. Plaintiff appears to allege that the IRS, a federal “corporate” agency, lacks the requisite statutory authority to collect taxes from him due to his status as a United States citizen who is a Moor of Cherokee descent. Plaintiff owes $19,566.36 in unpaid taxes. Plaintiff seeks to enjoin the IRS from collecting the taxes owed, to have any and all levies lifted, and to be reimbursed for all court costs associated with this action.

It's always interesting to learn something new.  I thought that this protester was totally off the wall claiming tax exemption as a "Moor of Cherokee descent".  Silly me.  There is actually is such a group of people.  They are descendants of African Americans held as slaves by the Cherokees.  There is a fairly recent controversy about whether members of the group should be considered tribal members.  Here is something on that.  So this guy is no further off the wall than most protesters and sheds some light on a neglected area of American history.  He still has to pay taxes, though.

Murray S. Friedland v. Commissioner, TC Memo 2011-90 This is one of those cases that is interesting for the cautionary tale included in the story behind the story.  Mr. Friedland was appealing his denial of a Whistleblower award.

Petitioner, a CPA, submitted a Form 211, Application for Award for Original Information (whistleblower claim), to respondent's Whistleblower Office (Whistleblower Office) in September 2009 concerning alleged violations of the Internal Revenue Code. He alleged that Lawjoy Realty Corporation (Lawjoy) and 601 West 149th Street, Inc. (West 149th), both C corporations, failed to pay millions in Federal corporate income taxes by impermissibly treating real property sales as stock sales in a corporate liquidation. He asserts that the structure of the sales was a sham and solely motivated to evade income taxes. Petitioner appears to have been a shareholder of both Lawjoy and West 149th.

This adds a new wrinkle to tax planning.  Mr, Friedland was presumably a minority shareholder in these companies, since some of the tax burden would somehow come out of his share.  It happens that Mr. Friedland was unsuccessful, but the IRS did recently award 4.5 million to an accountant who turned in his employer. I find the whole concept extremely distasteful but I think that in planning transactions that are at all aggressive it would be wise to keep out of the loop anyone who is not ethically bound to non-disclosure.

Bruce A. Brown, et ux. v. Commissioner, TC Memo 2011-83

This is another sad life insurance story.  Although life insurance is often thought of in the context of estate taxes, it is really not different than any other asset when it comes to transfer taxes.  Good planning will structure it so that it is not owned by the decedent keeping the build up in value out of her estate.  Any appreciating asset owned outside an estate produces the same benefit.  The connection to estate taxes is that the policy provides liquidity at just the right moment.  Life insurance is a tax favored vehicle for income tax purposes though.  Any build-up in value is tax deferred and proceeds payable by reason of the death of the insured are not taxable income.  People figure out ways to use life insurance policies to create income tax problems for themselves though.  Usually it has to do with policy loans.  This was one of those cases.

In total Mr. Brown paid $44,205 in premiums: $11,999 by check, $28,532 by loans, and $3,674 by dividends.

Northwestern's Computation of Taxable Gain

Northwestern sent Mr. Brown a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 1099-R showed a gross distribution of $37,365.06 and a taxable amount of $29,093.30. The Form 1099-R described the $37,365.06 as “loans repaid at surrender” and described the $29,093.30 as “taxable amt. at surrender”.

According to Northwestern's calculations, the $29,093.30 taxable amount was equal to the policy's cash value of $37,365.06 minus what it called “net cost” of $8,271.76. Net cost was calculated as “total premiums” (the premiums paid by loans, $28,532; by checks, $11,999; and by dividends, $3,674) minus what Northwestern called “total dividends” (in which Northwestern included the $2,986.94 dividend payment to Mr. Brown in 2004, the $31,063.30 received by Mr. Brown on surrender of the paid-up additional insurance in 2004, and the $1,883 dividend payment to Mr. Brown in 2005).

Mr. Brown prepared the Browns' return, which did not report any income from terminating the life insurance contract. Before filing the return, he consulted Mrs. Brown about the Form 1099-R. They believed that Northwestern based its report that Mr. Brown had a $29,093.30 taxable gain on the theory that a debtor has a taxable gain when a creditor cancels a debt. They believed Northwestern was incorrect because Northwestern had not forgiven Mr. Brown's debt. Having concluded that Northwestern analyzed the termination of the policy incorrectly, the Browns made no further attempt to determine the proper tax treatment of the transaction.

Incidentally the Browns are both attorneys and Mrs. Brown has an LLM in taxation.

As I read the case the numbers get a little confusing.  It seems pretty clear that the Browns never actually received any money.  The problem was the interest:

The policy allowed Mr. Brown to borrow from Northwestern against the policy's cash value. The policy labeled these loans “premium loan[s]” if they were applied to policy premiums or “policy loan[s]” if they were used for anything else. Both types of loans accrued interest at an annual effective rate of 8 percent. If unpaid, the interest was capitalized, meaning Northwestern added accrued interest to principal. ........

 By 1997 the annual interest accrual exceeded the premium; by 2002, it was twice the premium.

The interest which was being paid with policy loans did not add to basis.  It was a non-deductible expense.  That is how you can use an insurance policy to manufacture phantom taxable income for your self.  As a counterfactual to this scenario it would be interesting to look at what it would have cost the Browns to have had a term life insurance policy of $100,000 for 23 years (Actually in the later years their net death benefit would have been less than $70,000).  My guess is that it would have been a bit less than the $12,000 of actual cash outlay they had on this policy.  Maybe half.  And there would have been no phantom income when they decided the policy wasn't needed anymore.

To add insult to injury, the Brown's got hit with an accuracy related penalty.