Thursday, June 28, 2018

Redstone Family Saga Writ Large In Favorable Tax Court Decision

This post was originally published on Forbes Oct 31, 2015

The Estate of Edward Redstone, brother of Viacom Chairman Sumner Redstone, received a favorable ruling from the Tax Court in its challenge of an IRS assertion of a gift tax deficiency.  The tax was $737,625 and an assertion of fraud or alternatively negligence and failure to file could have tacked on as much as $553,219, but the stakes were much higher.  Even without the penalties, by my somewhat rough computation, the interest on the tax would have been around $15.5 million.

As Abraham Lincoln said, you have to be careful about quotes cited on the internet but the one attributed to Albert Einstein that compound interest is the most powerful force in the universe, is something he should have said whether he did or not.  Interest on tax deficiencies has been compounding daily since 1982, nearly a decade after the gift tax return that the IRS claims Edward Redstone neglected was due for gifts made in 1972.

Family Business

Sumner Redstone, famously took his father's theater chain National Amusements to another level by investing in companies that produced content, coining the term "Content is king".  The Redstone family saga would probably make some great content.  It has elements of Greek tragedy about it, but there are other Forbes contributors who cover that sort of thing much better than I can.  This particular Tax Court decision relates to one of the elements of the family drama, the buyout of Edward from National Amusements.

The stock ownership of National Amusements was equal among the founding father, Mickey, and the two brothers.  That ownership went back to the company's founding in 1959.  While building the drive-in business Mickey's practice had been to have three corporations for each drive-in - one to own the real estate, one for the theater operation and one for the refreshments.

That sort of thing could save a lot of corporate income tax back in the day - meaning before the Tax Reform Act of 1969 forced corporations with common ownership to share one set of favorable tax attributes such as surtax exemptions or used property investment credit limitations among them.  The complicated structure created difficulties with financing, which is why the holding company was formed.

The various corporations had different ownership percentages.  If the holding company stock had been assigned based on book value in the subsidiaries the ownership would have worked out 47.88% Mickey, 26.49% Sumner and 25.63% Edward.  The stock was issued equally and the three stock certificates, each for 100 shares were kept in the company safe.  When it came to jobs there was a difference between Edward and Sumner.
Mickey gave Sumner, his elder son, the more public and glamorous job of working with movie studios and acquiring new theaters. Edward had principal responsibility for operational and back-office functions. His duties included maintaining existing properties and developing new properties.
Dad Made Him Do It

More drama.

Edward's son Michael has issues, that I would just as soon leave for others to discuss.  Mickey did not think Edward had handled things well, which created family tension.
About this time Edward began to feel marginalized, not only within his extended family, but also within the family business. He became dissatisfied with his role at NAI, with certain business decisions that Mickey and Sumner had made, and with what he regarded as a lack of respect for his views. He began to discuss, in general terms, the possibility that he might leave the family business. This possibility became more concrete when Sumner, without first discussing the matter with Edward, hired Jerry Swedrow to take over Edward's responsibilities for NAI operations. When Edward learned of this he became incensed. In June 1971 he abruptly quit the family business.
At this point the contribution discrepancy back in 1959 came into play.
Mickey and his attorneys also developed an argument that a portion of Edward's stock, though registered in his name, had actually been held since NAI's inception in an “oral trust” for the benefit of Edward's children. This argument built on the fact that Mickey in 1959 had contributed 48% of NAI's capital yet had received only 33.33% of its stock. In effect, Mickey contended that he had gratuitously accorded Edward more stock than he was entitled to, and that, to effectuate Mickey's intent in 1959, the “extra” shares should be regarded as being held in trust for Edward's children. Mickey initially insisted that at least half of Edward's shares were covered by this alleged oral trust.
The parties negotiated for six months in search of a resolution. They explored, without success, various options whereby Edward would remain in the business as an employee or consultant. Edward offered to sell his 100 shares back to NAI, and the parties explored various pricing scenarios under which this might occur. As the family patriarch, however, Mickey had most of the leverage, and he insisted that Edward acknowledge the existence of an oral trust for the benefit of Edward's children. Mickey's insistence on an oral trust was a “line in the sand” and a “deal breaker.”
Litigation commenced, but finally there was a settlement.  Edward was paid $5 million for 66 2/3rds of his 100 shares and agreed that the other 33 1/3rd were held in trust for his kids.  Edward's accountant did not think that a gift tax return was required, because there had been no donative intent.

Who's Gonna Know?

We used to have an expression at Joseph B Cohan and Associates - "old and cold".  The idea was that if something happened long enough ago, it was not going to be questioned.  So you would think that after 40 years the transfer of those shares to a trust would be "ancient and frozen", but apparently not as far as the IRS is concerned.   Edward died late in 2011, so perhaps it was diligence on the part of the estate tax auditor who would have been clued into the "oral trust" story because of messy litigation commenced in 2006 by Michael and trustees for trusts set up for Sumner's children Brent and Shari and Edward's children Michael and Ruth Ann.

Not A Gift

The Tax Court ruled that Edward's transfer of shares to a trust for his children in 1972 was not a gift as it satisfied the three requirements to be a transaction in the "ordinary course of business".  It was "bona fide":
Edward's agreement to release his claim to 33 1/3 shares of NAI stock represented a bona fide settlement of this dispute. Although Edward had a reasonable claim to all 100 shares registered in his name, Mickey had possession of these shares and refused to disgorge them, forcing Edward to commence litigation. The “oral trust” theory on which Mickey relied was evidently a theory in which he passionately believed. And it had some link to historical fact: at NAI's inception, Edward was listed as a registered owner of 33.33% of NAI's shares even though he had contributed only 25.6% of its assets.
It was "arms length":
All the elements of arm's-length bargaining existed here. There was a genuine controversy among Edward, Mickey, and Sumner; they were represented by and acted upon the advice of counsel; they engaged in adversarial negotiations for a protracted period; the compromise they reached was motivated by their desire to avoid the uncertainty and embarrassment of public litigation; and their settlement was incorporated in a judicial decree that terminated the lawsuits.
There was no "donative intent":
Edward's objective throughout the 1971-1972 dispute was to obtain for himself ownership of (or full payment for) the 100 NAI shares originally registered in his name. Mickey floated in late 1971 the concept that Edward had held a portion of these shares since 1959 in trust for his children. If Edward had been motivated by donative intent toward his children, he could have embraced Mickey's concept at once and resolved the dispute without the expense and family disharmony generated by filing two lawsuits. Edward filed these lawsuits because he refused to embrace the “oral trust” theory and wished to obtain possession, in his own name, of all 100 shares
 There May Be More

Sumner also has a Tax Court case in process related to 1972 gift tax.  There was an attempt to get the Tax Court to rule in his favor on a summary basis under the doctrine of laches, but the Tax Court ruled against that.  The IRS is pursuing Sumner for the same amount of gift tax that it was seeking from Edward.  Presumably when Edward transferred the 33 1/3 shares of stock to a trust for Michael and Ruth Ann, Sumner did the same to a trust for Brent and Shari.

I'm thinking that the Government will have an incentive to settle with Sumner, since some, although not all, of the arguments Edward's estate made should work for Sumner.

Other Coverage And Comments

Lew Taishoff  is suspending judgment on Edward's case, but he had done something on the interim decision in Sumner's case.
 On another topic, Peter Reilly, CPA, Forbes’ formidable blogger, asked if I had any comment on Estate of Edward S. Redstone, Deceased, Madeline M. Redstone, Executrix, 145 T. C. 11, filed 10/26/15. ....
Reflecting, it might just be that Edward’s favorable result might bail out Sumner as well, as IRS’s case depends upon various stock transfers being gifts, and Edward beat that one. But I’d need to see more facts before coming to that conclusion. And that’s why I’m reserving comment at this time.
Jack Townsend had a post about the case in a somewhat surprising place, his DOJ Tax Division Alumni Blog - with the title - Tax Division Alumnus in the Tax News.  The alumnus is none other than Sumner who did a stint with DOJ Tax  before joining the family business in 1954.  The stint at DOJ Tax is not even the most intriguing piece of Sumner's biography.  While still an undergraduate at Harvard, he was recruited by the Army to help break Japanese codes.

The Moral? First, there’s no gift to the thief who points a gun at you, and there’s no gift when you transfer shares because you have to.
Perhaps more importantly, gift tax can be assessed forever if you don’t file a gift tax return. If there is any question on whether a gift might have happened, or realistic risk that the IRS will challenge the amount of a gift, it’s wise to file a gift tax return even when it doesn’t appear gift tax is owed. Otherwise the statute of limitations never starts running, and you might be fighting a forty-years war with the tax man.
Joe's advice is sound, although I'm not sure it would have helped Edward, because I believe that zero liability gift tax returns did not start the statute running back in the day.
 Joe was kind enough to check my interest computation by running it through a program which I am too cheap to buy and confirmed that I was within a few thousand dollars.  If you have trouble wrapping your head around a three-quarter million deficiency generating $15.5 million in interest, you can try the following.

The pre-TEFRA simple interest which started at 6% and had gone as high as 20% in 1982 added about 87% to the tab.  The daily compounded rates since 1982 started out high - 16%.  The average rate over the 33 years since then has been about 7.5%.  Using the rule of 72 that will cause you to double not quite 4 times in 33 years.  That won't give you the answer I came up with after a couple of hours on excel or that Joe came up with because he spent maybe $150, I'm too cheap to lay out, but it will be in the general neighborhood.

There was a write-up on .  Taxnotes has something , but you have to remember what I said about how I am a cheapskate. has a fairly lengthy write-up by Dawn S. Markowitz.

My friend Matt Erskine, who has a boutique practice focusing on estate issues and unique assets wrote me:
In my opinion, the tax court is correct. The transfer of stock to the trust for the children is not a gift. The taxpayer met the standards for the exemption to the gift tax as in the due course of settlement of a business dispute. The father was not going to be able to get anything if he did not settle the dispute on the "oral trust" for his children. Looking at the totality of the transaction, it is apparent it is not a gift. 
This is a case where, again, the IRS is taking a highly technical approach of compliance with nuances of the code and blowing them up into fatal flaws when in fact they never had a case on the facts in the first place.
In terms of lessons learned, referring to the "oral trust" Matt's comment was:
This is an example of one of the greatest dangers, in fact the greatest danger, for a family controlled company - nothing is written down. 
Being in the movie business and all you would think the Redstones. would have been familiar with the remark attributed to Samuel Goldwyn - "A verbal contract isn't worth the paper it's written on."

My own closing comment is that even though there was a favorable result here, I don't think that it would be wise to attempt to do something like this on purpose.

IRS Commissioner Koskinen Impeachment Trial Would Be Historic

This post was originally published on Forbes Oct 28, 2015

Unless, like a sensible person, you have been shielding yourself from learning about developments in the interminable, never-ending IRS scandal, now on Day 902 by Tax Prof count, you are aware that impeachment articles against IRS Commissioner John Koskinen have been drawn up.

If the House votes to impeach Mr. Koskinen, he gets tried by the Senate. Two-thirds of the senators have to vote in favor for there to be a conviction.  The effect of conviction would be that Koskinen would be immediately fired and if they want to rub it in disqualified from ever holding federal office.  There is no appeal.

It's About The E-mails

Mr. Koskinen came into the IRS after what I call the "core scandal", delays and intrusive inquiries on tax-exempt application by Tea Party and similar groups. His "high crimes and misdemeanors" relate to IRS response to the investigation by the Committee on Oversight and Government Reform of the House of Representatives.  IRS employees in Martinsburg, West Virginia erased 422 backup tapes destroying as many as 24,000 Lois Lerner e-mails.  A couple of months later Mr. Koskinen testified that nothing had been destroyed.  He also testified that backup tapes from 2011 had been recycled.  Previously he had promised to provide all the Lois Lerner e-mails. He was slow in informing the Committee that there were problems with crashed hard drives and backup tapes.  Subsequently TIGTA investigators found more than 1,000 Lois Lerner e-mails that the IRS had missed in all its rooting around.  This video dramatizes it if you don't want to slog through the resolution.

Is John Koskinen Worried?

Most of what I know about the workings of large organizations comes from reading history and biography and reports from college classmates.  There was also this brief interlude in the "twilight" of my career where I was a managing director in a not-quite Big 4 firm.  Overall the impression I have is that the larger the organization the more it is dominated by people who are worried about their careers.  People who aren't worried about their careers can accomplish lot until they get fired.

Probably the best-known example of this principle is John Boyd, who is considered by some to be a military thinker on the level of Sun Tzu. He would tell young officers that they would come to a point in their career where they have to decide whether they want to be somebody or do something.
If you decide you want to do something, you may not get promoted and you may not get the good assignments and you certainly will not be a favorite of your superiors. But you won’t have to compromise yourself. You will be true to your friends and to yourself.
One of my classmates told me a story once.  He had been warned that a particular person had a lot of power.  So he asked what that person could conceivably do to him.  The answer was that he might have the power to see that he had to retire as a lieutenant colonel.  Trust me, that is not how you terrify somebody who grew up working class.

John Koskinen is 76 years old and is being threatened with losing his IRS job a couple of years early and "Oh the horror" of being ineligible for another government job.  I'm betting that the impeachment threat is not scaring him at all and that he took the IRS job to do something, rather than be somebody. Koskinen could have come into the IRS and thrown as many people under the bus as possible in order to look good, but he made a different choice. He said in an interview.
I was telling somebody earlier , my experience in organizational turnarounds is that people are never the problem. It’s the structure, the leadership, the resources you’re given. This is the best workforce I’ve ever been associated with at the front end of a start-up, and it’s because there’s a mission.

There have only been nineteen impeachments since the Constitution went into effect in 1789.  Three Presidents, a senator, fourteen judges and a Secretary of War. There have been seven acquittals.  The charges cover a range of behavior.  Have you ever heard the expression "sober as a judge"? Well Judge Mark Delahay, not so much.   He was impeached for being drunk on the bench and ended up resigning in 1873.  Judge West Hughes Humphreys was impeached for supporting the Confederacy.  He kept his job as a Confederate judge, until they, you know, lost the war. William Belknap, Secretary of War under Ulysses Grant is the only appointed executive branch official ever impeached.
A House of Representatives’ committee uncovered evidence supporting a pattern of corruption blatant even by the standards of the scandal-tarnished Grant administration. 
The trail of evidence extended back to 1870. In that year, Belknap’s luxury-loving first wife assisted a wheeler-dealer named Caleb Marsh by getting her husband to select one of Marsh’s associates to operate the lucrative military trading post at Fort Sill in Indian territory. Marsh’s promise of generous kick-backs prompted Secretary Belknap to make the appointment. Over the next five years, the associate funneled thousands of dollars to Marsh, who provided Belknap regular quarterly payments totaling over $20,000.
Interestingly, he had served as Iowa Collector of Revenue under Andrew Johnson.  He resigned before the House voted his impeachment but they went ahead anyway.  He was acquitted.

How Might Koskinen's Trial Play Out?

I'm thinking that the impeachment charge closest to that of Koskinen's would be the one against Andrew Johnson for violating the "Tenure in Office Act" by removing Edwin Stanton as Secretary of War.  Fundamentally, the dispute was probably more about Johnson being "in their face" with Radical Republicans.  Of course, those Radical Republicans had a very different set of concerns than the current batch.  They were kind of hoping the federal government might enforce civil rights legislation to protect the recently liberated African Americans.  Johnson not so much.

At any rate, I tend to think that the Koskinen impeachment might not play out that well for Republicans.  I could see Koskinen turning the tables on them in his defense in the Senate and making a case that Issa's committee never was interested in finding out what actually happened, but was mainly looking for stupid remarks by Lois Lerner that could be played up by Fox News.

According to my legal brain trust, the rules for the impeachment trial may be set by the Senate on a more or less ad hoc basis, since it does not come up that often, so it might be arranged to avoid discovery that Republicans would find embarrassing.

Other Coverage

Joe Kristan is a tax blogger with whom I feel very simpatico, as we were both working tax CPAs in regional firms. Joe still is, while I am sem-retired strving to be the first tax blogger to give up his day job entirely.  We differ a bit in our view of the Commissioner.  Even after Koskinen did us all a big solid by easing up the compliance requirements of the repair regs, Joe did not become a fan.  Even so, Joe does not think the impeachment is such a hot idea.
A resolution has been introduced to impeach IRS Commissioner Koskinen. While his conduct in office has been awful, I hope they don’t really try to make it happen. It could backfire, and even if he were impeached, there will never be a conviction. I would rather they spend the time and energy reducing the powers of all IRS commissioners by reducing the power of the IRS through tax reform.
I would further add that even if he is convicted - So what?
You will be able to find links to a wealth of commentary on the Tax Prof Blog - The IRS Scandal Day 902.. If you have been following this you will probably not be surprised to learn that Elijah Cummings does not think the impeachment proposal is such a good idea. "Calling this resolution a stunt or a joke would be insulting to stunts and jokes."

Interview With Student Loan Activist Alan Collinge On Bankruptcy Protection

This post was originally published on Forbes Oct 28, 2015

I recently wrote about an article by Professor Victoria Haneman concerning the interaction of student debt planning with joint income tax filing.  One of the things I discussed with her is a disturbing trend of schools coaching students to minimize their adjusted gross income in order to maximize the amount of their loan that will be forgiven if they stick with Income Based Repayment or similar programs.  That brought up the subject of the future debt bomb.

 When graduates complete their term in Income Based Repayment or something like it (twenty or twenty five years generally) the remaining debt is discharged.  Depending on what they have been doing, the discharge might be taxable as COD income.  If we think of someone who after getting a Ph.D. in history, toils for twenty years as an adjunct when not washing cars or waiting on tables, the amount of the discharge will be some multiple of the original debt, giving them a tax liability perhpaps as much as the original debt.  The program is new enough that this has not happened to anybody - yet.

Bankruptcy is a better a deal, becaue debt discharge income while bankrupt is excluded from taxable income.  But you can't get out of student debt through bankruptcy.  Or can you?  There have been murmurmings that it can be done.  I heard from Alan Collinge of Student Loan Justice.Org.  Alan argues that the chance of bankruptcy relief for people buried  under student debt remains remote, and that the murumurrers may be consultants who are engaging in bait and switch.

Peter J Reilly:   So Alan,is bankruptcy relief becoming more available for student loans?

Alan Collinge: In recent months, a false impression has been sewn in the mainstream media about student loans being dischargeable in bankruptcy. These articles, usually written by debt "coaches", credit counselors, and others with suspicious motives, cite statistics showing that 40-50% of people who attempt to get their student loans discharged win relief. These articles usually are accompanied by a litany of advertisements for the services that these people render. But when looking more closely at the statistics being thrown around, it becomes obvious that most of these articles are selling false hope to distressed borrowers, and that bankruptcy for student loans is impossible for the vast majority.

Reilly: How are they selling false hope?

CollingeIn these articles, one of the more frequently cited papers is from Jason Juliano (Harvard University Law School).  Juliano found that about 40% of people attempting to get their student loans discharged in 2007 actually got some level of relief (either a partial or full discharge of the debt.  Steve Rhode, a debt coach and blogger at the Huffington post claims that this has risen to 58% according to his own research

Reilly: Well that sounds promising, Right?

Collinge: Wrong. First of all, Juliano's 2007 study could only find 213 cases where people actually tried to get a discharge for their loans. 213 people, compared to about 35 million student borrowers at the time. This is a ridiculously small sample size. But it gets worse. Rhode could only find 35 attempts to get student loans discharged in 2012 out of more than 40 million borrowers. If the first study's sample was ridiculously small, the sample Rhode used was nearly non-existent! To make any pronouncements about the likelihood of getting a bankruptcy discharge based on data as scant as these is an affront to science itself.
What's more, Rafael Pardo did a study from 2007, where he found that the debt-to-income ratio of the tiny number of people who attempted to get a discharge of their student loan debt was an "astronomical" 4.2 (Pardo's words, not mine) compared to a ratio of 1.2 for the average citizen filing for bankruptcy that year. It makes sense that the tiny number of people attempting to get their student loans discharged would be among the most extreme, severe cases. That only 40-50% of these get any sort of relief speaks volumes about the chances for ordinary citizens.

Reilly: Why do so few people attempt to get their students loans discharged in bankruptcy?

Collinge:There are very good reasons that so few people even attempt bankruptcy for their student loans. Almost no well-versed lawyers will recommend it because of the unlikelihood of winning.   Also It is an expensive, stressful, and difficult process.  What is more, since 2007, various repayment programs have been implemented that make "undo hardship" almost impossible to prove except for borrowers who have less than 20 years left to live, like a recent case that is being falsely touted as a game changer by many of the same "snake oil salesmen" I alluded to earlier.   These repayment programs- even though they are being shamelessly administered to kick as many people out as possible- nonetheless serve as a basis for defeating the hardest "prong" of proving undue hardship; that the borrower is unlikely to be able to ever repay the debt.

And make no mistake, even for the most destitute borrowers, the Department of Education, ECMC, and the entire lending industry are continuing to pour massive resources into defeating them in bankruptcy court by using shameless fear tactics with the judges, who they pressure ceaselessly - and usually successfully- to make bankruptcy determinations against, these most impoverished individuals rather than for them.  It comes as no surprise, therefore, that the already tiny number of people trying to use the bankruptcy laws for student loans has shrunk dramatically since 2007.

Saying that bankruptcy is possible for student loan borrowers is like saying that winning the lottery is possible -  you can say it, but it ain't going to happen for the overwhelming majority of borrowers, even if they go through the expensive and difficult process of trying.  The "debt coaches", and others perpetuating this myth have no intentions of guiding distressed borrower successfully through bankruptcy.  Most are just trying to get them "in the door", so that they can sell them "loan rehabilitation", where the borrowers pay 10 months worth of payments (which goes into the pocket of the collection companies), the loan is repackaged as a much larger loan, and ultimately resold.  The nearly 20% commission on these "rehabilitated" loans make this a hugely lucrative endeavor.  Never mind that 60% of rehabilitated loans or more wind up defaulting a second time.  This is among the scummiest and harmful components of the Student Loan Scam.

Reilly: Are there other aspects of this that trouble you?

Collinge: Yes.  There is a larger, more sinister phenomenon at work here:   the student loan industry cherry-picks data like these and pushes them in the media for the sole purpose of keeping bankruptcy gone from student loans, something that has allowed them to rob billions of dollars from millions of people over the years.  This is a predatory cash cow for them, and they will grasp at the flimsiest of data in order to make the predatory student loan system look better, and to perpetuate the shocking financial carnage that is being inflicted upon millions, and is poised to devastate far more Americans going forward, and to a far greater degree. 

Reilly: So is there a solution to this problem?

Collinge: There are three good bills in Congress right now that would solve this problem by, at long last, forcing the student loan industry to contend with the same bankruptcy protections that every other lender for every other type of loan must contend with.  

Alan has labored long on this issue.  I first encountered him while covering - from afar - Occupy Wall Street and he had already been at it a long time.  He is the author of The Student Loan Scam: The Most Oppressive Debt in U.S. History - and How We Can Fight Back. Here is a somewhat dated update on his efforts.

Maureen O'Hara's Ill Fated Cuban Oil Tax Shelter

This post was originally published on Forbes Oct 27, 2015

Maureen O'Hara, who died Saturday, was a classic actress in some classic movies.  So I guess it shouldn't be a surprise that she took a whirl at the classic tax shelter - oil wells.  Julian Block sometime ago got me into checking whether celebrities who pass away played a role in tax history.  That led me to Fitzsimons v Commissioner (37 TC 179), which was decided by Judge William Fay in 1961 in the first year of his service on the court.  Judge Fay helpfully mention that "The petitioner is a motion picture actress known professionally as Maureen O'Hara.

The Need For Shelter

The years at issue were 1954 and 1955 and you can understand why Ms. O'Hara would have been seeking shelter.  There are 14 films in her filmography from 1950 to 1955 including the classic Quiet Man in 1952

and two of my favorites The Long Gray Line in 1955

and Rio Grande in 1950

The top marginal rate in those days was 91%.  A big attraction of oil as an investment was the percentage depletion deduction.  What is great about percentage depletion is that you can keep deducting even after you have recovered your cost, which is why owning a gold mine is like owning a gold mine ,  while owning an oil well can be even better.  Percentage depletion for oil wells was 27.5% of revenue limited to 50% of net income from the property.  And this was before they started with all those silly alternative minimum tax things and passive activity loss rules were not even on the horizon.

Too Aggressive

The problem for Ms. O'Hara was that her advisers (I'm thinking it was her advisers anyway) were a bit too aggressive.  She made two $50,000 lease payments in 1954 and 1955
On December 20, 1954, the petitioner acquired a lease from the Cuban Corporations under which she would have the right to select 250,000 hectaries of the land covered by the grants from the Cuban Government. The lease was to run for 2 years and for so long as exploration or drilling operations were being conducted and thereafter for so long as oil, gas, or other hydrocarbon substance was being produced in commercial quantities from the selected land.
Judge Fay ruled that since the payments would provide benefits beyond the two years they had to be capitalized.
In any event, these bonus payments are not deductible. A payment may not be deducted solely on the grounds that it is not a capital payment. It must be shown further that the payment is an ordinary and necessary expense.York Water Co. , 36 T.C. 1111 (1961). In the present case the payment of the bonus resulted in a longstanding direct benefit to the petitioner. This benefit was to extend into the indefinite future. Therefore, it cannot reasonably be said that the payment was an ordinary and necessary expense to be deducted in a single year.
There has to be a sort of cruel irony about Ms. O'Hara being told that she needed to have capitalized her 1954 and 1955 payments to acquire Cuban oil interests in 1961 of all years just a few months after the ill-fated Bay of Pigs Invasion and less than a year before the missile crisis.  Hopefully, the deficiency didn't eat up everything from the Parent Trap.

About Oil Deals And High Marginal Rates

I remember learning about what an abuse oil and gas depletion was when I was a high school lad, before I knew anything else about taxes (There was an article about it in Ramparts).    The rate was cut to 22% in 1969 and 15% in 1975 and percentage depletion in excess of basis became an AMT preference. Tax shelters became such an important factor in the oil industry that when the Tax Reform Act of 1986 killed most classic shelters, a special exception for "working interests in oil and gas property" was carved out (Section 469(c)(3)).  You will still see things about limiting oil and gas tax breaks as in this discussion of President Obama's budget.

Republican presidential candidates have been calling for cuts in the top marginal rate from 39.6%.  Democrats, except for Lincoln Chafee, who has dropped out, have not come out with any proposed rates. Bernie Sanders has indicated that his top rate might be over 50%.

I'm afraid that a move like that would send us back to the days of obsessive sheltering, but we'll see.

God May Bless Your Pot Shop - Tax Court Not So Much

This post was originally published on Forbes Oct 24, 2015

According to this story in the Sacramento BeeBryan Davies thought that Satan had planted the idea of opening a medical marijuana dispensary in his mind .  After praying about it though, he determined that it was a message from God.  So at his Canna Care dispensary even though you had to pay for your medical marijuana, the bibles were free.  There were also regular prayer services.  Unfortunately, God has not yet spoken to the IRS on the matter.   Even though medical marijuana is legal in California, it is still a schedule  I controlled substance under federal law and Internal Revenue Code Section 280E - Expenditures in connection with the illegal sale of drugs - holds:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
Canna Care Inc was before the Tax Court challenging deficiencies totaling over $800,000 for the years 2006, 2007 and 2008.

It Is What It Is

Unless you can figure out a way to combine high margins and low operating expenses Section 280E will kill a business or force it underground.  Of course probably when TEFRA was passed in 1982, all illegal drug businesses were underground.  Presumably the legislation comes from the "That's how they got Al Capone" syndrome reflecting a desire to use the tax law as one more weapon in the War on Drugs.  Nancy Reagan, notwithstanding, people were often saying yes, rather than just saying no.  Unanticipated was the "kind of legal in some places" status of marijuana that our federal system has evolved.
The decision was pretty cut and dried. an illustration of Reilly's First Law of Tax Planning - It is what it is.  Deal with it.  There are three elements to make Section 280E applicable.  There is a trade or business.  There is trafficking.  There is a controlled substance.

Trade or Business - Check
Whether petitioner was operated in accordance with California law's restrictions on profiting from the distribution of marijuana is not an issue before us, and it does not affect our finding that petitioner was engaged in the business of distributing marijuana for purposes of section 280E. There is no doubt that Mr. Davies incorporated petitioner to produce income. In fact, it was clear from Mr. Davies' testimony that he entered into the medical marijuana business in order to cure his family's financial difficulties. Mr. Davies and the other shareholders received wages well in excess of those paid to petitioner's other employees, and the payment of such wages would not have been possible if petitioner had not had income.
Trafficking - Check

For trafficking the Tax Court went to its decision in the case of Martin Olive.(That's right this is not the Tax Court's first time at this rodeo.)
We have previously held the sale of medical marijuana pursuant to California law constitutes trafficking within the meaning of section 280E. Olive v. Commissioner, 139 T.C. at 38 (”[A] California medical marijuana dispensary's dispensing of medical marijuana pursuant to the *** [CUA] was `trafficking' within the meaning of section 280E.”); CHAMP, 128 T.C. at 182. DOJ memoranda and FinCEN guidance released after the years at issue that represent exercises of prosecutorial discretion do not change the result in this case. Petitioner regularly bought and sold marijuana. This activity constitutes trafficking within the meaning of section 280E even when permitted by State law.
It seems to me that there should be an argument there, since trafficking has this negative connotation and DOJ has indicated that legal marijuana regulated by state law does not impact traditional federal enforcement priorities, that Congress would not consider what was going on at Canna Care to be trafficking.  In the Committee Report on TEFRA the rationale for 280E is:
There is a sharply defined public policy against drug dealing to allow drug dealers the benefit of business expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons is not compelled by the fact that such deductions are allowed to other, legal, enterprises. Such deductions must be disallowed on public policy grounds.
It does not seem to me that that rationale applies to medical marijuana in California.  The public policy is now quite a bit fuzzy.  Note the term "drug dealers", which also has a very negative connotation.  I would have been inclined to let them have the deduction on that basis, but unfortunately my appointment to the Tax Court will not be coming anytime soon.

Controlled Substance-Check

This one is definitely is an "is what it is".  Congress made a list and marijuana is on it.
Petitioner advances numerous arguments as to why marijuana should no longer be considered a schedule I controlled substance. We reject these arguments. Marijuana was a schedule I controlled substance during the years at issue. As recently stated by the Court of Appeals for the Ninth Circuit, to which an appeal in this case would lie: "[T]he only question Congress allows us to ask is whether marijuana is a controlled substance `prohibited by Federal law.' *** If Congress now thinks that the policy embodied in § 280E is unwise as applied to medical marijuana sold in conformance with state law, it can change the statute. We may not.” 
Another Way?

Given everything else that was going on at Canna Care Inc - the prayer meetings and bible distribution most notably - I would have been inclined to taking a shot at church status with the provision of medical marijuana being an integral part of the ministry.  That would take 280E out of the picture.

Does 280E Make Any Sense?

Don’t use the tax law to do anything other than measure income and collect taxes. Special carve-outs, whether punitive or beneficial, linger long after the moral panic surrounding their enactment passes. 
I wonder if Joe is feeling the Bern.

Probably not, but I can't resist asking.  I agree with Joe's analysis and as a matter of fact think that 280E violates Reilly's First Law Of Tax Policy - Make tax policy the Switzerland of the culture war.

Lew Taishoff also covered the case.  Lew was taken with Bryan Davies being on a mission from God in his pot dispensing.
Well, after nearly forty-nine (count ‘em, forty-nine) years during which I’ve practiced law in a highly-urban environment, I thought I’d heard it all, but Tax Court is an endless “medley of extemporanea.”
Larry Brant also had something titled - A Real Bummer for The Marijuana Industry as did Russ Fox with - Up In Smoke, Again.