Blame it on the Scrivener

Originally published on Passive Activities and Other Oxymorons on May 16th, 2011.
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Xianfeng Zhang v. Commissioner, TC Summary Opinion 2011-21

This was a substantiation case.  They mentioned the famous Broadway producer, but only to say that his rule didn't apply.  Taxpayer won on home office, but all his travel expenses were disallowed:

Petitioner testified that he took three separate trips to China for business purposes in 2006—one in June lasting approximately 90 days, another in September lasting approximately 60 days, and a third that began in December 2006 and ended sometime in 2007. Petitioner entered into evidence three airplane tickets for flights from both Beijing to Los Angeles and Los Angeles to Beijing. The dates on the airplane tickets are not consistent with the dates or periods of travel to which petitioner testified. Although petitioner's passport bears customs stamps from both the United States and China, some of the stamps are illegible. The stamps that are legible do not correspond with the dates petitioner testified he was in China for business.

Petitioner did produce several receipts that appear to be for automobile and lodging expenses in China. The receipts, however, are in Chinese and do little to explain petitioner's business activities. The receipts do not satisfy the strict substantiation requirement of section 274(d). Petitioner has failed to substantiate the travel expenses he claimed for his trips to China. Therefore, we sustain respondent's disallowance of petitioner's deduction for travel expenses.

ESTATE OF ANTONIO J. PALUMBO v. U.S., Cite as 107 AFTR 2d 2011-1274

This one looked kind of interesting, not least in part because the dollars are pretty big - over eleven million.  Mr. Palumbo had a will that left the residue of his estate to a charitable trust.  Then his attorney redid his will and there was a "scrivener's error" - poor Bartleby gets blamed for everything.  The new will didn't have a residuary clause.  Managing to die intestate with a valid will is quite a feat, but that's what his son contended.  Finally there was a settlement between the son and the charitable trust. Then the IRS gets into the act and says the settlement doesn't qualify for the estate tax charitable deduction.  The taxpayer won, although the court ruled in late April that the government's postion had enough justification that the Estate could not get attorney's fees.

SMITH v. U.S., Cite as 107 AFTR 2d 2011-1228

Mr. Smith, on the other hand, did get attorney's fees of $78,167.02.  The IRS put him though a lot in resisting his refund claims including claiming that he hadn't filed them and then admitting that they did.  They contested both his net worth (if over $2,000,000 you don't get fees) and that their postion had been justified at some point or other even though they ended up caving.

Desmond D. Conyers v. Commissioner, TC Summary Opinion 2011-25

This was an innocent spouse case where the spouse claiming relief was the husband and the wife was deceased.  The only income on the joint return had been from his roofing business which he pretty much controlled.  His story was:

At trial petitioner testified that sometime after respondent's examination he became aware of large sums of cash withdrawn from two of his bank accounts and that he now believes that his wife had been taking money and fixing the books to support a drug and alcohol addiction. He also testified that payment of the tax in issue would cause him such hardship that his only option would be to file for bankruptcy.


The Court wasn't buying it:

Other than this brief and conclusory testimony, petitioner produced no evidence to support these allegations. In the light of the facts indicating that petitioner knew about the operations of his business and its substantial income, we cannot find that petitioner has proven that he is eligible for relief under section 6015(f).


Abdul M. Bangura v. Commissioner, TC Summary Opinion 2011-23

This seems like a pretty run of the mill clueless taxpayer substantiation case.


In connection with the audit of his 2004, 2005, and 2006 tax returns, petitioner told the examining agent that he was not required to provide the Internal Revenue Service with any records or documentation other than those which had been submitted with his income tax returns. Indeed, petitioner never provided the examining agent with documents of any kind with respect to years 2004, 2005, and 2006 during the audit for those years. Nor did petitioner respond to the IDR for 2007.

 The agent really piled it on assuming that there must have been gross receipts to pay the unsubstantiated expenses.


Although the examining agent used the business expenses set forth on Schedule C in reconstructing petitioner's income, he determined that deductions for these expenses should be disallowed for lack of substantiation. The examining agent also determined that for 2007 petitioner was liable for an addition to tax pursuant to section 6651(a)(1) for failure to file a timely return and an accuracy-related penalty pursuant to section 6662(a).

The Court at least gave the taxpayer a break on that.

Consequently, we hold that the examining agent may not use petitioner's disallowed Schedule C expenses to reconstruct his income. Because of this error, respondent must recalculate petitioner's 2007 unreported income.

When it came to the penalties, though, the Court did not find his argument about being somebody just starting in business and learning through honest mistakes at all compelling.

Yet when asked by the examining agent to provide documentation to substantiate his claimed business expenses, he failed to do so. Petitioner asserted that this was not negligence; rather, “it's more or less when you're starting out doing something, like a medical doctor doing operations or maybe a lawyer representing somebody in the courtroom, you have a lot to learn. You do make mistakes here and there.” We find petitioner's cavalier attitude unacceptable.

Here is the punch line.  The taxpayer was a CPA.  I can hear the Wandering Tax Pro laughing out loud in New Jersey right now, even if he is "down the shore".

If You Kill Your Parents It's Your Own Fault You are an Orphan

Originally published on Passive Activities and Other Oxymorons on May 13th, 2011.
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Here are a few items that I didn't quite get to in tax season.

CCA 201106015

The law firm provides one of its attorneys to perform legal services for a municipality. It's usually the same attorney every time. The firm sends an invoice to the municipality, and the municipality pays the firm. The municipality does not issue a Form 1099. The attorney is paid by the law firm. Small municipalities essentially contract out for these services when they can't afford their own full time city attorney.

The question is whether the IRS should assert that the attorney is an employee of the municipality, rather than an employee (or partner) of the law firm for purposes of the services provided to the municipality.

My answer is no. The attorney is not an employee of the municipality. ———————————

It is nice to know that sometimes national office will restrain the overzealous.  What they would be accomplishing other than creating aggravation for the small municipality is beyond me.

Roger S. Campbell, et ux. v. Commissioner, TC Memo 2011-42

There were a couple of issues in this case around substatntiation, but the main thing was a hobby loss question on Amway activities.  I remember going to some Amway presentations and it is really shocking to me that people can actually lose money on something that sounds like such a good deal.

Petitioners did not conduct the Amway activity in a businesslike manner. Although they maintained a separate bank account for the activity and maintained records for certain aspects of it, petitioners never used these records as an analytical tool for improving profitability. Mrs. Campbell testified that she did not know whether the Amway activity was profitable in any given year until she completed petitioners' tax return for that year which, for 2 of the taxable years in issue, did not occur until almost 2 years later. It is a fair inference that petitioners' recordkeeping was directed more towards substantiating deductions on a tax return than assessing the profitability of the Amway activity.

Considering all the facts and circumstances, including especially the confusing state of petitioners' Amway records, we conclude that a substantial portion of the costs of goods sold respondent disallowed for 1998 and 1999 represents Amway purchases that petitioners withdrew from inventory for personal use or use in their other businesses. This commingling of the Amway merchandise, resulting in substantial inaccuracies in reported costs of good sold, is further evidence that petitioners' Amway activity was not conducted in a businesslike fashion. It also resulted in petitioners' claiming business deductions for personal expenditures.


Although petitioners have prior entrepreneurial experience and both operated other businesses concurrently, they had no experience with operating a direct marketing distributorship before they were recruited as Amway distributors. Petitioners obtained advice only from their upline distributors and other interested Amway individuals, persons who had a direct financial interest in the maximization of petitioners' sales volume, without regard to petitioners' profitability.

In view of the foregoing, petitioners have failed to prove that they carried on their Amway activity with the requisite objective of making a profit. Consequently, their deductions arising from the Amway activity are limited by section 183.

In the presentations it was always about you recruiting people who recruit people and so on. It always seemed that somebody somewhere had to be selling an awful lot of soap for the thing to work.

U.S. v. THOMAS, Cite as 107 AFTR 2d 2011-1599

This was a protester who was complaining about having to file all his delinquent returns as a condition of his supervised release.  He figures the IRS already did substitute returns and that it was going to be hard to dig up records from that long ago.  The Court had no sympathy as they cited one of my favorite jokes.

We hold that the district court correctly calculated the applicable sentencing range and did not abuse its discretion in imposing an obligation to file all unfiled tax returns and pay all outstanding tax arrears as a condition of supervised release.

We note that any difficulties that may arise from the age of the necessary documents or the passage of time are entirely self-inflicted; had he complied with his duty to file the returns when they were initially due, there would be no such troubles. His contention on appeal that this state of affairs amounts to a “burden” imposed by the district court is absurd, like killing your parents and complaining of being an orphan.


Jeffrey S. Charlton, et ux., et al. v. Commissioner, TC Memo 2011-51

This was a statute of limitations case.  The underlying plan was clearly a loser:

During 1998, Jeffrey and Timothy formed Graphic Connections Group, LLC; Wealth Builders International, LLC; and Golf Links Display Group, LLC (collectively, the partnerships). Pursuant to the partnerships' operating agreements, Jeffrey and Timothy each had a 1-percent interest, and the domestic trusts had a 98- percent interest, in each of the partnerships. The domestic trusts paid the personal expenses of Jeffrey's and Timothy's families and distributed income to the Belize trusts. Jeffrey and Timothy used foreign bank accounts in Belize and Antigua to access the income. On August 1, 1999, Token Trust purchased Titan Trust's and Timothy's interests in the partnerships.

One of my rules is to not get involved in any plan that includes a place I can't easily point out on the map. (Belize is in Central America by the way.  You probably already knew that.)  As it turned out though the Tax Court believed that Mr. Charlton was gullible rather than fraudulent:

Jeffrey, who undoubtedly had a penchant for fast and easy money, foolhardily followed the Aegis system (i.e., structuring the transactions and resisting the IRS audit). See Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Gajewski v. Commissioner, supra. Nevertheless, Jeffrey maintained adequate records and made all pertinent information available to Mr. Moore, his longtime trusted, yet imprudent, CPA. See Niedringhaus v. Commissioner, supra at 211. To his detriment, Jeffrey relied on the professional judgment of Mr. Moore, who inexplicably believed in and acquiesced to an elaborate scheme designed by con artists. See Estate of Temple v. Commissioner, 67 T.C. 143, 162 (1976) (holding that reliance upon an accountant to prepare accurate returns may negate fraudulent intent if the accountant was supplied with all the information necessary to prepare the returns); Marinzulich v. Commissioner, 31 T.C. 487, 490 (1958) (holding that a taxpayer's reliance upon his accountant to prepare an accurate return may indicate an absence of fraudulent intent).

If you are using Mr. Charlton as a guide to your future plans, I would point out that if you go shopping for a CPA who is as gullible as you are, you might not be able to rely on who ever you end up with.  If you talk to two of them and neither one will drink the Kool-Aid with you, give it up.

Enterpeneur Wants Comprehensive Tax Compliance Solution

Originally published on Passive Activities and Other Oxymorons on May 8th, 2011.
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In inviting guest bloggers, I have not limited myself to other tax nerds.  I want to get the viewpoint of people who have to deal with tax problems, while spending their time on more socially productive activities.  I am very gratified that Bobbie Carlton has agreed to be featured here

I met Bobbie at Mass Innovation Nights, but she is not just somebody you can meet there she is the founder.  Now if the founder of Mass Innovation nights identifies the need for a new tax software product, how long before someone is coming out with it ?  Here is what she has to say:

Two weeks ago I got a big book in the mail – no, not a delivery from Amazon but a book-sized sheaf of paper called my taxes. As an entrepreneur, a small business owner, and a part-time employee of yet a third company, with a freelancing spouse, two kids and a house, our taxes are probably a mite more complicated than most people but nothing that far out of the ordinary. We work with a wonderful CPA. I keep careful records all year, carefully logging mileage in an Excel spreadsheet, inputting my receipts, and in general, spending a lot of time I don’t have keeping this one more ball in the air.

I am the co-founder of a monthly product launch party and networking event called Mass Innovation Nights. We’re readying a new website and want to provide it as a platform to help other communities do the same thing we’ve been doing for the last two years – helping innovators and entrepreneurs get more buzz for their products by using social media. In a single night one of our events can generate hundreds of blog posts, tweets, Facebook and LinkedIn posts, online video and pictures. It is great, “no” cost visibility for the companies and their innovative products (more than 250 of them in just two years.)

One thing most of these products have in common is a reason for being – they solve a problem. They make something easier, faster, prettier, tastier, cheaper, better. I see new products all the time – a lot of companies send me cool new products because I blog about innovation.

Here, try this out. Tell us what you think. And, I usually am able to quickly discern the problem they solve. And every time I see a problem, someone comes up with a product to solve that problem. Until now.

Where’s my small business tax solution? Yes, yes. I know about all the lovely tax software tools. (And, since I have a CPA, why do I need that anyway?) But what I am talking about is an integrated tax dashboard that collects my mileage from the car, that I scan receipts into, that helps me log hours (and maybe even invoice them back to clients) and captures all those home office deductions. I have mobile location-based tools like foursquare and SCVNGR that know when I am walking into a Starbucks and yet neither one can capture how many unreimbursed miles I drove to get there and log it to my account? COME ON. Get with the program. They are wonderful toys but give me a solution for my business and I will be forever grateful.

Bobbie Carlton is the co-founder of Innovation Nights LLC, the founder of Carlton PR and Marketing and the Director of Marketing for Accounting Management Solutions . Follow her on Twitter.

If there is one issue that is common to just about every single audit or tax case it is substantiation.  When dealing with auto use and meals and entertainment it is absolutely critical as the Cohan rule no longer works in those areas so the product that Bobbie is suggesting might have quite a market.

Hard Rock Case Still Up in the Air Though Some Elements Well Grounded

Originally published on Passive Activities and Other Oxymorons on May 5th, 2011.
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MORTON v. U.S., Cite as 107 AFTR 2d 2011-XXXX

I promised myself that if I got far enough ahead on my Monday, Wednesday, Friday commitment, I would start doing more posts.  The MWF posts have been done on a roughly FIFO (first in, first out) basis so some of them have aged a bit.  I'm going to grab from the top of the pile for any Tuesday Thursday bonus posts, so they might be a little fresher.

This is a bit of a celebrity case.  Peter Morton was one of the founders of Hard Rock Cafe.  His Los Angeles restaurant, Mortons, was the setting for the Julia Phillips novel "You'll Never Eat Lunch in this Town Again".  He sold the Hard Rock Hotel in Las Vegas in 1995, but he continues to own the brand.  The dollars involved are pretty respectable.  It is a refund claim for $9,755,483.  Absent all that, I would still find the case intresting.  There are three issues two of them somewhat sophisticated and one fairly mundane.  Ironically the taxpayer was able to get summary judgement on the sophisticated issues but the mundane one remains undecided.

The question is about the deductibity of private jets and whether a like-kind exchange of jets was blown.  One aspect of the like-kind exchange issue is very straightforward:

In 1999, Plaintiff sought to exchange the G-III for the G-IV aircraft. The main reasons for this exchange were concerns about the safety and the level of noise generated by the G-III. Plaintiff entered into an agreement with a qualified intermediary for the exchange and an escrow agreement with an escrow agent. The agreement was executed on September 30, 1999, but the escrow agent accidentally and in contravention of the escrow agreement wired funds from the escrow account to RWB. Mr. Ogaz returned the funds the following day.

Ooops. Don't you hate when that happens ?  The Court ruled, however, that with a properly drafted exchange facilitation agreement, an error by one of the parties will not void exchange treatment.

Defendant acknowledges that Plaintiff abided by these requirements and would have effected a valid like-kind exchange but for the accidental placement of funds into RWB's account instead of the escrow agent's account.  Defendant stresses that before the funds were placed in escrow, the money was deposited into RWB's checking account; thus Defendant contends that because RWB had possession and control over the funds, Plaintiff had “actual receipt” of them. 

We disagree that an accidental transfer followed by an immediate return of funds would constitute actual or constructive receipt. Significantly, Plaintiff was bound by contract not to “receive, pledge, borrow or otherwise obtain the benefits of the Exchange Value” for at least 45 days.. Legally, he could not do anything but return the funds to the proper account. If he had done anything other than return the funds, he would have been liable for conversion, or even theft. 
Additionally, Plaintiff should not be penalized for another's mistake when he took every step to validly effect a deferred like-kind exchange. Plaintiff complied with all the requirements of the qualified intermediary safe harbor over which he had control; he did not have control over the mistaken actions of a third party. Because he complied with the requirement in all other aspects, we conclude that he validly effected a deferred like-kind exchange.

In many cases good documents cannot salvage poor execution.  One of my earliest posts illustrates this principle in the case of family limited parnterships.  Of course in the like-kind exchange area, the right documents are crucial as Ralph Crandall discovered much to his chagrin.  I would say, however, that "poor execution" might be a little harsh for a mistake like depositing in the wrong account and fixing the mistake the next day.  Compare it to the Estate of Sylvia Riese where the property of a terminated QPRT was not retitled for months and no rent was ever paid by the grantor.  If the Tax Court can forgive that, having the money in the wrong account for a day should also be forgivealbe.  Let's call it less than perfect execution.

This was also a Section 183 case, sometimes referred to as "hobby loss". but the actual title is "Activities Not Engaged in For Profit":

In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.

It is not surprising that Mr. Morton owned several entities for several different purposes- ownership of different property, management, etc.  He picked one of them RWB, an S corporation, to own the jet.  He provided the corporation with the funds to pay related expenses.  A different corporation 510 Development Corporation hired the flight team of pilot, co-pilot and flight attendant.  We don't need to get into the details of the purposes of the various entities to frame the issue.  RWB, all by itself, was not about to make a profit from owning the plane.  So the IRS wants to disallow any expenses over and above some charter income.  Mr. Morton maintains that the plane was being used for his overall enterprise - himself and all his various entities.  The Court approves of the latter approach:


Case law supports Plaintiff's “unified business enterprise” theory and would allow him to take deductions for aircraft use that furthers the business purpose of entities other than RWB. This deduction may be allowed despite the fact that the aircraft is titled in RWB's name, and RWB did not use the aircraft to further its particular profit motive. As long as Plaintiff used it to further a profit motive in his overall trade or business, the deduction is allowed.

I think that both the holdings in this case are pretty important.

Mr. Morton has not, however, entirely won - at least not yet and the reason is pretty mundane:

Given that Plaintiff may impute his business activities and the business activities of one entity to his other entities, the Court must still examine whether the evidence shows that the aircraft expenses were for legitimate business purposes. The facts are in dispute. Defendant contests the purpose of many of the trips, and specifically takes issue with Plaintiff's trips to the Hamptons because his children, girlfriends, and friends of his children traveled with Plaintiff on the aircraft and stayed with Plaintiff at his vacation homes. RWB kept flight logs that identified the date and time of the trip, the number of passengers, the departure and arrival airports, the time in flight, and the pilots. However, RWB did not keep systematic records of the identity of the passengers on its flights nor the reasons why any passengers were on its flights.  The lack of information about the people included on the trip makes it difficult to say at this point definitively that the flights were or were not for business purposes.

Though Plaintiff met with his accountant sometime after the trips to categorize them as “personal” or “business,” , the Court cannot definitively say that these meetings were sufficiently contemporaneous to regard these categorizations as conclusive. Plaintiff said little at oral argument to enlighten the Court about the process of determining the business or personal nature of the trips. Because the Court is unconvinced of Plaintiff's categorizations, it defers judgment on the nature of the individual trips. The Court also must defer a determination as to whether depreciation deductions are allowed because this determination is dependent on substantiating the business usage of the aircrafts.

If the Gulfstream is classified as personal use property, it would be disqualified from 1031 treatment.  I will hazard a guess that 1031 would not be that imporant in that case as the plane would not have been depreciable.

Note that this is a refund case so Mr. Morton must have spent over $20,000,000 or so of after tax dollars on his jets.  In case you are wondering what other perks go with being the founder of the Hard Rock Cafe, check out his super model on again off again girl friend Linda Evangelista

Saying Goodbye to 2010

Originally published on Passive Activities and Other Oxymorons on February 7th, 2011.
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I know that you haven't been wondering how I do my blog, but I am going to tell you anyway.  I look at every federal court tax decision and an alphabet soup of IRS pronouncements (PLR, CCA, PMTA etc) as they are released by the Research Institute of America.  A small percentage of them strike me as interesting for one reason or the other (practical utility, humor, cause for reflection).  Those I copy into a draft post, which I will then labor over as the spirit moves me.  Having the full text in my draft post allows me to easily paste quotes into the body of my post.  The effect of this method is to leave me with a collection of draft posts.  Sometimes when I look at them I wonder why I thought they were interesting in the first place.  I've committed to a Monday Wednesday Friday schedule.  If something seems of immediate interest, I will put it up as a bonus post.  The side effect of this process is the accumulation of material that doesn't quite turn into a full length post.  Rather than consign it to the dustbin (You might be surprised at the number of developments than nobody would write about if I didn't), I will group a bunch of them together.  So in this post and maybe a subsequent one I will clean out anything left over from last year.  The only thing the items have in common is that they came out in the waning days of 2010.  If you can detect a theme, congratulations.

TAX PRACTICE MANAGEMENT, INC. v. COMMISSIONER OF INTERNAL REVENUE JOSEPH ANTHONY D'ERRICO v. COMMISSIONER OF INTERNAL REVENUE, TC Memo 2010-266

This was a fairly run of the mill substantiation case although the numbers were respectable (over 200k in deficiencies).  The fact that it was a tax preparation business added a touch of irony.  The most interesting feature was an airplane.  It was purchased in December.  Mr. D'Errico took it on a test flight which allowed him to visit some clients.  He then leased it out, because he was to busy to fly around during tax season.  He sold his tax business before he got to use the airplane to visit clients.  He, of course, took a 179 deduction in the year of acquisition.  The tax court didn't buy it.

TPM has not demonstrated that the airplane was acquired with the requisite intent or motive of making a profit. Other than D'Errico's self-serving testimony, TPM has not presented any evidence that it contemplated using the airplane for purposes of TPM's management or marketing operations. Further, the airplane leasing agreement specifically provides that TPM entered into the agreement with the intention of generating revenue to offset the airplane's operating costs.

Private Letter Ruling 201048025

This was a fairly convoluted like-kind exchange that was allowed.  As far as I could make out an entity swapped with a related party, which then acquired property.  The key to the whole thing seemed to be that as a group there was no net increase in cash.

Related Party intends to reinvest an amount equal to the total sale price of the Related Party Relinquished Properties less exchange costs. In the event that Related Party acquires replacement properties having a value less than 100 percent of the value of the Related Party Relinquished Properties, the difference will result in the Related Party recognizing gain arising from the exchange in the full amount of such difference, but the amount of gain so recognized will not exceed x% of the gain realized by Related Party on its transfer of the Related Party Relinquished Properties.

If somebody has studied this ruling and could post a comment I'd really appreciate it.

Edward Daoud, et ux. v. Commissioner, TC Memo 2010-282

This was also a substantiation case.  It was notable for two reasons.  The first was the introduction:

The Daouds owned two Wienerschnitzel franchises in Southern California, both of which gobbled up unusually large amounts of money. These expenses grabbed the Commissioner's attention and during his audit of the Daouds' 2000 and 2001 returns, he found that they had reported a large loss on kitchen equipment they never owned, and lacked substantiation for many of the other deductions that they claimed. The Commissioner determined a large deficiency for each year, and wants to add fraud or at least accuracy-related penalties. We make our way through the resulting menu of possibilities to determine the correct taxes and penalties.

You don't read a lot of stories about Tax Court judges shooting themselves, so you know that they have to have a sense of humor.  Sometimes it comes through.

The story of the unallowed loss on the kitchen equipment is one that Robert Flach, The Wandering Tax Pro will love.  (Mr. Flach still prepares returns by hand rather than use expensive and unreliable software):

Mr. Daoud conceded that he and his wife were not entitled to the loss on the sale of kitchen equipment, but he tried to explain why he reported a loss for equipment he had neither bought nor sold. He testified that he was unsure how the $110,015 loss got on his return, but he speculated that the bid was mixed up with all the other paperwork on his desk, which caused him to enter it into Turbo Tax by mistake. He also testified that the date he recorded on the Form 4797, Sales of Business Property, as the date that he sold the equipment was simply one that he chose at random after Turbo Tax prompted him to enter a date. He went on to explain that he gave the altered document to the revenue agent "out of panic."

The Turbotax made me do it defense was unavailing:

This case is a good example of why we allow the Commissioner to prove fraudulent intent using circumstantial evidence and the taxpayer's entire course of conduct. Mr. Daoud claims that he reported the loss by mistake, and he asks us to believe that he first learned about it when the revenue agent brought it to his attention. We do not believe him--Mr. Daoud's credibility suffered during trial. His testimony was often suspect, and the records he provided have proven not to be what he said they were on many subjects.

The judge elaborated on the credibility theme.  He didn't yell "Pants on fire", but it was close.

Private Letter Ruling 201051025

In my more paternalistic moments, there is a provision of the tax law that I would keep secret from some people.  One of the ways that you can avoid a 10% penalty on early withdrawal from you IRA is by committing to a series of distributions.  I just turned 59, myself, and I am looking forward to my 1/2 birthday so I wouldn't need to consider something like that myself.  And of course I'm glad my younger self never thought about it.  Nonetheless, there might be circumstances where it makes sense.  The ruling was about someone who adopted that course then managed to screw it up.  The IRS was forgiving.

1. The failure to distribute the entire required distribution amount for Year 6, and a proposed makeup distribution for Year 7 will not be considered a modification of a series of substantially equal periodic payments and will not be subject to the 10 percent additional tax imposed on premature distributions under section 72(t)(1) of the Code.
2. The fact that the amount of the annual payment computed pursuant to section 72(t)(2)(A)(iv) of the Code was paid in a single sum in Year 1 and in monthly distributions in Year 2 through Year 7 will not be considered a modification of a series of periodic payments and will not be subject to the 10 percent additional tax imposed on premature distributions under section 72(t)(1) of the Code.

That is not a complete wrap on 2010, but it will do for now.

The Stuff You Find In Tax Court Opinions

Originally published on Passive Activities and Other Oxymorons on January 14th, 2011.
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Dean F. Pace, et ux. v. Commissioner, TC Memo 2010-273

The Sovereign Military Hospitaller Order of St. John of Jerusalem, of Rhodes, and of Malta was established in the mid- eleventh century, when merchants from Amalfi founded the Benedictine Abbey of St. Mary of the Latins in Jerusalem. By 1080 the abbey built St. John's hospital--located on the traditional site of the angel's announcement of John the Baptist's conception--which provided a place of refuge for poor and sick pilgrims visiting the Holy Land. Under the leadership of Brother Gerard, the Hospital of St. John grew to include several ancillary hospices in Palestine along the pilgrimage route. Pope Paschal II officially recognized the hospital in 1113, establishing the Order of St. John.


I thought there was something wrong with my browser, but there wasn't.  The above is actually the second paragraph of a Tax Court decision.  Dean Pace is a member of the Sovereign Military Hospitaller Order of St. John of Jerusalem.  He is also a successful trial attorney.  Naturally he represented himself in Tax Court.  I will refrain from quoting the saying as to what that indicates about the intelligence of his client.

There is a logical division of labor between attorneys and accountants in the compliance area of the tax world.  (Construe accountants very liberally to included bookkeepers and serious tax return preparers). If we want to consider a compliance matter that goes the distance the continuum would be basic record keeping, return preparation, initial audit, appellate conference, tax court, appellate court.  (That's for tax determination, we don't need to get into actual collection starting another sequence).  As you run along the continuum the matter becomes less a matter for accountants and more a matter for attorneys.  Viewed in another way as you go backwards things are less a matter for attorneys and more a matter for accountants.  Most of the work in the initial audit is accountants work.  Revenue agents are accountants and want to see a trail of numbers adding up into totals that then goes to a particular line on the return.  They don't want a story.  Although, the best case is not to be audited at all, having an audit that stops at the agent level is the next best possible result.  If the basic record keeping and return preparation have been done well, coming up with a package to present to the revenue agent is a fairly painless process.  If they have not been done well it can be a major project, but it is mainly an accountants project.

Cases like that of Dean Pace or Thomas Hale show you the result of applying the attorney sensibility from the outset.  Here are some of the highlights in Mr. Pace's case:

Pace traveled extensively in 2001, spending thousands of dollars on airfare, hotels, and incidentals. But he has failed to adequately substantiate such expenses under section 274. He provided credit-card statements and his appointment book as evidence, but the appointment book didn't include the purpose of the travel. A substantial portion of the travel expenses also appears to be related to nonbusiness travel--including a pilgrimage to Lourdes that he undertook as a Knight of Malta and wine-tasting events in Paris. We therefore uphold the Commissioner's denial of all travel expenses.

He depreciated his car using a novel method,  but the Code does not allow such creativity.


Pace attempts to substantiate $1,711 in office expenses with a list of expenses containing check numbers, dates, and descriptions. He did not, however, introduce into evidence the underlying canceled checks, and the only testimony supporting the deduction was conclusory statements by Pace and his secretary that the office expenses were “incurred in the ordinary course of business.” Therefore, we disallow in full these office expenses.


Pace deducted custom-made shirts and a tie as office expenses. He explained that he found it difficult to buy some of his clothes off the rack because of his unusual physique. Our own observation makes us suspect that Pace was being modest, but no inspection could affect our necessary conclusion: expenses in this category are not deductible because Pace failed to establish that the clothing was not suitable for everyday wear. See, e.g., Hamilton v. Commissioner, T.C. Memo. 1979-186 [¶79,186 PH Memo TC]; Rev. Rul. 70-474, 1970-2 C.B. 35. And he wore one of his bespoke shirts to trial-- showing without any doubt its suitability for everyday use.


We find Pace's evidence--both records and testimony--of the amounts of these contributions credible, and his grand tour through the Order's medieval and early modern history engaging. But his argument for treating them as business expenses, rather than charitable contributions, is another matter. Payments that qualify as charitable contributions are not deductible as ordinary and necessary business expenses under section 162 if they fail to qualify as legitimate business expenses.

I'll bet the stories about the Order drove the revenue agent crazy.
He has failed to establish that the California state taxes he deducted on his 2001 return were paid in 2001. His 2001 California return shows a $34,989 tax liability--precisely the amount of state and local taxes deducted on his 2001 federal return. But Pace couldn't possibly have paid his 2001 California state taxes during 2001, because the California return wasn't executed until 2003 (and he showed us no evidence of withholding, estimated payments, or designated use of the prior year's refund to the California Franchise Tax Board). He hasn't offered any other evidence to establish that state and local taxes were paid in 2001. We therefore uphold the disallowance of this deduction in full.

Although the Court upheld 84% of the deficiency and allowed the assessment of the accuracy related penalty, they didn't seem to have any hard feelings toward Mr. Pace.  Judges, of course, are lawyers not accountants.  They refused to sanction him for his behavior in Tax Court.

 Pace vigorously contested the Commissioner's determination, resulting in a weeklong trial, 760 pages of trial transcript, and thousands of pages of credit-card statements, canceled checks, and other documents. But Pace's aggressive advocacy doesn't rise to the level of sanctionable behavior. He may be long winded--as many lawyers and even some judges are--but delay and frivolous positions were not the crux of his case.

This is the first tax court opinion I have encountered that has a reference to a papal encyclical

In the best of all possible worlds, perhaps, Pace's pursuit of the unified life would be recognized and rewarded. See, e.g., Pope Paul VI, Pastoral Constitution on the Church in the Modern World--Gaudium et Spes sec. 43 (December 7, 1965). But the Code imposes a more exact and less merciful accounting: business expenses, charitable contributions, and the costs of everyday life must be identified, segregated, and substantiated by reliable documents and credible testimony.

The difference between the trial attorney viewpoint and that of the accountant is probably best summed up in his defense to the accuracy penalty.

Pace offers a novel defense to the accuracy-related penalty in his opening brief--that it's the IRS's fault because it didn't settle. Review of the caselaw fails to find any support for this penalties-don't-apply-when-the-IRS-won't-settle argument. And Pace never argued any of the valid defenses to the penalty. See secs. 6662(d)(2)(B), 6664(c)(1). We therefore find that he is subject to this penalty.

An accountant is thinking that a tax return is supposed to come out to a correct answer (possibly resolving any doubtful elements in favor of the client).  Of course if a return has enough moving parts she will expect that someone else might come up with a different answer, but a third accountant would be able to do a reconciliation that accounted for the difference. That is not what a return is to a trial attorney.  A return is a first offer.

If you will forgive me going into the realm of fantasy, I'd like to imagine how things would have come out if Mr. Pace had been my client.  It would, of course, vary depending on what point in the process he had hired me.  If he were a regular client I would have had him have at least a part time bookkeeper.  His actual return would probably have had a tax due greater than the return he filed (possibly not if there were some planning done).  I would have gone to the initial audit with a neat package and might have gotten a no change or possibly given up some travel and entertainment and auto expense.  I have little doubt that Mr. Pace would have done better on his 2001 return under that scenario than he actually did.  But consider, that was just one year.  What about all the years that he didn't get audited ?  I really can't say that he would be better off.

If he had hired me at the point of the initial audit, I have little doubt that he would have done better.  I would not have let him talk to the revenue agent except fairly late in the process.  The agent would have as neat a package with as many possible numbers tied out as possible.  Probably the agents proposal would have been more than Mr. Pace wanted to pay, but possibly not.  The package going up to appellate would not, however, be something from an utterly exasperated agent who disallowed everything.  Although I would never have deducted the charitable contributions on Schedule C had I prepared the return, I would have had a plausible reason if the agent brought that issue up.  Since the package was so neat, they might not have brought it up.  Depending on the exact mix of the issues, I would probably have totally unleashed Mr. Pace in dealing with appellate, although I probably would have tried to keep him off the medieval history.  Bottom line, he probably still could have had a blast representing himself in Tax Court, but there would have been a much smaller deficiency at stake. (I probably would have told him to use a tax attorney).

The most interesting scenario is if he hired me after botching the initial audit.  Appellate is the point where for the most part the accountants work is done if things have been done right from the start.  Whether the case is handed off almost totally to attorneys at that point is a fairly complex question.  But, of course, this case was probably handled wrong from the start resulting in an exasperated agent who disallowed everything.  The first thing that I would do is make up the same package I would have made for the agent tying out as many numbers as possible. It is possible that the appellate conferee, who might be an attorney, would not examine the package like an accountant would.  They might just accept it.  Then appellate and Mr. Pace could negotiate.  I would supplement Mr. Pace's persuasiveness with research on whatever technical issues there might be left.

I think I would have enjoyed working for Mr. Pace.  Of course, he might have driven at least one of my firms staff members to distraction, so I'm not sorry that he didn't think to call me.  Besides one of the most intellectually stimulating Tax Court decisions of all time would not have been written.

Some Items of Interest

Originally published on Passive Activities and Other Oxymorons on December 22, 2010.
______________________________________________________________________________
I've got quite a few developments that I'd like to share that I can't seem to work into a full length treatment.  In rough chronological order they are :

NEW PHOENIX SUNRISE CORP. v. COMM., Cite as 106 AFTR 2d 2010-7116, 11/18/2010


Tentative title was "How Sweet it Is ?".  This was similar to the currency swap I wrote about in October. This deal had a business purpose fig leaf.  Even though the transaction on which millions of dollars of losses were claimed was almost guaranteed to have a loss of around $100,000 there was a chance of an enormous return :
The fourth possible outcome would occur if the spot rate for one of the option pairs “hit the sweet spot,” meaning that the long option and the short option comprising one of the option pairs expired in the money and out of the money, respectively. This would happen if the spot rate on December 12 were 127.75 or 127.76 yen per dollar, or if the spot rate on December 18 were 128.75 or 128.76 yen per dollar. Then, Capital would earn a profit of $73,500,000 on its net investment of $131,250 because it would have an additional receipt of $73,631,250 on either December 14 or December 20. The final possible outcome would occur if both option pairs hit the sweet spot. Then, Capital would earn a profit of $147,131,250 on its net investment of $131,250 because it would have additional receipts or $73,631,250 on both December 14 and December 20.

According to the IRS expert that the Court accepted there actually was no chance of the sweet spot being hit since the counter party had enough discretion and market clout to prevent it.

CC 2011-004

The following steps should be taken when a taxpayer is alleging, in an appeal to the Tax Court from a notice of determination sustaining a levy action, that the levy should not proceed because it would cause economic hardship: 1) the administrative record should be reviewed to determine whether the taxpayer raised economic hardship and whether the facts support the assertion that the levy would prevent the taxpayer from meeting necessary living expenses; and 2) if a credible argument of economic hardship was raised, but the settlement or appeals officer did not address the issue, a motion should be filed requesting that the case be remanded to Appeals so that the settlement or appeals officer can consider properly whether the levy action is inappropriate because the taxpayer would suffer an economic hardship if a levy is served.


This is a change in IRS policy regarding levies where taxpayers are not in current compliance.  Regardless of the current compliance, the appeals officer must consider hardship.  A study of collection cases sometimes makes me think that the income tax really is voluntary.

Hardy Ray Murphy, et ux. v. Commissioner, TC Memo 2010-264

Tentative title was "Brother Can You Spare a Deductible Dime". This was a substantiation case.  Taxpayer was taking a deduction for lunches that he bought for some homeless men that he befriended.  For a period of time he and his wife were regular churchgoers

Mr. Murphy claims he contributed between $100 and $200 each time he went to church for a total of $300 to $500 each week. While Lake Avenue Church did provide envelopes for contributions, petitioners did not use them. In addition to contributions to Lake Avenue Church, petitioners contend they made small contributions to San Gabriel Union Church and St. Mark's Episcopal School. Both Mr. Murphy and his daughter attended St. Mark's Episcopal School. Mr. Murphy asserted that the total amount of tithing to the two churches and the school was approximately $20,000.

The Tax Court pointed Mr. Murphy to the substantiation rules for charitable contribution.  I'd like to believe Mr. Murphy, but I don't recall any news reports of church ushers dying from shock when they found portraits of Benjamin Franklin in the collection plate so I'm a little skeptical.


U.S. v. BOWDEN, Cite as 106 AFTR 2d 2010-7195, 11/30/2010

Tentative title for this one was "King David Headed for the Clink".

Wesley David Bowden appeals his conviction on six counts of attempted tax evasion and his six concurrent prison terms of 24 months each. The Government has moved to dismiss the appeal as frivolous or for summary affirmance or, alternatively, for an extension of time.

Bowden asserts that the only issue on appeal is whether the district court had jurisdiction to convict him. He contends that it did not because he is a sovereign and not subject to the laws of the United States.

The Court found his appeal to be frivolous.  So maybe he should try jester rather sovereign.

NEVADA PARTNERS FUND, LLC v. U.S, Cite as 105 AFTR 2d 2010-2133, 04/30/2010

At the October 2, 2001, meeting, Williams and his attorneys met with KPMG agent Donna Bruce, who understood that the purpose of the meeting was to alleviate large gains arising from the B.C. Rogers note exchange, having been informed that the gain would amount to nearly $20,000,000.00. She told Williams that KPMG had been recommending to its clients facing the imminent prospect of large ordinary and capital gains a new strategy to be pursued through an investment advisor experienced in financial structure, hedge funds and more exotic forms of investment designed to provide tax benefits. Bruce named several investment advisors to be considered by Williams, including a hedge fund called Bricolage, LLC, in New York City, an entity owned and managed by one Andrew Beer.

Another convoluted KPMG deal that didn't work out as intended.  I think I'm going to stop studying these things as I might get confused by them.

CCA 201048043


Tentative title was "Say What ?" I really don't know what they are talking about here.  I suppose if I ran down the references I would have a clue, but I don't think I'll bother.  Hope it is nothing important.
UIL No. 6227.00-00
Release Date: 12/03/2010
ID: CCA_2010102109152937
Release Date: 12/3/2010 Office: —————
UILC: 6227.00-00

From: —————————- Sent: Thursday, October 21, 2010 9:15:31 AM To: —————————— Cc: —————- Subject: RE: TEFRA question ————-


Correct. If an NBAP has been issued, then any AAR issues would be resolved in the FPAA and no separate petition of the AARs could be filed. I.R.C. 6228(a)(2)(B). In addition, we cannot issue any affected item notices of deficiency until after the partnership proceeding is complete. GAF v. Commissioner.

EMMANUEL OWENS v. COMMISSIONER OF INTERNAL REVENUE, TC Memo 2010-265

Mr. Owens is a corrections officer in a state system.  The way the judge in this decision kept emphasizing that he had signed one return under pains and penalties or perjury and then an amended return with a significantly different position also under such pains and penalties, I was thinking the judge was hinting that he could end up in a federal facility in a capacity other than as corrections officer.  His original return had $22,921 in unsubstantiated schedule A job related deductions.  The amended return moved them to Schedule C.  They remained unsubstantiated and thus non-deductible.  Fairly typical tax court case, but I found it a little amusing.

Well, I'm back to studying the tax bill.  You won't be learning about it here unless there is something quirky that is not being heavily noticed.

Does Cohan Still Rule ?

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

COHAN v. COMMISSIONER OF INTERNAL REVENUE, Cite as 8 AFTR 10552, 03/03/1930

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:




P.S.

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.

And Another Purge

This was originally published on PAOO on November 17th, 2010.

I was starting to worry about running out of material, but my last ramble through the hottest stuff on RIA indicated that I am well supplied for a while, so I will continue purging those items that I just couldn't seem to turn into a full length post. I thought they were worth sharing when I first saw them though and have looked at them each a dozen or so times since then, so I hate to let them go without a little salute.


Henry A. Williams v. Commissioner, TC Summary Opinion 2010-125

had a fairly messy set of facts. The bottom line is that when it comes to deducting alimony, oral agreements are not worth the paper they are printed on.

Anthony Cicciarella, et ux. v. Commissioner, TC Memo 2010-195 was about medical expenses, but the issue was really just substantiation. The taxpayers had a not unusual amount of lameness, telling the court that they had "researched" the wrong year, but best of all that some of their records were destroyed in a flood. Unfortunately the flood occurred before the records would have been produced. I was going to title the post "Antediluvian".

THE HENRY E. & NANCY HORTON BARTELS TRUST v. U.S., Cite as 106 AFTR 2d 2010-6004

was a good example of an "is what it is" decision. The exempt trust was taxable on UBIT from securities transactions that it had entered into on margin. Trust's attempt to sidestep statute's clear language with claim that UBIT was really meant only to apply in case of unfair competition was off base since statute was clear and didn't limit UBIT in manner suggested.


More Fun For Landlords

was a title of a post I was working on about the extension of 1099 requirements to landlords. The cautionary note that I wanted to make is the language in several IRS audit manuals :

The examiner must be aware of the potential of the information return test work because it can often lead to significant tax dollars which the primary return (corporate, partnership, or individual) may not produce. Large adjustments can be produced through back-up withholding, return penalties, and even on the returns of the payees who were required to report the compensation but did not receive information returns.


If you were supposed to send somebody a 1099, you were supposed to ask them for their social security number of EIN. Since you didn't ask they didn't give it to you. Therefore you should have subjected their payments to back up withholding. It's a nightmare. You can get out of the back-up withholding by getting them to sign a form swearing they reported the income. Good luck.
Rev. Proc. 2010-36, 2010-42 IRB, 09/30/2010

gives taxpayers a special procedure for claiming a casualty loss from corrosive drywall :

An individual who pays to repair damage to that individual's personal residence or household appliances that results from corrosive drywall may treat the amount paid as a casualty loss in the year of payment.

Taxpayers who have a pending claim for reimbursement may deduct 75% of the amount they spend for repairs in the year they spend it. The loss is claimed on Form 4864 and taxpayers should mark "Revenue Procedure 2010-36" on the top of the form.

Joel P. Arnold v. Commissioner, TC Memo 2010-223

I found the IRS and the Tax Court a little mean spirited in this one. The taxpayer worked as a field auditor for the State of Georgia. He was allowed to check out a state vehicle for his work, but if he travelled more than a certain distance he was required to stay over. This would prevent him from going home to his chronically ill son. So he used his own car and claimed mileage which was disallowed. On the other hand they did allow his job hunting expenses, which were based on the same motivation.


ARGYLE v. COMM., Cite as 106 AFTR 2d 2010-6759 10/14/2010



The taxpayer is a CPA, appealing a Tax Court decision, pro se (That means fool for a client). He tried to file as single even though his divorce had not gone through. He was also trying to deduct legal expenses for criminal proceedings for simple assault, the assault being a kiss. Seemed like an interesting story, but ultimately I couldn't make anything much out of it.

Willard R. Randall v. Commissioner, TC Summary Opinion 2010-163

Mr. Randall was entitled to $69,000 in property equalization from his ex-spouse. He offset the amount against alimony that he was required to pay. The IRS wanted to deny the deduction, but the taxpayer won. I was going to title the post "Still Better to Swap Checks", but as I read it more closely I saw that it was possible that check swapping might not have been a viable alternative (e,g, if the property being equalized was illiquid). It does illustrate the principle that your life will be simpler in the long run if you don't skip transaction steps.

You Should Wear Shoes in Tax Court But Don't Bring the Box

Thomas F. Hale v. Commissioner, TC Memo 2010-229

This was originally published on October 27th, 2010.

Over 500 years ago Fra Luca Bartolomeo de Pacioli published a text book Summa de arithmetica, geometria, proportioni et proportionalita.  Included in the text book was a description of the methods that Venetian merchants used to keep accounts.  The method, known as double-entry became remarkably popular.  During the 1980's a product known as Quicken tried to abolish double entry to the delight of many small businesses and the consternation of the world's accountants.  The makers of Quicken, thankfully, came out with Quickbooks.  Now double entry is there behind the scenes.  Not as many people have to learn it anymore.

Even before computers became fairly pervasive, there were people who didn't want to learn double entry.  I used to think that was odd, but then I realized that other people didn't break license numbers down into their prime factors while driving, so maybe I was the peculiar one.  If such a person needed to do record keeping there was a solution.  We used to call then "Dumb" books, but after I studied them some, I came to admire them.  I only once saw somebody work the whole system thoroughly, but they did work.  One-write was probably better, but Dome books worked.  So I am glad to see that they still exist and can be purchased from Amazon.

Thomas Hale might have been well advised to purchase a Dome book.  Thomas Hale was a professor at Idaho State University, an attorney and a landlord.  God bless him, I can see why he never got to double entry.  The IRS claimed that he understated his rental income and legal fees and claimed unsubstantiated deductions for 2003, 2004 and 2005 assessing tax deficiencies totaling over $60,000 and penalties over $10,000. Professor Hale petitioned the tax court. Things did not go that well.

 At trial, petitioner introduced into evidence approximately 317 pages of uncategorized photocopies of receipts, canceled checks, invoices, and similar documents. He also offered copies of Federal and State tax returns that he had submitted to respondent during respondent's examination. He made no attempt to tie that evidence to respondent's adjustments underlying the deficiencies in question. At the conclusion of the trial, we set a schedule for briefing and provided petitioner with detailed instructions as to the form and content of briefs, directing him to Rule 151(e), which addresses that subject. In particular, we cautioned him to set forth in response to each adjustment made by respondent the facts in evidence that he believed supported his claim that respondent erred in making that adjustment. Petitioner failed to file any brief.


I must admit that I have not studied Rule 151(e).  This case, however, should not have gotten beyond the agent level without categorizing the various receipts and cancelled checks and tying them to the tax return. That appears to be what the Tax Court was looking for.

 In support of his claim that his only income was what he reported on his return and he has adequately substantiated all of his deductions, petitioner offers us what amounts in effect to a shoebox full of papers. Petitioner has ignored our specific instructions that he link his evidence to respondent's adjustments. We need not (and shall not) undertake the task of sorting through the voluminous evidence petitioner has provided in an attempt to see what is, and what is not, adequate substantiation of the items on petitioner's returns

Professor Hale taught European history.  Europe has had an awful lot of history so his unfamiliarity with Fra Pacioli's contribution might be understandable.  A Dome book would have done the trick for him though.  Another possibility might be the deduction summary guides offered by a much more seasoned tax blogger than myself. Robert Flach still prepares tax returns by hands distrusting the "flawed software" that most of the rest of use. 

What you can't tell from reading the case is to what extent Professor Hale was denied deductions that would have been legitimate, if they had been substantiated. Assuming they were significant, he could have saved himself quite a bit by engaging a tax professional at some point in the process.

You Have to be Able to Keep Your Face Straight

This was originally published on PAOO on August 9th, 2010.

Willie J. Moore, et ux. v. Commissioner, TC Summary Opinion 2010-102 is a good illustration of the principle that Summary opinions make up in entertainment value what they lack in precedent. The issue was car and truck expense totalling just over $36,000 supported by logs recording approximately 94,000 business miles driven in three cars. Mr. Moore was an employee of the City of Houston, but also worked as a mortgage broker and a real estate agent. From the case:

At trial, petitioners introduced two Excel spreadsheets that petitioner described as mileage logs for the Mercedes-Benz and the Cadillac. The mileage log for each vehicle consists of a 12- page spreadsheet with one page for each month of the year and an entry for each day of the month. Each daily entry includes the beginning and ending odometer readings, the total “deductible business miles driven” and the total “nondeductible commuting miles driven”, and the destination and “business reason” for the “business miles driven”. For all entries, the beginning odometer reading matches the ending odometer reading for the previous entry.

On petitioner's mileage log the entry for “business miles driven” typically exceeds 100 miles per day and occasionally is over 200 miles per day. For every Monday through Friday throughout the year petitioner listed 60 commuting miles; these miles were included on the log even for those days that petitioner admitted were holidays for his City of Houston position. ...... The daily entry for Thanksgiving Day 2004 indicates that petitioner commuted to his City of Houston job and also drove 119 miles to “preview bank foreclosure” at some undisclosed location; the daily entry for Christmas Day 2004 indicates that petitioner drove 150 miles to Hempstead, Texas, to “preview property for investment”. Daily entries were not made on January 31, February 29, July 31, and October 30 and 31.
On Mrs. Moore's mileage log the entry for “business miles driven” also typically exceeds 100 miles per day and is as much as 345 miles for a single day. Every day, Sunday through

Other than the commuting miles, petitioner's log includes no personal miles whatsoever. Saturday, includes an entry of 15 commuting miles. ... The daily entry for Thanksgiving Day 2004 indicates that Mrs. Moore commuted 15 miles and drove 95 business miles from La Marque to Galveston to “place ad in newspaper/visit client”.
Petitioners contend that these vehicles were used solely for business and not for any personal purpose (other than commuting) such as going to church or to the grocery store. According to petitioner, “anytime you're moving, you're actually in business”. So, for example, “when you drive to the grocery store, you will transact business.” In this regard, when asked by the Court what part of the grocery store was most conducive to conducting his business, petitioner replied as follows:

MR. MOORE: I would say the meat section, where they have the chips and all that good stuff. That's where people stop, and the fruit section; that's where I, you know—and if you're an agent and people know you're an agent, they will stop you and you will—you know, just have a conversation with them. If they're in the store and you pass a [business] card out.

THE COURT: I mean, do you wear a sign that says, I'm an agent, and stop them-- MR. MOORE: No. This is only the people that know you, not strangers. You know, this would be individuals who live in the same community you live in and may have wanted to talk to you but haven't seen you. When they get to chance to see you—it might be a church member, you know, a deacon at the church *** . We find petitioner's theorem regarding the transmutation of nondeductible personal expenses into deductible business expenses through kinesis to be so fundamentally flawed that we reject it without further discussion, and we move on to a consideration of the proffered mileage logs.

The mileage logs are, of course, the bedrock of petitioners' case. Unfortunately for petitioners, we are unable to accept those logs at face value because we are not convinced that they reliably record petitioners' use of their automobiles. By way of example, we point to the following.


Petitioner's mileage log claimed commuting miles for several days that were holidays for his full-time position with the City of Houston. In addition, petitioner stated that “my commuting miles include occasional *** personal use”; however, petitioner's log shows the same 60 commuting miles for each entry Monday through Friday.

Petitioner also stated that some personal miles were included in business miles because, as previously quoted, “any time you are moving, you're actually in business”. Although petitioner stated that he worked every day of the year, the log for his vehicle is missing entries for several days; nevertheless, the ending odometer reading from the last entry before the skipped day or days is the same as the beginning odometer reading of the next entry. Petitioner argued that the log is not “incorrect”, but he did admit that there are some days on which “there might have been an error on the log.”


Mrs. Moore's mileage log lists 15 commuting miles for each day except for the 5 days for which there is no entry. However, the mileage from League City, where petitioners' home is located, to La Marque is approximately 13 miles. Thus, round trip travel or commuting miles from petitioners' home to the La Marque office is approximately 26 miles. Therefore, every entry for commuting miles on Mrs. Moore's mileage log is understated by approximately 11 miles.


Finally, petitioners were unable to produce third-party records of their vehicles' odometer readings, such as service records, for 2004 or any other year, or any other evidence which might support the claimed mileage.

There didn't seem to be any doubt that Mr. Moore actually had the two businesses and used his cars so you would think that the court would have allowed him something. Maybe you think Mr. Moore was being a smart negotiator by starting high. I could really delude myself and say you might be thinking about my post of December 30 which explains the Cohan rule. Unfortunately, automobile expenses are covered under Code Section 274, which takes them out of the Cohan rule. Which means if you don't have good records, you get nothing, which is what Mr. Moore got.

Cohan Rules

Originally published in PAOO December 30, 2009.

Every tax geek who visits New York should be sure to stop at Times Square to pay respects to the founder of one of our great principles - The Cohan Rule.  As a Broadway producer Cohan had to spend lots of money entertaining and the like.  The court thought that even though he didn't have any receipts, he must have spent something and the IRS should recognize that.

Sadly the scope of the Cohan rule is constantly narrowed by legislation.  Cohan, himself, would have been nailed by Code Section 274 and you can no longer deduct all the cash you put in the collection plate every Sunday.

The rule still has validity in other areas.  So when you are audited and you don't have receipts, try to have a good story.  If it works, you should be sure to give your regards to Broadway.