January Tax Decisions
By Cody R. Gackle on March 1, 2022
-
Cody R. Gackle
View Bio
Rare Taxpayer Victory in Case Involving the Strict Substantiation under Section 274(d). Nelson v. Commissioner, Docket no. 892-19 (no precedential effect).
Of the four cases the Tax Court decided this month regarding strict substantiation under section 274(d), only one taxpayer prevailed. Section 274(d) provides that certain expenses, such as vehicle mileage, travel expenses, and unreimbursed employee expenses, are not deductible unless the taxpayer substantiates the deductions with adequate records or sufficient evidence corroborating his or her own statement that establish: (1) the amount of the expense, (2) the time and place of the travel or use of the property, and most importantly (3) the business purpose of the expenditure.
In a bench opinion, the Tax Court held that the taxpayer was entitled to deduct travel and unreimbursed employee expenses. The taxpayer was employed as chief of operations for a skin care company with its principal place of business in Washington, D.C. As part of his duties, the taxpayer managed the company’s bottling and distribution activities located in Dallas, TX. Taxpayer regularly flew to Dallas and stayed in hotels for up to three weeks at a time. The exhibits the taxpayer presented corroborated the taxpayer’s credible testimony that expenses for out-of-town lodging, air travel, and car rental were deductible unreimbursed employee expenses. The exhibits included receipts and annotated bank and credit card statements as well as the taxpayer’s testimony and detailed categorization of expenses.
Eastern District of Virginia affirms deduction for punitive damage award payment. Altria Group, Inc. v. United States, No. 3:19-cv-00910 (E.D. Va. Jan. 19, 2022).
After judgment against Phillip Morris in a negligence and fraud suit, Phillip Morris paid the State of Oregon over $100 million. Altria Group, Inc. (“Altria”), as the parent company of Phillip Morris, amended its tax return to deduct the entire portion of the punitive damage payment paid to the plaintiff and a portion of the punitive damages award paid to Oregon. IRS allowed the deduction for the award paid to the plaintiff but disallowed a deduction for the punitive damage award paid to Oregon. The IRS argued that the payment made to Oregon was disallowed deduction under Section 162(f) as a fine or similar penalty paid to a government for the violation of the law. Altria paid the tax and interest resulting from the IRS adjustment and then filed a claim for refund.
The court determined Altria was entitled to a refund for the amount of the punitive damage award paid to Oregon because the amount was not barred by Section 162(f).
The issue was whether Section 162(f) prevented Altria from claiming as an ordinary and necessary business expense deduction the portion of a punitive damage award that was paid to Oregon pursuant to Oregon’s “split recovery statute.” Section 162(f) prevents a deduction for “any fine or similar penalty paid to a government for the violation of any law.” Pub. L. 112-10 (Apr. 15, 2011).
The Oregon “split recovery statute acts as a default payment scheme to allow the State to help finance a fund to be used to compensate victims of crime.” Further, the court concluded that the statute “does not act to punish the party against whom the punitive damage award was made.”
Thus, while Altria did pay part of the award to a government, the punitive damage award was not for a fine or similar penalty. Altria paid Oregon a portion of the award in the negligence and fraud case because the Oregon split recovery statute intervened, establishing Oregon as a judgment creditor of the award. Without the split recovery statute, the court concluded, the entire punitive damage award would have gone to plaintiff.
The Ninth Circuit clarifies when the statute of limitations runs in evasion of assessment cases under Section 7201. United States v. Orrock, No. 19-10388 (9th Cir. Jan. 26, 2022).
The Ninth Circuit affirmed the district court’s interpretation of the statute of limitations, holding the statute of limitations for evasion of assessment cases is the same as the statute of limitations for evasion of payment cases.
In 2007, the taxpayer, through his partnership, organized the sale of certain undeveloped real estate but did not report any income from the sale. In 2011, after the IRS began auditing the taxpayer’s 2007 return, the taxpayer reported the gain from a sale of land on his partnership return rather than reporting the gain on his personal tax return in 2007 when the sale occurred.
In 2016, a grand jury indicted the taxpayer on three felonies and the taxpayer argued that the statute of limitations had run. The district court disagreed, holding that the government sufficiently alleged the taxpayer committed an affirmative act of evasion in 2011.
A jury convicted the taxpayer on all counts and taxpayer appealed, contending that the six-year limitations clock began in 2009 when he filed his 2007 personal return that omitted the income from the sale of undeveloped property.
The Ninth Circuit agreed with the government that while the statute of limitations can begin once all the elements of the offense are satisfied, the limitations period may restart from the last affirmative act furthering the tax evasion. Thus, when the taxpayer committed another, final act of evasion in 2011, when he filed the partnership tax return, the six-year statute of limitations restarted.
Eleventh Circuit affirms FBAR penalties against taxpayer but holds the district court does not have the authority to recalculate taxpayer’s penalties, remanding the case back to IRS for penalty calculation. United States v. Schwarzbaum, No. 20-12061 (11th Cir. Jan. 25, 2022).
The taxpayer was a naturalized U.S. citizen with several foreign bank accounts in Switzerland and Costa Rica. The taxpayer used a CPA to prepare his U.S. tax returns and reviewed the FBAR instructions prior to reporting some of his foreign accounts. During tax years 2006-2009, the taxpayer either did not file an FBAR or only disclosed two of his thirteen foreign bank accounts. In 2011, the taxpayer voluntarily disclosed to the IRS the existence and balances of the eleven foreign bank account he had previously failed to report. In 2013 and 2014, the IRS imposed civil penalties of $13.7 million after determining the taxpayer willfully violated the FBAR reporting requirements. The IRS calculated the taxpayer’s penalties by using the highest annual balances for the foreign accounts the taxpayer failed to report during 2006-2009, for a total potential penalty of over $35 million. The IRS then mitigated the penalties by zeroing out the penalties in 2006, 2007, and 2009.
The taxpayer did not pay the penalties and the IRS filed a suit to collect. After a bench trial, the district court determined the taxpayer willfully violated the FBAR reporting requirements and concluded the IRS miscalculated the taxpayer’s FBAR penalties. 31 U.S.C. § 5321(a)(5), (C)(i), and (D)(ii) provide that the maximum penalty for willful FBAR violations is the greater of $100,000 or 50% of the “balance in the account at the time of the violation.” Because the IRS did not calculate the balance in the undisclosed accounts as of June 30 (the annual deadline to file an FBAR), the district court determined the IRS miscalculated the FBAR penalty. The district court then recalculated the taxpayer’s FBAR penalties based on the June 30 balances, arriving at new penalties of $12.9 million.
The Eleventh Circuit upheld the district court’s determination that the taxpayer willfully violated the FBAR reporting requirements. While the taxpayer did not knowingly violate the FBAR reporting requirements, the Eleventh Circuit reasoned, the taxpayer did act recklessly when he reviewed the FBAR instructions and then subsequently failed to report all of his foreign accounts. The Eleventh Circuit disagreed with the district court’s attempt at recalculating the taxpayer’s FBAR penalty, stating the Administrative Procedure Act (APA) does not give a district court the authority to do an agency’s job. Once the district court determined there was an error in the FBAR penalty calculations, the court should have remanded the penalties back to the IRS for recalculation.
Sixth Circuit found that the IRS need not notify the taxpayer of certain third-party summonses, following the literal language of the statute. Polselli v. Dep’t of Treasury, 23 F.4th 616 (6th Cir. 2022).
The taxpayer owed over $2 million in unpaid tax liabilities and the IRS investigated the location of taxpayer’s assets to satisfy those liabilities. The investigation revealed that the taxpayer had access to and use of bank accounts held in the name of his wife. The taxpayer was a long-time client of a law firm. Based on this information, the IRS issued administrative summonses to the banks of the taxpayer’s wife and lawyers in an attempt to collect over $2 million of the taxpayer’s unpaid liabilities. The IRS did not notify the taxpayers of the summonses, claiming the summonses were issued “in aid of the collection” of tax assessments and therefore the IRS was not required to notify the taxpayers.
The bank of the taxpayer’s wife notified her that the IRS had summoned her records and she petitioned to quash the summons in district court. The law firm also petitioned to quash after receiving notification from its bank of the summonses. The United States moved to dismiss the petitions for lack of subject-matter jurisdiction, arguing that the United States waived its sovereign immunity from suit only for parties entitled to notice of the summonses under the Internal Revenue Code. Under IRC Section 7609(c)(2)(D)(i), the IRS sought the bank records “in aid of the collection” of the taxpayer’s assessed liability, the government argued and therefore the taxpayers were not entitled to notice. The district court agreed with the government.
The Sixth Circuit affirmed the district court’s decision to dismiss the case for lack of subject-matter jurisdiction, holding that Section 7609 defines the scope of the United States’ sovereign immunity. While a narrow class of taxpayers petitioning to quash an IRS summons are not barred by sovereign immunity, the court explained, the bar of sovereign immunity generally remains. Section 7609 requires the IRS give notice to any person who is identified in such a summons; however, several exceptions exist. The relevant exception in this case relates to third-party summonses when the summons is issued in aid of the collection of tax. As the IRS summonses in this case fell squarely within that exception, the Sixth Circuit upheld the district court’s decision.
The Sixth Circuit joins the Seventh and Tenth Circuits in holding the IRS may issue a summons without notifying the taxpayer “as long as the third-party summons is used to aid in the collection of any assessed tax liability.” In the Ninth Circuit, the IRS may issue a summons to a third-party without notice only if “(1) the third party is the assessed taxpayer, (2) the third party is a fiduciary or transferee of the taxpayer, or (3) the assessed taxpayer has some legal interest or title in the object of the summons.”
For any questions about these decisions or any other criminal or civil tax-related matter, please feel free to contact Cody Gackle at (214)744-3700 or cgackle@meadowscollier.com.
Of the four cases the Tax Court decided this month regarding strict substantiation under section 274(d), only one taxpayer prevailed. Section 274(d) provides that certain expenses, such as vehicle mileage, travel expenses, and unreimbursed employee expenses, are not deductible unless the taxpayer substantiates the deductions with adequate records or sufficient evidence corroborating his or her own statement that establish: (1) the amount of the expense, (2) the time and place of the travel or use of the property, and most importantly (3) the business purpose of the expenditure.
In a bench opinion, the Tax Court held that the taxpayer was entitled to deduct travel and unreimbursed employee expenses. The taxpayer was employed as chief of operations for a skin care company with its principal place of business in Washington, D.C. As part of his duties, the taxpayer managed the company’s bottling and distribution activities located in Dallas, TX. Taxpayer regularly flew to Dallas and stayed in hotels for up to three weeks at a time. The exhibits the taxpayer presented corroborated the taxpayer’s credible testimony that expenses for out-of-town lodging, air travel, and car rental were deductible unreimbursed employee expenses. The exhibits included receipts and annotated bank and credit card statements as well as the taxpayer’s testimony and detailed categorization of expenses.
Eastern District of Virginia affirms deduction for punitive damage award payment. Altria Group, Inc. v. United States, No. 3:19-cv-00910 (E.D. Va. Jan. 19, 2022).
After judgment against Phillip Morris in a negligence and fraud suit, Phillip Morris paid the State of Oregon over $100 million. Altria Group, Inc. (“Altria”), as the parent company of Phillip Morris, amended its tax return to deduct the entire portion of the punitive damage payment paid to the plaintiff and a portion of the punitive damages award paid to Oregon. IRS allowed the deduction for the award paid to the plaintiff but disallowed a deduction for the punitive damage award paid to Oregon. The IRS argued that the payment made to Oregon was disallowed deduction under Section 162(f) as a fine or similar penalty paid to a government for the violation of the law. Altria paid the tax and interest resulting from the IRS adjustment and then filed a claim for refund.
The court determined Altria was entitled to a refund for the amount of the punitive damage award paid to Oregon because the amount was not barred by Section 162(f).
The issue was whether Section 162(f) prevented Altria from claiming as an ordinary and necessary business expense deduction the portion of a punitive damage award that was paid to Oregon pursuant to Oregon’s “split recovery statute.” Section 162(f) prevents a deduction for “any fine or similar penalty paid to a government for the violation of any law.” Pub. L. 112-10 (Apr. 15, 2011).
The Oregon “split recovery statute acts as a default payment scheme to allow the State to help finance a fund to be used to compensate victims of crime.” Further, the court concluded that the statute “does not act to punish the party against whom the punitive damage award was made.”
Thus, while Altria did pay part of the award to a government, the punitive damage award was not for a fine or similar penalty. Altria paid Oregon a portion of the award in the negligence and fraud case because the Oregon split recovery statute intervened, establishing Oregon as a judgment creditor of the award. Without the split recovery statute, the court concluded, the entire punitive damage award would have gone to plaintiff.
The Ninth Circuit clarifies when the statute of limitations runs in evasion of assessment cases under Section 7201. United States v. Orrock, No. 19-10388 (9th Cir. Jan. 26, 2022).
The Ninth Circuit affirmed the district court’s interpretation of the statute of limitations, holding the statute of limitations for evasion of assessment cases is the same as the statute of limitations for evasion of payment cases.
In 2007, the taxpayer, through his partnership, organized the sale of certain undeveloped real estate but did not report any income from the sale. In 2011, after the IRS began auditing the taxpayer’s 2007 return, the taxpayer reported the gain from a sale of land on his partnership return rather than reporting the gain on his personal tax return in 2007 when the sale occurred.
In 2016, a grand jury indicted the taxpayer on three felonies and the taxpayer argued that the statute of limitations had run. The district court disagreed, holding that the government sufficiently alleged the taxpayer committed an affirmative act of evasion in 2011.
A jury convicted the taxpayer on all counts and taxpayer appealed, contending that the six-year limitations clock began in 2009 when he filed his 2007 personal return that omitted the income from the sale of undeveloped property.
The Ninth Circuit agreed with the government that while the statute of limitations can begin once all the elements of the offense are satisfied, the limitations period may restart from the last affirmative act furthering the tax evasion. Thus, when the taxpayer committed another, final act of evasion in 2011, when he filed the partnership tax return, the six-year statute of limitations restarted.
Eleventh Circuit affirms FBAR penalties against taxpayer but holds the district court does not have the authority to recalculate taxpayer’s penalties, remanding the case back to IRS for penalty calculation. United States v. Schwarzbaum, No. 20-12061 (11th Cir. Jan. 25, 2022).
The taxpayer was a naturalized U.S. citizen with several foreign bank accounts in Switzerland and Costa Rica. The taxpayer used a CPA to prepare his U.S. tax returns and reviewed the FBAR instructions prior to reporting some of his foreign accounts. During tax years 2006-2009, the taxpayer either did not file an FBAR or only disclosed two of his thirteen foreign bank accounts. In 2011, the taxpayer voluntarily disclosed to the IRS the existence and balances of the eleven foreign bank account he had previously failed to report. In 2013 and 2014, the IRS imposed civil penalties of $13.7 million after determining the taxpayer willfully violated the FBAR reporting requirements. The IRS calculated the taxpayer’s penalties by using the highest annual balances for the foreign accounts the taxpayer failed to report during 2006-2009, for a total potential penalty of over $35 million. The IRS then mitigated the penalties by zeroing out the penalties in 2006, 2007, and 2009.
The taxpayer did not pay the penalties and the IRS filed a suit to collect. After a bench trial, the district court determined the taxpayer willfully violated the FBAR reporting requirements and concluded the IRS miscalculated the taxpayer’s FBAR penalties. 31 U.S.C. § 5321(a)(5), (C)(i), and (D)(ii) provide that the maximum penalty for willful FBAR violations is the greater of $100,000 or 50% of the “balance in the account at the time of the violation.” Because the IRS did not calculate the balance in the undisclosed accounts as of June 30 (the annual deadline to file an FBAR), the district court determined the IRS miscalculated the FBAR penalty. The district court then recalculated the taxpayer’s FBAR penalties based on the June 30 balances, arriving at new penalties of $12.9 million.
The Eleventh Circuit upheld the district court’s determination that the taxpayer willfully violated the FBAR reporting requirements. While the taxpayer did not knowingly violate the FBAR reporting requirements, the Eleventh Circuit reasoned, the taxpayer did act recklessly when he reviewed the FBAR instructions and then subsequently failed to report all of his foreign accounts. The Eleventh Circuit disagreed with the district court’s attempt at recalculating the taxpayer’s FBAR penalty, stating the Administrative Procedure Act (APA) does not give a district court the authority to do an agency’s job. Once the district court determined there was an error in the FBAR penalty calculations, the court should have remanded the penalties back to the IRS for recalculation.
Sixth Circuit found that the IRS need not notify the taxpayer of certain third-party summonses, following the literal language of the statute. Polselli v. Dep’t of Treasury, 23 F.4th 616 (6th Cir. 2022).
The taxpayer owed over $2 million in unpaid tax liabilities and the IRS investigated the location of taxpayer’s assets to satisfy those liabilities. The investigation revealed that the taxpayer had access to and use of bank accounts held in the name of his wife. The taxpayer was a long-time client of a law firm. Based on this information, the IRS issued administrative summonses to the banks of the taxpayer’s wife and lawyers in an attempt to collect over $2 million of the taxpayer’s unpaid liabilities. The IRS did not notify the taxpayers of the summonses, claiming the summonses were issued “in aid of the collection” of tax assessments and therefore the IRS was not required to notify the taxpayers.
The bank of the taxpayer’s wife notified her that the IRS had summoned her records and she petitioned to quash the summons in district court. The law firm also petitioned to quash after receiving notification from its bank of the summonses. The United States moved to dismiss the petitions for lack of subject-matter jurisdiction, arguing that the United States waived its sovereign immunity from suit only for parties entitled to notice of the summonses under the Internal Revenue Code. Under IRC Section 7609(c)(2)(D)(i), the IRS sought the bank records “in aid of the collection” of the taxpayer’s assessed liability, the government argued and therefore the taxpayers were not entitled to notice. The district court agreed with the government.
The Sixth Circuit affirmed the district court’s decision to dismiss the case for lack of subject-matter jurisdiction, holding that Section 7609 defines the scope of the United States’ sovereign immunity. While a narrow class of taxpayers petitioning to quash an IRS summons are not barred by sovereign immunity, the court explained, the bar of sovereign immunity generally remains. Section 7609 requires the IRS give notice to any person who is identified in such a summons; however, several exceptions exist. The relevant exception in this case relates to third-party summonses when the summons is issued in aid of the collection of tax. As the IRS summonses in this case fell squarely within that exception, the Sixth Circuit upheld the district court’s decision.
The Sixth Circuit joins the Seventh and Tenth Circuits in holding the IRS may issue a summons without notifying the taxpayer “as long as the third-party summons is used to aid in the collection of any assessed tax liability.” In the Ninth Circuit, the IRS may issue a summons to a third-party without notice only if “(1) the third party is the assessed taxpayer, (2) the third party is a fiduciary or transferee of the taxpayer, or (3) the assessed taxpayer has some legal interest or title in the object of the summons.”
For any questions about these decisions or any other criminal or civil tax-related matter, please feel free to contact Cody Gackle at (214)744-3700 or cgackle@meadowscollier.com.
