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October Tax Decisions

By Paul M. Budd on November 30, 2021
Taxpayer allowed to deduct alimony payments through his Section 125 cafeteria plan per Tax Court decision in Charles H. Leyh v. Commissioner, 157 T.C. No. 7 (Oct. 4, 2021).

In a case of first impression, the Tax Court held that a taxpayer could deduct alimony payments for his then-spouse's health insurance pursuant to separation agreement through his employer's Section 125 cafeteria plan wage withholdings. The IRS initially disallowed the alimony deduction, alleging it created a “windfall” to the taxpayer by granting him the practical equivalent of multiple deductions for the same expense. But the taxpayer petitioned the Tax Court, which disagreed with the IRS’s characterization of the transaction. The Tax Court found there was no question the payment met the applicable statutory requirement for alimony. While the taxpayer also excluded the payment from income under Code Sections 106 and 125, allowing the alimony deduction for the applicable tax year, for which he and his spouse filed their returns married filing separately, did not cause an impermissible double deduction under the matching design of the spousal alimony regime. Accordingly, the court found the taxpayer's deduction was “properly viewed as being matched against his [spouse's] alimony income, not against [the taxpayer's] excluded wage income.” Moreover, disallowing the deduction would violate the matching principle and result in an excess tax burden on the taxpayer. The Tax Court also dismissed the IRS's alternate argument, that Section 265 's rule barring a deduction for exempt income otherwise provided a “backstop” against the taxpayer's deduction. Thus, the Tax Court held the deduction was permissible under the Tax Code and entered its decision for the taxpayer.

IRS improperly assessed underpayment interest on a deficiency while it held overpayments from the taxpayers’ credit-elect funds, per Fifth Circuit decision in Goldring v. United States, No. 20-30723 (5th Cir. Oct. 4, 2021).

The Fifth Circuit overturned the IRS’s improper assessment of interest on a tax deficiency while the Government had receipt of sufficient overpayment credit-elect funds from the taxpayers to satisfy the deficiency. The case arose from an IRS audit and deficiency assessment for the taxpayers’ 2010 tax year. When the IRS assessed the 2010 deficiency, it also assed interest on the 2010 deficiency from the date the tax was due until the deficiency was paid--despite the taxpayers making sufficient credit-elect overpayments for 2010 and subsequent tax years to satisfy the deficiency.

After the taxpayers paid the 2010 deficiency, they filed a refund suit in district court. The taxpayers’ refund claim included a separate claim for a refund of the interest, which the taxpayers asserted was improperly assessed because they made advance credit-elect overpayments to satisfy the deficiency. The district court, however, disagreed with the taxpayers’ argument for a refund of the interest. Instead, the district court sided with the Government’s position that the interest accrual was proper because the Government was required to honor the taxpayers’ credit-elect overpayment under I.R.C. §§ 6402(a)-(b) and 6513(d), and could not redirect the payment to the earlier tax year to satisfy the deficiency.

The taxpayers, however, appealed the decision to the Fifth Circuit and prevailed. The Fifth Circuit cited the “use-of-money” principle in reversing the district court’s decision and granting the taxpayers’ claim for a refund of interest. Under the “use-of-money” principle, the Government had use of the taxpayers’ sufficient overpayment funds to satisfy the 2010 tax deficiency, regardless of the specific year the overpayment was applied to. Thus, the Government was never deprived of the use of the taxpayers’ overpayment funds, and the deficiency was not to the detriment of the Government's fisc. The Fifth Circuit also said the Government could not cite any clear, statutory authority to support its accrual of underpayment interest while holding sufficient credit-elect overpayment funds from the taxpayers to satisfy the deficiency. Accordingly, the Fifth Circuit reversed the district court's decision and awarded the taxpayers a refund of the interest improperly assessed on the tax deficiency.

Texas business owner liable for corporation’s taxes as alter ego of the business in Lothringer v. Commissioner, No. 20-50823, 128 AFTR 2d 2021-6305 (5th Cir., Oct. 8, 2021).

The Fifth Circuit affirmed the trial court’s decision holding an individual taxpayer personally liable for his corporation’s unpaid taxes as the alter ego of the business. The IRS assessed, and then filed suit, against the individual owner and his corporation to collect more than $1.7 million of unpaid taxes accrued by the business. The IRS assessed the owner personally liable for the unpaid corporate tax, alleging that the business was the alter ego of the individual taxpayer. Applying Texas law to the facts in the case, the district court agreed with the IRS, finding the individual (1) was the sole shareholder, officer, director, and owner of the business; (2) exercised complete dominion and control over the business; (3) failed to adhere to corporate formalities; (4) loaned substantial money to the business; and (5) paid his personal loans using the corporation’s bank account. As such, the facts supported the district court finding the individual owner liable for the unpaid business taxes under a theory of alter ego liability. The taxpayer appealed; however, the Fifth Circuit affirmed the district court’s decision.

Federal court splits the difference on FBAR penalties, sustaining willful penalties for two of the four tax years at issue in United States v. Hughes, (N.D. Cal. 3:18-cv-05931-JCS Entry 162, Oct. 13, 2021).

A federal court held a taxpayer’s failure to file FinCEN Forms 114 (“FBAR”) to report foreign bank accounts was a “willful” violation subject to the heightened penalty under 31 U.S.C. § 5321(a)(5)(C)(i) for two out of four tax years at issue. Conversely, the court held the taxpayer’s failure to file FBARs for the other two years was a “non-willful” violation subject to the lesser penalty under 31 U.S.C. § 5321(a)(5)(B)(i).

The distinguishing fact between the “willful” and “non-willful” FBAR violations? Schedule B.

The taxpayer was a bookkeeper who prepared her own tax returns. For tax years 2010 through 2013, she was required to file an FBAR to report her offshore bank accounts. For 2010 and 2011, the taxpayer did not include Schedule B with her Form 1040 tax return to report her interest and dividend income. This was notable because Schedule B specifically asks taxpayers if they had any foreign bank accounts and whether they must file an FBAR. Because the taxpayer did not include Schedule B with her 2010 or 2011 tax return, she did not answer these questions for either tax year. The taxpayer did, however, complete and attach Schedule B with her 2012 and 2013 tax returns, answering "yes" to both questions on Schedule B, thereby confirming her foreign bank accounts and acknowledging her FBAR filing requirements.

Of course, the taxpayer failed to file FBARs for any of the four tax years at issue, and the IRS assessed willful FBAR penalties for all four years. The Government then filed suit in federal court to enforce collection of the penalties, where both parties filed cross-motions for summary judgment asking the court to rule on whether the violations were willful.

On the issue of willfulness, the court ruled in the taxpayer's favor for the first two years, but ruled for the Government on the latter two years. For tax years 2010 and 2011, the court found the taxpayer’s failure to file FBARs was nonwillful because she did not file a Schedule B with her 2010 or 2011 return. The taxpayer had to sign both returns under penalty of perjury, certifying she examined the returns and accompanying statements. And because she did not include Schedule B with either return, the court found no indication the taxpayer reviewed Schedule B’s questions regarding her 2010 or 2011 foreign accounts or FBAR filing requirements. Thus, in the absence of any evidence the taxpayer was aware of her 2010 or 2011 FBAR filing requirement, the IRS failed to meet its burden to establish the taxpayer knowingly failed to file FBARs for 2010 or 2011. Accordingly, the taxpayer’s violations for 2010 and 2011 were deemed non-willful by the court.

By contrast, the court sustained the willful FBAR penalties for the 2012 and 2013 tax years based on the taxpayer’s inclusion of Schedule B with her 2012 and 2013 tax returns. Unlike the earlier years, the taxpayer completed Schedule B and affirmatively answered both questions acknowledging her foreign accounts and FBAR filing requirements. Accordingly, the court found “no doubt” the taxpayer was aware of her FBAR filing requirement for 2012 and 2013. Thus, her failure to file FBARs for the later two years was a knowing, willful violation subject to the heightened penalty under 31 U.S.C. § 5321(a)(5)(C)(i).

Tax Court grants innocent spouse claim for relief in Todisco v. Commissioner, T.C. Summ. 2021-35 (Oct. 13, 2021).

The Tax Court granted a taxpayer’s claim for innocent spouse relief for multiple tax years for which she filed a joint tax return with her husband. The taxpayer filed a joint tax return with her husband for tax years 2010 through 2015. During this time, the taxpayer did not work and earned no income of her own, while her husband worked construction and generated substantially all of their household income. The IRS subsequently audited their 2010 and 2015 joint return and issued a notice of deficiency proposing additional tax based on the disallowance of certain job-related deductions claimed by the taxpayer’s husband.

The taxpayer divorced her husband in 2016 and filed a claim for innocent spouse relief with the Tax Court, seeking relief from the 2010 and 2015 tax deficiencies. As with most innocent spouse cases, the taxpayer’s case required a fact-intensive analysis by the Tax Court on two questions under I.R.C. § 6015(b)(1): whether the taxpayer had reason to know of the understatements of tax, and whether it was inequitable to hold her liable for the tax deficiency based on the facts and circumstances.

On the first question, the taxpayer testified at trial that she did not know any details about her ex-husband’s job-related expenses that were disallowed during the IRS audit. She further testified that she had no involvement in the preparation of their tax returns and did not review the returns before she signed them. In addition, the taxpayer testified that she did not know what caused the tax deficiency and was not involved in the IRS audit. She was unaware of the IRS audit until she received the IRS notice of deficiency in the mail, and her former husband berated her when she asked him what the deficiency notice was about. Based on her credible testimony, the Tax Court found the taxpayer satisfied the first requirement under Section 6015(b)(1)(C) that she did not know about the understatement of tax.

The Tax Court next considered whether it would be inequitable to hold the taxpayer liable for the deficiency based on the facts and circumstances. Applying the facts in the case to the equitable factors in Rev. Proc. 2013-34, the court considered the taxpayer’s (1) marital status, (2) economic hardship, (3) knowledge or reason to know of the understatement of tax, (4) legal obligations, (5) significant economic benefit, (6) compliance with tax laws, and (7) mental or physical health. Based on these factors, the Tax Court concluded that equitable relief was warranted based on the facts and circumstances. Accordingly, the taxpayer satisfied all requirements for innocent spouse relief under Section 6015(b)(1), and the Tax Court granted her request for innocent spouse relief.

Taxpayers lose refund suit for Section 1341 claim of right deduction from trustee’s unauthorized sale of grantor trust’s restricted stock in Heiting v. United States, No. 20-1324, 128 AFTR 2d 2021-6362 (7th Cir. Oct. 18, 2021).

The Seventh Circuit affirmed the district court’s rejection of taxpayers’ claim for a refund from a deduction of trust income under the claim of right doctrine. The taxpayers were the grantors and beneficial owners of a grantor trust. The trust held different classes of securities, most of which the trustee had unconstrained authorization to trade. However, the trust held a few securities that the trustee was not authorized to trade without obtaining the taxpayers’ express authorization. The trustee inadvertently sold some of the trust’s restricted stock without the taxpayers’ authorization, which generated realized gains and taxable income on the taxpayers’ Form 1040 individual tax return. In a later tax year, the taxpayers discovered that the trustee violated the trust agreement by selling the restricted stock. Upon learning this, they filed a refund claim for a deduction attributable to the amount of income realized from the unauthorized sale of restricted stock in the earlier tax year under the claim of right doctrine. Under I.R.C. § 1341, the claim of right doctrine provides taxpayers may claim an offsetting deduction in a later tax year if they reported and paid tax on income in an earlier tax year on the belief they had an unrestricted right to the income during the reporting year, but discover in a later tax year they did not, in fact, have an unrestricted claim of right to the income already reported and included as taxable income in the earlier tax year.

The IRS denied the taxpayers’ initial refund claim and the taxpayers filed a refund suit in district court. The district court, however, dismissed the taxpayers’ refund case by granting the Government's motion for summary judgment on the claim of right issue.

On appeal, the Seventh Circuit affirmed the district court's dismissal of the taxpayers’ claim. In the Seventh Circuit opinion, the court said the taxpayers’ refund claim under the claim of right doctrine failed as a matter of law because the taxpayers did not establish an unrestricted right to the income realized from the trustee’s unauthorized sale of stock in the earlier tax year. The trustee’s inadvertent sale of the stock did not restrict or inhibit their right to the income from the stock sale. Nor did the trustee’s subsequent repurchase of the same amount of stock on a later date for a reduced price restrict the taxpayers’ claim of right to the income. The unauthorized sale of stock merely accelerated the taxable gain from the sale of the stock. Additionally, the taxpayers had not sought any legal recourse against the trustee to establish a legal obligation to return property or compensate the taxpayers for damages incurred from stock sale. Thus, there was no support for the taxpayers’ claim that their right to income from the sale of the stock was legally restricted in a subsequent tax year, and the appellate court affirmed the dismissal of their refund claim.

Tax Court sustains IRS levy against partner for partnership adjustments he failed to protest in partnership-level proceedings in Ronald M. Goldberg v. Commissioner, No. 12871-18-L, T.C. Memo 2021-119 (Oct. 19, 2021).

The Tax Court upheld the IRS's administrative collection determination to proceed with the proposed levy of a taxpayer’s outstanding tax liability from partnership adjustments to his oil and gas interest. The taxpayer requested a Collection Due Process appeals hearing to protest the liability and challenge the limitations period on the assessment from the underlying partnership proceedings. However, the taxpayer was required to properly assert these arguments at the partnership-level, which he failed to do. The taxpayer claimed he was unable to participate in the partnership-level proceedings because he never received a notice of the beginning of administrative proceedings (“NBAP”) that resulted in the conversion of his partnership items to non-partnership items for which the assessment limitations period had expired. However, the taxpayer’s argument failed because the lack of an NBAP did not result in the automatic conversion of partnership items. Rather, the final partnership administrative adjustment (“FPAA”) was the operative notice which the taxpayer should have challenged at the partnership level. And based on the facts, it was clear he had actual notice of the partnership-level proceedings but did not file a timely protest. In addition, the taxpayer was barred from challenging the underlying liability in the Collection Due Process hearing and subsequent Tax Court proceedings because he had a prior opportunity to challenge the liability in response to an earlier lien notice under Section 6320. And the Tax Court found the IRS record showed the IRS Appeals settlement officer followed proper procedures for sustaining the levy. Thus, the Tax Court sustained the levy.

Ninth Circuit affirms civil fraud penalty against married taxpayers in Chico v. Commissioner of Internal Revenue, No. 20-71017, 128 AFTR 2d 2021-6266 (9th Cir. Oct. 26, 2021).

The Ninth Circuit affirmed the Tax Court’s decision finding married taxpayers liable for a civil fraud based on the facts in the record. The Ninth Circuit held the Tax Court did not err in finding clear and convincing evidence of fraud based on the facts in the record as applied to the six badges. Applying the badges of fraud to the taxpayers’ case, the Tax Court found the taxpayers 1) understated their income by more than $275,000 over three years; 2) produced no adequate records to substantiate the figures reported on their tax returns; 3) failed to file tax returns for their business despite multiple requests by the IRS revenue agent auditing their returns; 4) unreasonably attributed their underreported income to nontaxable investments from an inheritance, despite the IRS revenue agent identifying these transfers has nontaxable; 5) concealed business income failing to report constructive dividends and reporting only some of the income they received from the business, and 6) failed to cooperate with the IRS revenue agents investigation by ignoring information and interview requests and blaming their attorneys for failing to produce adequate records. Additionally, the taxpayer-husband was a paid tax return preparer. Thus, his specialized knowledge and experience in corporate and business taxation further supported the fraud penalty.

IRS prevails on jurisdictional argument concerning statute of limitations on FBAR penalty assessments in United States v. Solomon, No. 9:20-cv-92236 (S.D. Fla. Oct. 27, 2021).

In yet another FBAR case, a federal court denied a taxpayer's claim that FBAR penalties were barred by the statute of limitations on assessment. The IRS brought suit to enforce collections of a nonwillful FBAR penalty assessed against a taxpayer for multiple tax years. In court, the taxpayer filed a motion for summary judgment, asserting the court and Government were barred from enforcing the FBAR penalties on jurisdictional grounds because the IRS assessed the penalties after the six-year statute of limitations on FBAR penalty assessments expired under 31 U.S.C. § 5314.

The issue was whether the taxpayer could voluntarily waive the assessment statute after it expired. During the audit, the taxpayer signed an IRS form consenting to extend the time to assess civil penalties for failure to file FBARs, however, the statute extension was signed after the applicable FBAR assessment periods had expired. In the district court, the taxpayer argued that because she signed the consent to extend the assessment period after the assessment period expired, her late-signed waiver form had no legal effect, the subsequent FBAR penalty assessments were untimely, and the district court had no jurisdiction to enforce the untimely penalties. Thus, the taxpayer argued that the FBAR assessment statute is a jurisdictional defense that cannot not be waived after it expires, much like the Tax Code’s statute of limitations on tax assessment under 26 U.S.C. § 6501 cannot be waived after it expires.

The court, however, disagreed with the taxpayer's argument that the Title 31 FBAR penalty assessment limitation statute mirrored the Tax Code’s assessment limitation statute. Instead, the court adopted the Government's position that the FBAR penalty statute of limitations is not a jurisdictional defense, but an affirmative defense that a taxpayer may waive at any time, even after the assessment period has lapsed. And because, in the court’s opinion, the FBAR assessment limitation statute is not a jurisdictional defense, the taxpayer could (and did) consent to waive the affirmative defense to an untimely assessment by signing the consent to extend the assessment period, even after the assessment period had lapsed.

In distinguishing Title 31’s FBAR assessment statute from the Title 26 Tax Code assessment statute, the court noted: "the key inquiry in determining if a limitations period can be waived is ‘whether it limits courts’ subject matter jurisdiction—in which case its time bar is not waivable—or is instead a non-jurisdictional claim processing rule—in which case waiver is permissible.’” Because 31 U.S.C. §5321(B)(1) makes no reference to a court's jurisdiction, the court concluded that the FBAR assessment statute operates merely as an affirmative defense, not a limit to the court’s jurisdiction. Thus, the court held the FBAR penalty assessment was timely because the taxpayer waived her affirmative defense under the assessment limitation statute by singing the consent to extent the assessment period, regardless of when the consent was signed.

The taxpayer has since appealed the decision to the Eleventh Circuit.
***
For any questions about these decisions or any other civil tax-related matters, please feel free to contact Paul Budd at (214)749-2442 or pbudd@meadowscollier.com.