Caudle v. IRS, T.C. Memo. 2014-196 (Sept. 24, 2014).
The Tax Court clerks must have put in overtime last weekend because several opinions were released last week. One of these, Caudle v. IRS is a portrayal of what might happen if a taxpayer decides not to file a 1040 at all. There, the taxpayer (from Front Royal, Virginia) failed to file in both 2005 and 2006. Id. at p. 2. Consequently, the IRS calculated what it expected the taxpayer to have paid based on W-2s, 1099s, and other income reporting documents filed by her employers (a Substitute for Return). It then mailed the taxpayer this information via certified mail. She did not respond, so the IRS began the process of levying her tax debt against her property (Letter 1058). Id. at p. 3.
At that point, the taxpayer requested a Collection Due Process hearing, which is actually possible by phone. However, the hearing officer required the taxpayer to identify sources of income and wealth from which to pay what the IRS had determined to be her tax debt, 1040s from the four years surrounding the two tax years at issue (from 2004 to 2009) as well as estimated payments in 2010. The taxpayer was unable to comply prior to the phone hearing, at an in-person hearing, or by means of mail correspondence. Ultimately, the Settlement Officer sent the taxpayer a Notice of Determination Concerning Collection Action. Id. at p. 4.
The Tax Court has the power to review these collection determinations, which was invoked by the taxpayer in this case. However, the standard of review is highly deferential where the taxpayer has failed to properly place the underlying tax debt at issue. Id. at pp. 5-6. That is, the Court reviews the IRS administrative determination for an “abuse of discretion.” After reviewing the steps taken by the IRS for compliance with the procedural due process requirements of federal tax law, the taxpayer’s tax debt was affirmed. Id. at pp. 10-11.
This case is not very legally significant, but it is instructive for anyone who has ever wondered what could happen if one simply failed to file a 1040. Strategically, this case demonstrates one of the worst ways to get to the Tax Court.
Bohner v. IRS, 143 T.C. 11 (Sept. 23, 2014).
Certain retirement plans qualify for favorable tax treatment. These can include government retirement system accounts, ERISA plans, and IRAs, to name a few. Some plans, like an IRA, allow for the receipt and investment of income prior to paying income taxes thereon. See IRC § 408. A transfer of money between these special retirement plans without loosing this favorable treatment is called a “rollover.”
In Tuesday’s Tax Court case of Bohner v. IRS, 143 T.C. 11, a divided court effectively held that tax treatment of these rollovers is governed by the Internal Revenue Code and by the rules governing the retirement plans themselves. There, the taxpayer attempted to rollover money from his IRA into his Civil Service Retirement System account. Despite his having satisfied the requirements of pre-tax IRA rollovers (§ 408(d)(3)(A)(ii), the Court held that he owed tax on the money taken out of his IRA that he put into is CSRS account. The majority (9 judges) found the fact that the federal laws and regulations governing the CSRS did not allow for IRA rollovers. Bohner at p. 10 (citing 5 U.S.C. § 8334(c) and 5 C.F.R. 831.303 (2001)). Therefore, the majority held that the money taken from Mr. Bohner’s IRA was taxable. Id. at pp. 10-11. The dissent (6 judges) remained unpersuaded—the IRC § 408(d)(3)(A)(ii) requirements were met, so the money distributed from the IRA should not be taxable because it was all deposited in the CSRS account. Bohner at pp. 28-29.
Look for an appeal in the 11th Circuit as a large portion of the Tax Court found itself in the minority, which, from a tax law perspective, was highly persuasive.
Salzer v. IRS, T.C. Memo 2014-188 (Sept. 16, 2014).
Every once in a while, a taxpayer decides not to pay taxes because they do not agree with the current administration/government and they do not want to support it. In case there was any doubt, doing so and then deriding the government before the Tax Court (a part of the government) has yet again been established as a losing litigation strategy. Salzer v. IRS, T.C. Memo 2014-188 (Sept. 16, 2014). The Tax Court was kind enough to reproduce Mr. Salzer’s tirade at length:
“We are citizens of the United States of America. We have paid taxes to what we thought was the United States of America. Apparently through the years, socialism has taken control of this country without us being aware of it. In 2008, George W. Bush asked the American people to accept socialism and Barak [sic] Obama has plowed straight ahead with tons more. We resoundingly reject it which is shown in our not having submitted a tax form for 2008 or 2009 and will not be doing so for 2010. We support the United States of America, the republic, the Christian nation; we do not support this socialist government that has hijacked Washington DC. God has said “Blessed is that country whose God is the Lord.” (Psalm 33:12) This government has shown nothing but malice toward the American people, has attacked our soldiers and veterans in various ways, has attacked our children at the public schools by trying to push wrong beliefs-- contrary to the Bible-- to them, has sexually assaulted our people at the airports in the name of security, is killing the unborn, has taken over car companies, have taken control of the banks, taking over our health care and sold us to China. We know what socialism is. Socialism is not “just another economic theory”. There is no good kind of socialism. It is an anti-Christian, anti-American and against the U.S. Constitution. It is about trying to control people and deprive them of what they need. Because of it, millions of people have died. We reject this whole heartedly. We do not want this happening to the people of this country or anywhere. This needs to stop now.
"We support the true United States of America. Once we get it back, we will submit our tax forms to it. In fact, we will be making every effort to be the first in line. It should be quite clear from our records that before these problems, we have always filed on time and correctly. But, until our government is returned, we will not submit your forms.”
Id. at pp. 4-5.
Irrespective of how you feel about the rhetoric, this is an example of what not to do before the Tax Court. Note, this is a "Memorandum" Opinion, which means the principles of law governing the outcome of this case were so well-established, the Court merely had to apply them as written to reach a conclusion. No new law or even an interpretation of old law was required to reach the conclusion in this case based on the arguments presented--not the litigating position one should aim for.
Virginia Attorney General Opinion No. 13-114 (January 2014).
Last month (August 2013), I posted about the United States v. Windsor (May 2013) and IRS Revenue Ruling 2013-17 (September 2013) via LinkedIn and Twitter. Recall, this Federal Supreme Court case and IRS opinion both held that same-sex couples would be afforded the same rights as heterosexual couples where they were legally married according to the laws of the location where such marriage was completed. Windsor thus “overruled” the Defense of Marriage Act (“DOMA”) insofar as it purported to usurp state power to define and recognize marriage. The Constitutional underpinning of this decision was the Federal Fifth Amendment protection for the “equal liberty of persons.” In short, if a state recognizes the legality of same-sex marriage, the Federal Government cannot act, via its tax laws, to deny that same-sex legally married couple the same tax benefits other heterosexual, legally-married couples receive.
This case and its reverberations through the legal world was seen as a victory for same-sex marriage advocates. However, Windsor is a very conservative approach to affording same-sex marriages the same legal dignity as heterosexual marriages. A January 2014 Attorney General Opinion from Virginia illustrates the “conservativeness” of Windsor quite well. Therein, the Virginia AG opines that the Virginia Governor has no authority under the State Constitution to order the Virginia Department of Tax to recognize same-sex marriages for the purposes of Virginia income tax treatment. This AG Opinion relies exclusively on the Virginia Constitution and statutory scheme to arrive at this conclusion. The Federal Fifth Amendment analysis in Windsor, consequently, does not apply. The Commonwealth of Virginia thus takes advantage of the conservativeness of Windsor to continue denying same-sex couples in Virginia the same marital dignity and tax treatment as heterosexual married couples.
A Factual Heartwarmer (But Completely Legally Insignificant)
This week has been slow for the U.S. Tax Court (so far anyway). However, last week was a good one. That is, Roberts v. IRS is a real heart-warmer (for a lawyer) despite its legal insignificance. There, a very responsible grandfather took in three of his young grandchildren because their mother was unable to support them. He only made about $30,000 that year and claimed some deductions related to caring for his minor children. Mr. Roberts triumphed (pro se) against the IRS's efforts to assess deficiencies for his claiming dependency exemption, earned income credit, and head of household filing status.
This case will not be talked about in legal circles at all because the law is applied in a very straightforward way in a Summary Opinion - no precedential value. The legally significant cases are often those where the facts are very bad for a party, but the process is applied such that the result is the opposite of what was expected based on those facts. In any case, I've highlighted the Roberts case because the law here vindicated a man who has gone out of his way to support his family. If more Tax Court cases produced such results, there would be much less public ire directed at the Revenue Code and the courts.
Congress has determined it would like to encourage the export of American products and services while increasing the competitiveness of Americans in the international economy by allowing "qualified individuals" to completely exclude "foreign earned income" from their gross income. I.R.C. § 911. A taxpayer becomes a qualifying individual by remaining in a foreign country for the entire tax year (12 months) or can prove he or she was actually outside the country for 330 full days during a period of 12 consecutive months. § 911(d)(1).
While the concept of living abroad to be a "qualified individual" is relatively straightforward, the case of Tobey v. IRS, 60 T.C. 227 (1927) is helpful for explaining the concept of "earned income" in an international setting. There, Mr. Tobey was an American artist living and doing most of his painting in Basel, Switzerland beginning in 1960. Id. at p. 228. He was domiciled in the state of Washington, where he had offices, bank accounts, and an attorney. In 1965 and 66, he sold many of his paintings in art galleries in Europe and the U.S. The taxpayer argued that roughly $25,000 earned from the sales of his paintings in Europe met the definition of "earned income," entitling him to an exemption under IRC § 911 for that amount. Conversely, the IRS argued that he was merely selling a capital product abroad, he did not "earn" the income there. After a lengthy review of precedent, the Tax Court clarified: "Income which accrued to the individual from application of his personal skills, whether received in the form of wages, salaries, professional fees or otherwise, was intended to be 'earned' income. Income which accrued to the individual as return on capital was not considered 'earned.'" Id. at p. 231. Accordingly, the taxpayers personal efforts creating colorful pieces of art to be sold in Europe, where he painted them, so his personal efforts constituted the basis for his income. Id. at p. 235. "We conclude that since the paintings were the result of petitioner's personal efforts, the income derived from their sales was "earned income" within the ambit of section 911(b) and is excludable from gross income to the extent of $25,000 per year under section 911(a)." Id.
In summary, the Earned Income Exclusion is a unique opportunity available to Eligible Family Members (E.F.M.s) within the Foreign Service who start their own businesses abroad or go to work for a company in a foreign country. The location criterion is relatively straightforward, at most involving disputes over counting days. Nonetheless, the more aggressive a taxpayer's position when filing time approaches, the more research that is necessary to securely position oneself prior to filing with the IRS or disputing a deficiency before the Tax Court.
Many Foreign Service families own homes state-side, which they rent while they are abroad. The Internal Revenue Code (IRC) allows for deductions on several home-related expenses, but each deduction has its own unique legal requirements. In general, there is no "double-dipping" or claiming a deduction twice for the same expense. The case of Hume v. IRS perfectly illustrates an important difference: deductible business expenses under IRC Sec. 162 (reported on Schedule C) versus deductible home mortgage interest payments under IRC Sec. 163(h) (reported on Schedule A).
In Hume v. IRS, a married couple bought a home in San Clemente, CA (Calle Pacifica) where they lived with their children as a family. They purchased a second home (Cazador Lane) that they intended to use as a rental property. Unfortunately, things did not go according to plan and Mr. Hume and Ms. Dilani divorced. The Cazador Lane home was never actually rented out or advertised as a rental/sale property. The couple then refinanced both homes for a total of over $3 million in new mortgages. Mr. Hume initially claimed the mortgage interest expenses on both homes as a Schedule C deduction for business expenses (IRC Sec. 162). The IRS disagreed that he met the ongoing business requirements of Section 162 and assessed a deficiency. The IRS's position was that, at best, Mr. Hume could deduct the mortgage interest he was paying on $1.1 million of his home loans on Calle Place alone (the only place he'd lived) because he never actually commenced operating the home as a rental property--a business. The Tax Court agreed with the IRS:
" . . .it is the third factor, whether petitioners’ business had actually commenced, that is ultimately determinative here. While not conclusive, it is important to note that Mr. Hume derived no income from and did not rent out Cazador in either of the two years at issue. Mr. Hume testified that petitioners never were able to get Cazador into a “condition to be able to” rent it. Additionally, Mr. Hume was living at Cazador during 2008 and 2009. Accordingly, his course of conduct was not consistent with that of a person who believed he was renting or able to rent out the property during 2008 or 2009.
"We conclude that during 2008 and 2009 petitioners had not yet restarted the prior owner’s rental business that petitioners had abandoned in December 2005 and therefore petitioners are not entitled to a section 162 deduction for 2008 or 2009. Consequently, the mortgage interest petitioners paid on the indebtedness secured by Cazador and Calle Pacifica is not a section 162 ordinary business expense, but rather is deductible, if at all, as qualified residence interest pursuant to section 163(a) that is subject to the limitations of section 163(h)."
The lesson here is that if you hope to deduct expenses, particularly mortgage interest, on a business property, you must actually be operating your business. Alternatively, if you hope to deduct your home mortgage interest, you must actually be living in the residence--your home.
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