Federal Income Tax Update
I. Tax Court Finds Equitable Tolling May Excuse a Late-Filed Tax Court Petition; Gilbert vs. Commissioner; TC Memo 2026-10.
The IRS examined Mr. and Mrs. Gilberts’ 2015 and 2016 tax returns during 2018. The Gilberts appealed the case to the IRS appeals office and were assigned to an appeals officer named Ms. Levina. Ms. Levina faxed the Gilberts a proposed settlement computation on January 18, 2023. On July 25 and August 10, 2023, the Gilberts replied to Ms. Levina stating they disagreed with Ms. Levina’s calculations. Unbeknownst to the Gilberts, in February 2023, the IRS mailed them a statutory notice of deficiency assessing tax. The IRS sent notices of deficiency to Mr. and Mrs. Gilbert in February 2023 via certified mail. However, the notices were never delivered to the Gilberts and were returned to the IRS. The notices advised the Gilberts they would have to file a Tax Court petition by May 16, 2023, to challenge the assessments.
The Gilberts received an IRS notice on October 30, 2023, stating their tax overpayment for 2022 had been applied against their outstanding tax liability for 2016. The Gilberts filed a petition with the Tax Court. However, the due date for the petition had long passed. The IRS filed a motion for summary judgment requesting the Gilbert’s petition be dismissed for failing to meet the May 16 filing deadline.
The Gilberts cited numerous errors by the IRS, including failure to deliver the notices of deficiency. The Gilberts claimed the IRS did not follow its normal practices and procedures, such as sending courtesy copies of the notices of deficiency by regular mail once certified copies were returned as undelivered. The IRS did not send a copy of the notices to Mr. Gilbert’s work address, even though he had the authority to represent the couple under a power of attorney. The IRS transcripts for 2015 and 2016 did not indicate the notice of deficiency had been mailed to the Gilberts.
In denying the IRS’ motion for summary judgment, the Tax Court noted that numerous cases have found a notice of deficiency is valid even if it is not delivered to the taxpayer. However, based on the Third Circuit’s decision in Culp, 2023 U.S. App. LEXIS 18287, the court ruled Section 6213 is a claims processing statute, rather than a jurisdictional statute, and therefore potentially subject to equitable tolling to allow late filing if the taxpayer can show, due to extraordinary circumstances, it would be inequitable to strictly apply the Section 6213 time limits.
The equitable tolling doctrine has two discrete elements: (1) the litigant must have diligently pursued his rights, and (2) an extraordinary circumstance, beyond the litigant’s control, must have prevented the timely filing. The Gilberts clearly met the first part of that test, as they sent their Tax Court petition within two weeks of becoming aware of the IRS deficiency assessment when they received the refund notice on October 30, 2023. The Gilberts received no notice of the IRS’ unsuccessful attempt to provide them with the statutory notice of deficiency. More importantly, both the Gilberts and Ms. Levina continued to correspond as if the case were still with appeals. The Gilberts, therefore, should be given the opportunity to present further evidence about extraordinary circumstances beyond their control (i.e., the USPS delivery failure) prevented them from timely filing their petition.
II. Maker Has No Tax Basis in Self-Created Note Contributed to a Partnership; Continental Grand Limited Partnership, 166 T.C. No. 3 (2026).
USC was a US company that was the parent of FC, a German company. FS was a wholly-owned German subsidiary of FC. In March 2001, FC issued FS a $610 million note payable to FS. USC guaranteed payment of the note. In April 2002, FS elected to be a disregarded entity of FC, effective as of March 1, 2001, which was only a few days before FC issued the note to FS. FS contributed the $610 million note to PS, a partnership, in exchange for a partnership interest in PS. In 2009, FC fully repaid its note to FS. FS contended its tax basis in its partnership interest under Section 722 was $610 million.
The Tax Court held, regardless of the fair market value of the note in the hands of PS, FS had no tax basis in the note. Because FS became a disregarded entity of FC (the original maker of the note), FS was deemed to have contributed its own note to PS. Courts have consistently held a note, in the hands of its maker, has no cost, and therefore its tax basis to the maker is zero. Vision Monitor Software, LLC, TC Memo 2014-182.
III. Tax Court Denies Hobby Loss Deductions but Strikes Down 20% Accuracy Related Penalty; Schumacher, TC Memo 2026-47 (2026).
Mr. and Mrs. Schumacher were life-long horse enthusiasts. In 2001, they formed Schumacher Quarter Horses (“SQH”) and began breeding show horses. For 2017, 2018 and 2019, the Schumacher’s Schedule C losses for SQH offset a substantial portion of their wage income.
The Tax Court concluded the losses should be disallowed under Section 183. Although they were experienced and educated horse breeders and spent considerable time and effort in their endeavors, other factors weighed against them. They lost money every year from 2010 through 2019, long after they began operating SQH in 2001. Clearly the losses were not start-up losses. The Schumachers had a separate bank account for SQH but paid for many horse related expenses from their personal checking account. They had no business plan and did not change breeding and training strategies to enhance profitability. Although the Schumachers kept records of income and expenses, they did so primarily for tax reporting purposes and not for profit-making purposes. They did not track expenses for individual horses. Most of their records were handwritten and were neither complete nor detailed. The Schumachers derived great personal pleasure from their activities. Their wage income from other sources allowed them to absorb the losses in a tax advantageous manner.
The court, however, refused to uphold the 20% negligence penalty finding the Schumachers’ reliance on their tax return preparer’s advice constituted reasonable cause under Section 6664. The return preparer discussed the hobby loss factors every year with the Schumachers and concluded SQH was operated for profit within the meaning of Section 183.
IV. Cattle Farmer Beats the Hobby Test; Kolar, TC Memo 2026-15 (2026).
In 2016, Mr. Kolar took control of a family farm that had been in his family since the late 1800s. Mr. Kolar grew up on the farm. The ranch, consisting of over 800 acres of Texas farmland, had been used by the family for beef and dairy cattle, poultry and egg production, crops and raising catfish and pecans. Mr. Kolar earned a bachelor’s degree in animal science and a master’s degree in water supply and wastewater disposal. When he inherited and assumed control of the farm in 2016, the ranch was in grave disrepair, which required Mr. Kolar to restore much of its infrastructure. Soon after taking over the farm, Mr. Kolar decided to focus on beef cattle and envisioned growing the herd to more than 250 head. Mr. Kolar stated, when he took over the farm in 2016, he anticipated it would take five to six years to return the cattle operations to profitability.
The IRS disallowed Mr. Kolar’s farm losses for 2016, his first year of taking full control of the farm. Although 2016 was the audit year, the Tax Court reviewed farm operations from 2017 to 2022 to analyze his profit-making motives in 2016. Citing Himmel, TC Memo 2025-35, the court stated evidence from years outside of the audit year has probative value if it provides context to evaluate a profit motive during the audit year.
Mr. Kolar possessed the necessary background and educational expertise to meet the for-profit test. Mr. Kolar’s wife kept detailed financial records for the farm on a daily, weekly and monthly basis. Mr. Kolar rarely attended cattle shows. There was no recreational aspect of the farm operations. The problem was the tremendous losses the farm incurred from 2017 to 2022. The farm reported only $26,000 in gross receipts compared to over $2 million in losses. On the other hand, the court recognized Mr. Kolar encountered a number of unforeseen challenges during those startup years. In 2020, three of Mr. Kolar’s five farmhands died from COVID. Mr. Kolar lost a number of cattle to dehydration when a pipe burst due to freezing water wells. The ranch also was adversely affected by fire, drought, grasshoppers and floods.
Oil and gas wells on the farm produced over $2 million of income during the startup years. The court determined, however, the income producing oil and gas wells were a significant factor weighing against a profit motive for 2016. For purposes of determining the Section 183 activity at issue, the farm operations could not be aggregated with the valuable land holdings because the losses from the ranch would not support the separate activity of holding land for future appreciation. Reg. 1.183-1(d); Young, TC Memo 2025-95. Also, the unprofitable farming activity could not be aggregated with oil and gas exploration. Even though the activities were conducted on the same land, oil and gas extracting is fundamentally different than cattle ranching. More importantly, Mr. Kolar’s significant income from oil and gas leases, combined with the tax benefits of the farm losses, could indicate a lack of overall profit motive. Reg. 1-183-2(b).
Based on the totality of circumstances, the court concluded the factors weighing in Kolar’s favor slightly outweighed the two most significant nonprofit motive factors: the magnitude of ranching losses and the presence of significant income.
Keith Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.