Federal Income Tax Update
By This is the second installment of this article. The first installment was previously posted on the Tax Section’s blog.
I. No Easement Charitable Contribution Deduction Allowed Where Form 8283 Did Not Include Cost Basis Information.
In yet another case of a failed charitable contribution donation deduction, in Oakhill Woods, LLC v. Commission, TC Memo 2020-24, the Tax Court disallowed an easement charitable contribution donation deduction because the taxpayer failed to include tax basis information on the Form 8283. That resulted in a disallowed deduction of almost $8 million.
On its tax return for the year of the donation, the taxpayer did not report its income tax basis in the donated easement but instead added an attachment to the Form 8283 stating that “the basis of the property is not taken into consideration when computing the amount of the deduction.” The Tax Court ruled, since the tax basis information was not included on the Form 8283 as originally filed for the year of the donation, the charitable deduction failed the substantiation requirements of Section 170.
The Tax Court noted the taxpayer may not qualify for the reasonable cause defense under Section 170(f)(11)(A)(ii)(II). The LLC argued it prepared and filed its Form 8283 in this manner based on advice of its CPA, who prepared the return, as well as the advice of a consulting firm named Forever Forests. Because Forever Forests was involved with the conservation donation, another court would have to determine, at a later date, whether it was a “competent and independent advisor unburdened with a conflict of interest” and whether the CPA was a competent tax professional who provided tax advice independent of that supplied by Forever Forests.
II. Charitable Deduction Denied for Failure to Provide Tax Basis Information on Form 8283.
In Blau, 924 F.3d 1261 (CA DC, 2019), the court upheld the earlier decision of the Tax Court in RERI Holdings I, LLC, 149 TC No. 1 (2017), denying an LLC’s charitable contribution deduction for the value of property donated to a university. The taxpayer failed to include its cost basis in the donated property on its Form 8283. The LLC purchased property for $3 million in March 2002. It donated a remainder interest in the property to a university in August 2003. The LLC claimed a charitable contribution deduction of $33 million.
The taxpayer failed to include its cost basis on the Form 8283. The court denied the charitable contribution deduction because of a failure to substantially comply with the substantiation requirements of Reg. § 1.170A-13(c)(2). The court noted the taxpayer’s showing its tax basis on Form 8283 would have alerted the IRS of the potential overvaluation of the contributed property based on the much lower amount paid for the property fairly soon before the contribution.
III. In Another Case, Substantial Compliance Saved Unqualified Appraisal.
In Emanouil v. Commissioner, TC Memo 2020-120, the Tax Court ruled an appraisal met the substantial compliance requirement of Section 170 even though the appraisal (1) did not identify the date of the charitable contribution and (2) did not contain a statement that the appraisal was prepared for income tax purposes.
IV. PLR Grants Relief as to Invalid S Election and Termination.
In PLR 201936005, an S corporation was a limited partnership that had, as an owner, another partnership. The limited partnership elected to be taxed as an S corporation. The IRS granted inadvertent termination of S Election relief for the partnership even though (1) the S corporation had an ineligible partnership as a shareholder, (2) the partnership failed to sign the Form 2553, and (3) the S corporation’s governing documents provided distributions were made in accordance with capital accounts rather than percentage ownership interests.
V. Partnership Entitled to Ordinary Worthless Loss Deduction for Investment in Family-Owned Real Estate Business.
In MCM Investment Management, TC Memo 2019-158, the Tax Court ruled a partnership was entitled to an ordinary loss deduction under Section 165(a) because its interest in a related family-owned real estate development business became worthless during the tax year. MCM Investment Management, LLC was owned by four members of the same family. MCM owned a 20% interest in a real estate development and sales business. The four family members owned the other 80%. The real estate development LLC (called “Companies”) began experiencing financial difficulties. In 2008, the four family members created a new entity (called “Holdings”), which purchased, at a discount, certain subordinated debt owed by Companies in an arm’s-length transaction. Later, Holdings contributed the subordinated debt to Companies in exchange for preferred equity. By the end of 2009, the four family members concluded, if Companies were liquidated, there would be nothing left to pay any of the subordinated debt after senior debt was paid.
The court held Holdings was entitled to an ordinary business loss deduction for the worthless interest in Companies. In Forlizzo, Tax Court Memo 2018-137, the court previously ruled a partner could claim an ordinary loss from a worthless investment in a partnership, if the partnership interest becomes worthless during the year. Under Section 165(a), a taxpayer may claim an ordinary loss deduction for its investment in a partnership if the investment becomes worthless and sale or exchange treatment does not apply. See also Citron v. Commissioner, 97 T.C. 200 (1991).
VI. Another Court Rejects The “My Boss Told Me Not To Pay” Argument Against Assessment of the Section 6672 Trust Fund Recovery Penalty.
In Myers v. U.S., 23 F.3d 935 (2019), Mr. Myers was the CFO and co-president of two companies that were owned by a parent company. The parent company was licensed by the U.S. Small Business Administration (SBA) as a small business investment company. The SBA had the power to place the parent company in receivership if it violated the terms of its license. In 2008, the parent company violated the terms of its license and was placed in receivership by the SBA. In 2009, the parent company got behind on its payroll tax filings. The representatives of the SBA specifically told Mr. Myers to prioritize other vendors over the trust fund taxes.
The IRS assessed the trust fund recovery penalty against Mr. Myers. The District Court granted summary judgment in favor of the IRS, and Mr. Myers appealed. The Eleventh Circuit noted a long line of precedent rejecting the “my boss told me not to pay” argument. See, e.g., Thosteson v. United States, 331 F3d 1294 (11th Cir. 2003). However, Mr. Myers argued his case was different because the parent company’s receiver was the SBA, a governmental agency. Mr. Myers argued he should not be held liable because it was not a boss telling him not to pay the taxes, it was a governmental agency. The court ruled Section 6672 liability attaches regardless of whether the boss is a private entity or a governmental agency.
VII. IRS Motion to Dismiss 6672 Refund Claim Denied Where There was a Question of Fact Whether the Responsible Person Acted Willfully.
In Preinesberger v. U.S., 126 AFTR2d 2020-5143 (DC CA), Mr. Preinesberger owned less than 10% of the stock of Meridian Health Services Holdings (“Meridian”) and operated five skilled nursing home facilities in California for Meridian. Meridian got in financial trouble and stopped paying its payroll taxes, partly because of delays in reimbursement payments from Medicare and Medi-Cal. Meridian drew on a line of credit from Capital Finance, Inc. (“CFI”). Each time Meridian drew on its line of credit, Meridian was required to use all of the borrowed funds strictly for payment of net wages. CFI refused to allow Meridian to use any of the funds for payment of withholding taxes. In addition, unlike a typical business, the facilities could not simply cease operations when they could no longer pay their employees’ net wages and the necessary withholding taxes. Under state and federal regulations, nursing homes must follow a lengthy and detailed procedure for closure that includes notifying residents and required governmental agencies and transferring residents to other appropriate facilities. Accordingly, Mr. Preinesberger argued it was not possible for the facilities to meet both the withholding obligations and the regulatory obligations to remain open and maintain the well-being of their residents.
The IRS filed a motion to dismiss, which was denied by the District Court. The court held it was possible Mr. Preinesberger’s failure to withhold was not willful and it would be for a trier of fact to determine whether Mr. Preinesberger’s actions were involuntary, and therefore not willful. Federal and state regulations required CFI’s loan be spent to maintain the standard of care which arguably make the funds encumbered.
VIII. District Court Approves the Forced Sale of Real Property Owned by Taxpayer and His Non-Liable Sister.
In Dase, 125 AFTR 2d 2020-1079 (N.D. Ala.), Mr. Dase owed tax debts. When Mr. Dase’s father died, Mr. Dase and his sister inherited property located in Alabama as tenants in common. The IRS sought to force the sale of the entire interest in the property even though Mr. Dase’s sister owned a one-half interest and was not liable for Mr. Dase’s tax debts.
Although the IRS lien attached only to Mr. Dase’s one-half interest, the District Court allowed a foreclosure sale of the entire property. Based on Rodgers, the court concluded ordering a foreclosure sale of the entire property was appropriate because (1) an attempt to sell only Mr. Dase’s one-half interest would prejudice the interests of the government since no one would bid on a one-half tenant-in-common interest in the property, (2) the sister did not have any expectation that the property would not be subject to a forced sale because, under Alabama law, either tenant could force a sale of a tenant-in-common interest in the property, (3) the sister did not live on the property, and she would not be forcibly relocated by a sale, and (4) the sister would be adequately compensated for her interest in the property because she would receive one-half of the sales proceeds.
IX. Tax Return Was Deemed Timely Filed Even Without the Postmark.
In Seely, TC Memo 2020-6, the IRS issued Mr. and Mrs. Seely a notice of deficiency on March 28, 2017 for 2013, 2014 and 2015. The last date for the Seelys to file a Tax Court petition to challenge the deficiency was June 26, 2017. The Seelys filed a petition that the IRS received on July 17, 2017. Unfortunately, the envelope containing the petition had no postmark. The IRS took the position that the petition was untimely filed and moved to dismiss it.
The Tax Court held the petition was timely filed. The taxpayers submitted a declaration from their attorney, Mr. Boyce, stating, under penalty of perjury, he deposited the petition in the United States postal service collection receptacle in Washington, DC on June 22, 2017. The court noted under Sylven v. Commissioner, 65 TC 548 1975 and Mason v. Commissioner, 68 TC 354 1977 when the envelope bears no postmark, evidence regarding the mailing date may be introduced. The IRS argued the petition actually arrived 21 days after its due date and therefore contended Mr. Boyce’s declaration was not credible since the petition actually arrived 25 business days after the alleged mailing date. The court noted because the Fourth of July holiday fell between the date of the alleged mailing and the delivery date, there could have been a plausible explanation for the delay in delivery. In prior cases, holiday conditions at the post office (such as holiday closures, unusually large volumes of mail, or inefficiencies attributable to temporary staff) have been found to be a plausible explanation for short delays in delivery. See Rotenberry v. Commissioner, 847 F2d 229 (5th Cir.t 1988).
X. Failure to File Penalty Exception for Certain Small Partnerships.
A. Background. A partnership that fails to timely file a partnership return is subject to a $200 per partner penalty under Code Section 6698 unless the failure is due to reasonable cause. Under Code Section 6031(a), a partnership is required to file a return if it has any income or deductions allocable to its partners.
B. Program Manager Technical Advice 2020-001. The IRS issued Program Manager Technical Advice 2020-001 to confirm, under Revenue Procedure 84-35, certain small partnerships qualify for the reasonable cause exception for late filing penalties if certain requirements are met.
Revenue Procedure 84-35 provides certain small partnerships have reasonable cause for the late filing of a return if:
- A partnership has ten or fewer partners;
- Each partner is an individual, a C corporation, or the estate of a deceased partner; and
- Each partner reports his or her share of income or expenses of the partnership on a timely filed income tax return.
XI. Decision Narrows the Reasonable Basis Exception to the Negligence Penalty.
A. Background. Section 6662(b) provides for the assessment of certain penalties where there is negligence, substantial understatement of tax, or certain valuation misstatements. These are referred to as the accuracy-related penalties. The penalty is 20% of any tax underpayment.
A defense to the negligence penalty exists under Reg. § 1.6662-4(d) if the taxpayer’s return position was “reasonably based on one or more of the certain authorities set forth in Reg. § 1.6662-4(d)(3)(iii).” Reg. § 1.6662-3(b)(3). Reg. § 1.6662-4(d)(3)(iii) lists authorities a taxpayer can rely on to meet the reasonable basis defense, such as case law and revenue rulings. Likewise, under Section 6662(d)(2)(B), the substantial understatement penalty does not apply if there is or was substantial authority for the taxpayer’s position under the criteria of Reg. § 1.6662-4(d)(3).
The substantial authority standard is less stringent than the more likely than not standard but more stringent than the reasonable basis standard as defined in Reg. §1.6662-3(b)(3). Substantial authority exists only when the weight of the authorities supporting the treatment of the tax item is substantial in relation to the weight of the authorities supporting contrary treatment.
B. Wells Fargo. Wells Fargo v. U.S., 957 F.3d 8409 (8th Cir.), involved the disallowance of certain foreign tax credits involving a structured trust arrangement between Wells Fargo and Barclays Bank. The Eighth Circuit upheld the disallowance of the claimed foreign tax credits. However, more interesting was the court’s discussion of the reasonable basis defense to the assessment of the negligence penalty. The court ruled Wells Fargo did not satisfy the reasonable basis defense because it failed to submit evidence it subjectively based its return position on legal authority at the time the return was filed. In other words, under the reasonable basis defense, the taxpayer cannot base its return position on relevant authorities without showing it actually relied on those authorities when filing its tax return.
XII. IRS Could Not Re-Audit NOL Carryforward from Previously Audited Year.
A. Background. In numerous cases, courts have allowed the IRS to disallow NOLs carried to the tax year at issue where the taxpayer was unable to prove the exact amount of its NOL carryforwards. That is the case even if the original loss years were closed by the statute of limitations. See Powers v. Commissioner, TC Memo 2016-157, and Jasperson vs. Commissioner, 118 AFTR 2d 2016-5633 (11th Cir.).
B. FAA 2020501. In Field Attorney’s Advice 20202501, the IRS Chief Counsel determined the IRS cannot audit NOL carryforwards from previously audited years where the IRS had disallowed NOLs but, after the taxpayer requested an appeal, the Office of Appeals allowed the NOLs. Section 7605(b) prohibits the IRS from conducting repetitive audits. It provides a taxpayer will not be subject to unnecessary examination or investigation. There may be only one inspection of a taxpayer’s books of account for a tax year unless the IRS, after investigation, notifies the taxpayer in writing an additional inspection is necessary.
XIII. Workers at a Cleaning Business Were Properly Treated as Independent Contractors and not Employees.
In Santos v. Commissioner, TC Memo 2020-88, Mrs. Santos owned a cleaning business called Campos Cleaning that had contracts with several apartment complexes to do unit turnover cleaning, which is cleaning for recently vacated apartments before new tenants arrive. The contracts with the apartment complexes specified days and hours when common areas were to be cleaned. However, that was not the case as to recently vacated apartments. For recently vacated apartments, the complex managers contacted Mrs. Santos directly to schedule the cleaning. For cleaning common areas, the apartment complexes paid Campos Cleaning a weekly fixed amount from $510 to $780. For cleaning recently vacated apartments, Campos Cleaning was paid monthly at a fixed rate of $90 to $120, depending on the size of the apartments.
Mrs. Santos posted advertisements for workers. She only hired individuals with prior training in cleaning. She never provided training to them. Mrs. Santos spoke English but most of her workers did not. Mrs. Santos had no written employment contracts with any of her workers. She did not guarantee them a minimum amount of work. Her workers could decline to do a cleaning job for any reason. Many of Mrs. Santos’ workers cleaned for other individuals and businesses.
Mrs. Santos paid her employees weekly. The pay rate was based on a fixed rate of $50 to $70 per apartment cleaned, depending on the size of the apartment. She did not provide any paid sick leave or vacation and did not offer any employee benefits. However, Campos Cleaning did maintain general liability insurance and workers’ compensation insurance as required by the apartments.
Once an apartment was vacated, the complex manager contacted Mrs. Santos. She then sent one of her workers to do the cleaning by the deadline the manager established. The workers used their own transportation and furnished and used their own cleaning supplies. They were free to hire assistants. Mrs. Santos did not supervise the cleaning nor perform any post-cleaning inspections.
The Tax Court determined Mrs. Santos was more of a dispatcher than an employer. The court held the workers were properly characterized as independent contractors rather than employees.
XIV. Taxpayer was Liable for the Failure to Timely File Penalty Where Preparer Forgets to Hit “Send.”
In Intress v. U.S., 124 AFTR 2d 2019-5420, Christian Intress and Patrick Steffen hired a professional tax return preparer to file their 2014 income tax return. The preparer was in the process of submitting a Form 4868, Application For Automatic Extension Of Time To File U.S. Individual Income Tax Return, but the preparer failed to hit “send.” The preparer did not discover the missed deadline until October 2015, resulting in a penalty assessment of over $120,000 under Section 6651(a). In upholding the penalty assessment, the court stated the taxpayer’s reliance on their preparer to timely file the extension request was not reasonable cause for purposes of the penalty assessment. See United States vs. Boyle, 469 U.S. 241 (1985).
XV. Consent to Extend the Statute of Limitations was Invalid and Unenforceable Where the IRS Failed to Sign the Form 872 Prior To Expiration.
In CCA 201937017, the taxpayer signed a Form 872, Consent to Extend the Time To Assess Tax, before the statute of limitations expired. However, due to the government shutdown, an IRS representative failed to sign the Form 872 until the government shutdown ended. The IRS cannot enforce a Form 872, signed by it after the expiration of the statute of limitations, even if it was signed by the taxpayer prior to such expiration. Reg. 301.6501(c)-1(d) states the period of limitations to assess the tax may only be extended by consent prior to the expiration of the time to assess, and consent to extend “shall become effective when the agreement has been executed by both parties.” Thus, the IRS could not enforce the Form 872 against the taxpayer.
XVI. Taxpayers Could Not Challenge a Notice of Deficiency Sent to Last Known Address.
In Gregory, 152 TC No. 7 (2019), Mr. and Mrs. Gregory moved in the summer of 2015. However, the couple used their old mailing address when they filed their 2014 federal income tax return on October 15, 2015. A month later, the couple used their new address when they filed Form 2848. The couple also used their new address in April 2016 when they filed to extend the due date for their 2015 return. On October 3, 2016, just before Mr. and Mrs. Gregory filed their 2015 tax return, the IRS mailed a notice of deficiency to their old address. Mr. and Mrs. Gregory did not learn about the notice of deficiency until after the 90-day statutory notice period had expired.
The Tax Court held Mr. and Mrs. Gregory had not provided the IRS with adequate notice of their new address, and therefore the deficiency notice sent to their old address was valid. That meant the Tax Court petition filed by Mr. and Mrs. Gregory was untimely. Under the applicable regulations, the last known address is the address that appears on the taxpayer’s most recently filed tax return unless the IRS has been given clear and concise notice of a different address. In October 2016 when the IRS mailed the statutory notice of deficiency, the last tax return filed by Mr. and Mrs. Gregory was the 2014 return, which reflected the old address. Mr. and Mrs. Gregory should have filed a Form 8822, Change of Address, with the IRS.
Keith A. Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.