Larry's Tax Law

On January 27, 2014, Judge Haines of the United States Tax Court issued a decision in Ydney Jay Hall v. Commissioner, TC Memo 2014-6.  This case illustrates that a taxpayer’s failure to retain adequate business records to substantiate income and expenses will lead to disastrous results. 

The taxpayer, Ydney Jay Hall, is a practicing attorney admitted to practice before the United States Tax Court.  His law practice income was reported on Schedule C of his Individual Income Tax Return.  Upon examination of Mr. Hall’s 2008 return, the Service asked to review his books and records relating to the law practice.  The Service, believing Mr. Hall did not fully respond to its request for information, summoned bank records.  With that information, it reconstructed his business income for the tax year.  The results of the audit reconstruction were not pretty. 

The IRS issued a deficiency notice to the taxpayer, asserting he had underreported his income by $76,681 for the tax year.  In addition, the Service disallowed deductions for travel and other expenses listed on Schedule C totaling $63,542 as the taxpayer did not maintain any books or records for his business activities and failed to provide proof he actually paid the expenses (e.g., receipts, invoices, cancelled checks or other evidence of payment).   To put salt on the wound, the Service assessed an accuracy related penalty against the taxpayer.

Mr. Hall filed a petition in the United States Tax Court challenging the notice of deficiency and the assessment of taxes and penalty.  He represented himself in the case.

On December 17, 2013, the United States District Court for the Northern District of Georgia issued its decision in United States v. Morris Legal Group, LLC, 113 AFTR 2d, 2014-XXXX (D.C. Georgia).  Gilbert Greenburg, a disbarred attorney, was employed as the office manager of Morris Legal Group, LLC, a law firm in Atlanta, Georgia.  He helped set up and manage the law firm’s personal injury practice.  Interestingly, Mr. Greenburg had no written agreement with the law firm relative to the amount of compensation he was entitled to receive.  Rather, he wrote himself payroll checks from time to time based upon the level of the firm’s profits.  His compensation generally ranged from $4,000 to $8,000 per month. 

Mr. Greenburg owed the IRS over $100,000 in unpaid income taxes, interest and penalties.  On May 26, 2011, the IRS sent the law firm a Notice of Levy and formally requested it surrender Mr. Greenburg’s wages until the levy was released.  Morris Legal Group, LLC appears to have ignored the levy and continued paying Mr. Greenburg compensation.

Is a full time gambler in the trade or business of gambling?  If the answer is yes, two results follow (one result which is good and one result which is not so good):  (1) the gambler is able to deduct under Section 162 of the Code all of the ordinary, necessary and reasonable expenses incurred in carrying on the business; and (2) the net income of the gambler, if any, is subject to self-employment tax under Section 1401 of the Code.

In 1987, the United States Supreme Court was presented with the issue of whether a full time gambler was engaged in the trade or business of gambling.  Commissioner v. Groetzinger, 480 US 23 (1987).  Justice Blackmun issued the court’s opinion.  The Supreme Court thoroughly reviewed the history of the phrase “trade or business” in the context of the Internal Revenue Code.  The court stated: “[T]o be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income profit.  A sporadic activity, a hobby, or an amusement diversion does not qualify.”   Whether a taxpayer is engaged in a trade or business is a question of facts and circumstances.

In Groetzinger, evidence revealed the taxpayer spent substantial amounts of time preparing for and actually gambling.  He had been gambling for a long period of time; the activity was not sporadic.  It was continuous.  Mr. Groetzinger had no other “profession or type of employment.”  He engaged in gambling with the intent to make a profit.  The court ultimately concluded, gambling may constitute a trade or business, and based upon the facts presented, Mr. Groetzinger was engaged in the trade or business of gambling.

Mr. Groetzinger won the battle in that his victory allowed him to deduct is ordinary, necessary and reasonable expenses associated with his gambling activities.  He lost the war in part because his net income (if any) would now be subjected to self employment taxes.  The result was likely unsuspected by the taxpayer.

Within a few hours after my January 17, 2014 blog post, as we suspected, President Barack Obama signed the Consolidated Appropriations Act, 2014 (“2014 Act”) into law.  Now, at least until September 30, 2014, our federal government may operate without interruption.

Each year, our government must pass bills that appropriate funds for all discretionary spending.  In most years, a bill is passed by each of the twelve subcommittees in the House Committee on Appropriations and each of the twelve subcommittees in the Senate Committee on Appropriations.

When Congress cannot pass separate bills, it rolls the bills into one omnibus bill like the 2014 Act.  This has become the norm rather than the exception over the past several years.  You may be asking yourself why would Congress roll the bills into one single act rather than pass several smaller bills which will be easier for our lawmakers to review and debate.  There may be many reasons, including:

• • Too much party disagreement to pass individual specific bills;

• • Too many issues pending before lawmakers to deal with several pieces of legislation;

• • Time constraints that may prevent dealing with appropriations in a piece meal fashion; and/or

• • The desire to bury in a single massive act some controversial spending provisions.

On January 15, 2014, the House, by a vote of 359-67, passed an appropriations bill to fund our federal government through September 30, 2014.  The next day, January 16, 2014, the Senate passed the bill by a vote of 72-26.  The bill will now make its way to President Obama for signature.

 Once signed by President Obama, the bill, commonly known as the “Consolidated Appropriations Act, 2014,” will become law (the “Act”).  The Act spans 1,524 pages and contains some interesting provisions.  Title I of Division E of the Act focuses on the Department of Treasury. 

The Act provides the IRS with a 2014 budget of $11.3 billion.  This represents a budget decrease of $526 million or 4.4% from its 2013 budget. 

The $11.3 billion budget is primarily allocated among four areas:

On December 17, 2013, the US Tax Court issued its opinion in Chaganti v. Commissioner, TC Memo 2013-285.  The interesting issue before the court was whether the taxpayer, an attorney, was allowed under Section 162 of the Code to deduct amounts he was personally ordered to pay a trial court and opposing counsel in a case in which he was representing a client. 

Mr. Chaganti was initially ordered to pay a “fine” of $262, representing the charges of opposing counsel and his court reporter, for his role in his client’s failure to appear for a deposition.  When he did not pay the fine, the court held Mr. Chaganti in contempt and ordered immediate payment (with a daily penalty for late-payment).  About a month later, Mr. Chaganti finally paid the fine (without the late payment penalty). Throughout the case, he engaged in behavior the judge labeled as “unnecessarily protracting and contentious.”  The court eventually ruled against Mr. Chaganti’s client in the case.  The other attorney asked the court for sanctions against Mr. Chaganti (not Mr. Chaganti’s client) as a result of his “bad faith, unreasonable, and vexatious multiplication of the proceedings.”  The judge ultimately ordered Mr. Chaganti to pay opposing counsel around $18,000 (to compensate for the additional attorney fees incurred due to his actions) and to pay the court around $2,300 for paying the original penalty late.

On December 10, 2013, the US District Court for the District of New Jersey ended a long and drawn out saga between the IRS, and John and Francis Purciello.  The court’s decision (assuming the government does not appeal) should provide the Purciellos with much needed finality and a sense of vindication to end 2013.

The Purciellos filed their joint 2000 tax return, showing a refund due of about $42,000.  Although they contacted the IRS on several occasions, in writing and by telephone, inquiring about the refund, the Service failed to provide any response.  In late 2002, out of the blue, the IRS notifies the Purciellos that the refund was being applied to civil penalties assessed against Mr. Purciello for tax year 1998.  What civil penalties cried the Purciellos?  

Apparently, on April 3, 2002, the Service assessed Mr. Purciello with trust fund penalties for two quarters of 1998 relating to a company he had worked for in a strictly sales capacity.  The penalties, in the aggregate, amounted to more than $168,000.

Over the next two years, the Purciellos went back and forth with the IRS attempting to resolve the matter.  While they eventually received a small refund, the bulk of their claim appeared to be unsuccessful.  Consequently, the Purciellos were forced to file a claim for refund in the US District Court for the District of New Jersey. 

In the case of John D. Moore, et al. v. Commissioner, TC Memo 2013-249 (October 30, 2013), the US Tax Court was presented with the saga of John Moore.

Mr. Moore was a CPA.  He left the world of public accounting to embark on a career in a new industry.  In 1992, he became the Operations Manager of the Dallas, Texas Peterbilt truck distributor.  By 1995, Mr. Moore had climbed the corporate ladder and was appointed president of the company.

In 1992, the company granted Mr. Moore an option, good through December 31, 1999, to purchase five percent (5%) of the shares of the company, an S corporation.  In 1997, the company merged with another company.  As a result of the merger, Mr. Gary Baker entered the picture.  Mr. Baker ended up with 1,477,859 shares of the merged entity.  On December 30, 1999, Mr. Moore entered into an agreement to purchase all of Mr. Baker’s shares for $5,842,606.  The next day, on December 31, 1999, Mr. Moore timely exercised his option and purchased 500,000 shares of the company for $212,334.

As part of the purchase of the Baker shares, Mr. Moore signed a promissory note for the full purchase price of an amount just shy of $6,000,000.  It was all due and payable on May 5, 2000.  After signing the note, however, the parties revised it so that $3,000,000 would be due on June 14, 2000, and the balance would be paid in three equal annual installments.

In Peter Knappe v. U.S., 713 F3d 1164 (9^th Cir., April 4, 2013), the United States Court of Appeals for the Ninth Circuit was presented with the question whether reliance upon a tax professional may excuse the late filing of a tax return.

Peter Knappe was the personal representative of the Estate of Ingborg Pattee.  He was also trustee of her testamentary trust.

Mrs. Pattee died in 2005, leaving a large estate.  Mr. Knappe was her long-time friend.  Although he had business experience, Mr. Knappe had no experience serving as a personal representative or preparing estate tax returns.  So, he engaged the services of Mr. Francis Burns, CPA.  Burns had been his company’s outside accountant for several years.  Mr. Knapp was always satisfied with his work.

Burns told Knappe that a Form 706 for the estate of would need to be filed by August 30, 2006.  Knappe had trouble obtaining the needed appraisals on or before the filing deadline.  Burns advised Knappe that he could obtain an extension of one (1) year for both the filing and the payment of the taxes due.

Burns filed a Form 4786, seeking both an extension for filing and for payment of the taxes due. The extension sought was one year.

As we know, the filing extension, unless the personal representative is out of the country, is only six (6) months.  The payment extension, however, in the discretion of the Service, may be up to one year.  Burns, however, believed both extensions were automatically one (1) year.  OOPS!

The United States Sixth Circuit Court of Appeals was actually presented earlier this year with the “$64,000 Question.”  In Robert W. Stocker, II and Laurel A. Stocker v. U.S., 111 AFTR 2d 2013-556 (705 F3d 225) (6^th Cir., January 17, 2013), the court examined what sort of evidence a taxpayer must introduce in order to support the timely filing of a tax return in which a $64,000 refund was claimed.

In this case, Bob and Laurel Stocker filed an amended 2003 return, seeking a $64,000 refund.  The Service denied the claim on the ground that they did not file the return within the 3-year statutory period.

The Stockers filed suit in District Court.  The court quickly dismissed the case for lack of subject matter jurisdiction—the Stockers could not establish the jurisdictional prerequisite of timely filing the return by methods recognized by the Service or the courts.

The taxpayers argued that testimony and circumstantial evidence may support the timely filing requirement.  Mr. Stocker and his office manager, Karrin Fennell, testified that the return was timely deposited at a United States post office, postage prepaid.  They forgot, however, to attach the registered mail customer return receipt.  The taxpayers were, however, able to produce evidence that the Department of Revenue timely received the amended return.  So, they argued the IRS must have likewise received the federal return on time.  Unfortunately, the IRS’ records showed the return was postmarked 4 days after its due date.