Category Archives: Federal

Famous Fridays: Al Capone, The Most Famous Tax Evader of Them All

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In the first installment of what we intend to be an ongoing series profiling the tax troubles of the stars and other famous folk, we start with the most famous tax evader of them all.

Alphonse Gabriel “Al” Capone was one of the original American gangsters who rose to power during the 1920’s. Capone was not only recognized for his brutality and willingness to take lives, but also his keen business sense and extreme secrecy in managing his organization. In his rise to power, Capone consolidated much of the gambling, prostitution, liquor, and extortion rackets in Chicago and brought them under his control. He spent tens of millions of dollars on bribes to politicians, prosecutors, police officers, and other city officials. These tactics kept Capone from serving significant jail time, despite being a suspect for numerous murders during his reign.

An extremely cautious man, Capone dealt strictly in cash and kept his business dealings secret. Despite bringing in an estimated $100 million through his various business ventures in 1927, Capone never had a bank account. During their extensive investigation the Treasury Department only found one instance where Capone endorsed a check. In a raid of one of Capone’s gambling establishments, the Treasury Department found a book record showing net profits of $300,000 for 1924, $117,000 for 1925, and $170,000 for the first four months of 1926. During their investigation, Treasury also found a cashier’s check from 1927 amounting to $2,500 endorsed by Al Capone for the profits of the gambling establishment. Treasury used this evidence along with the testimony of one of Capone’s bookkeepers, and other employees testifying to various Capone wire transfers, to show that Capone had several hundred thousand dollars in unreported income.

On June 16, 1931, Al Capone pled guilty to tax evasion and prohibition charges. Much to his lawyer’s dismay, Capone boasted to the press that he struck a deal for a two-and-a-half year prison sentence. However, the presiding judge informed Capone that he was not bound by any deal. Capone changed his plea to not guilty and was convicted on November 24, 1931, sentenced to 11 years in federal prison, fined $50,000 and charged $215,000 in back taxes, plus interest due.

The publicity of Capone’s case caused criminals and legitimate citizens alike to take note and begin to pay the IRS for back taxes. In 1931, more than $1 million in unpaid tax filings were submitted, double the amount of the prior year.

Capone didn’t catch any breaks after his conviction. He contracted syphilis and suffered brain damage and insanity from the infection. Before his death in 1947, doctors concluded that he had the mental capacity of a 12-year-old child.

Supreme Court Adopts IRS Position on Jurisdiction and Application of Partnership Penalties

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Gary Woods and his partner, Billy Joe McCombs, generated substantial tax losses using the COBRA tax shelter. The COBRA shelter used offsetting options to inflate the basis of property distributed by a partnership, which is then contributed and sold to another partnership or pass through entity, resulting in a large tax loss without a corresponding economic loss. Messrs. Woods & McCombs reaped ordinary income losses of $13 million and capital losses of $32 million when they used the COBRA structure to purchase and sell $3.2 million of options.

After the IRS disallowed their losses, Woods filed a refund claim (which was denied) and pursued that claim with a complaint filed in the U.S. District Court. After Woods prevailed on certain issues in the 5th Circuit, the government petitioned the U.S. Supreme Court for certiorari. The case selected by the high court to resolve a split in the circuits. The Fifth, Federal and D.C. Circuits had all found for the taxpayers. Other circuits had adopted the government’s position.

The Supreme Court addressed two questions in an opinion authored by Justice Scalia. The Court first considered whether the district court has jurisdiction under TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) to determine valuation-related penalties at the partnership level. This is important because partnerships are not taxed as entities for Federal income tax purposes. The income and losses determined at the partnership level pass-through to each partner where they are taxed on the partner’s individual or corporate tax return.

One purpose of TEFRA was to allow determinations at the partnership level and prevent the need for multiple proceedings to determine the tax liabilities of items common to all partners in the partnership. The jurisdictional question has been widely litigated and this decision will affect many millions of dollars of pending tax penalties.

The second, related, question was whether the 40% gross valuation overstatement penalty under I.R.C. Sec. 6662 applied when a partnership was found to not have economic substance. A partnership lacking in economic substance ceases to exist for tax purposes.

The Court ruled for the government on both questions. On the first question, the Court held that there was jurisdiction to consider the penalty question at the partnership level. The court essentially adopted the position suggested at oral argument by Deputy Solicitor General Malcolm Stewart that “any question that will necessarily have the same answer for all partners should be presumptively be resolved at the partnership level.” Justice Scalia opined that “deferring consideration of those arguments until partner-level proceedings would replicate the precise evil that TEFRA sets out to remedy: duplicative proceedings, potentially leading to inconsistent results, on a question that applies equally to all of the partners.”

Relying on the “plain language” of the penalty the Court also held that the 40% substantial or gross valuation penalty applied to the overstated basis of the partners. “[O]nce the partnerships were deemed not to exist for tax purposes, no partner could legitimately claim a basis in the partnership greater than zero.” The Court adopted the observation of Fifth Circuit Judge Prado that “the basis understatement and the transaction’s lack of economic substance are inextricably intertwined” and therefore the penalties were “attributable to” the overstatement of basis that occurred once the partnership ceased to be recognized for tax purposes.

In an final note of interest to tax practitioners, Justice Scalia rejected the taxpayer’s reliance on the “Blue Book” – a publication of the Joint Committee of Taxation often published after the enactment of tax legislation explaining the legislative history of the statute – and clearly stated that this publication is not a relevant source of Congressional intent.

Read the entire opinion here:
U.S. v Woods, 517 U.S. __, No. 12-562 (Dec. 3. 2013).

IRS Resumes Field Exams & Collections

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irs-sealThe Internal Revenue Service is back and has released guidance on the resumption of field audits and collection activities. Here are some highlights:

  • If you received an audit report requesting a response in 10 days but were unable to respond because of the shutdown you may still respond.  However, your auditor also should re-establish contact before taking additional actions in your case.
  • If you received a 30 day letter, you should continue to adhere to the deadline.  You may contact your auditor to discuss your options.
  • Failure to pay and failure to file penalties are statutory and are charged from the due date of the return until the date of payment.  These penalties will not be abated during the period of the shutdown.

Please visit IRS.gov for more information or read the FAQs here:

FAQs: Resumption of Field Exam Activities

FAQs: Resumption of Field Collections Activities

Revised Due Dates for Tax Court Filings

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us_tax_courtBecause of the government shutdown which began October 1, 2013, and ended October 16, 2013, revised due dates apply for the following United States Tax Court filings.

Pretrial Memoranda

  • Pretrial memoranda for Regular and Small Tax Case sessions beginning October 28, 2013, are due by “October 24 if possible.” If filed, parties are asked to bring courtesy copies to calendar call.
  • Pretrial memoranda for Regular and Small Tax Case sessions beginning November 4, 2013, are due by October 31, 2013.
  • Due dates for pretrial memoranda in cases calendared for trial November 12, 2013, and thereafter are unchanged from those provided in the Standing Pretrial Order and Standing Pretrial Notice.

Opening, Answering & Reply Briefs

  • Opening, Answering & Reply Briefs with an original due date between October 1 and October 16 are due November 8, 2013.
  • Opening, Answering & Reply Briefs with an original due date between October 17 and November 4 are due November 15, 2013.

Answers

  • Answers with an original due date between October 1 and October 16 are due November 8, 2013.
  • Answers with an original due date between October 17 and November 4 are due November 15, 2013.

Decisions

  • Decisions with a due date between October 1 and November 21 are due November 22, 2013.

All Other Items & Actions

  • All other items to be filed or actions required to be taken with an original due date between October 1 and October 16 are due October 25, 2013.
  • All other items to be filed or actions required to be taken with an original due date between October 16 and October 27 are due October 28, 2013.

Please be reminded that statutory deadlines for filing petitions were not extended during the government shutdown.

Read the Tax Court’s official guidance here:
Tax Court Announcement Final 10.17.13

U.S. Tax Court Reopens Today

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UnknownThe United States Tax Court reopens today with the end of the government shutdown. Electronic forms may be filed and hand-delivered petitions will be accepted. Tax Court sessions scheduled to begin on October 21, 2013 will be held as previously scheduled.

Additional information will be posted with details about cancelled trial sessions and grace periods for suspended due dates.

Read more here:
US Tax Court Startup Interim Announcement

Tax Court Reverses Itself on Qualified Appraisals for Façade Easements

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UESThe proper standard for a qualified appraisal in the façade easement context has been vigorously contested by the IRS in recent years. In a rare reversal on reconsideration, the Tax Court adopted the Second Circuit Court of Appeals’ view of the necessary elements for a qualified appraisal in the context of these easement deductions. In short, the Court affirmed that the regulatory standard for a qualified appraisal requires only a method of valuation and a basis for valuation.

The decision under reconsideration was Friedberg v. Commissioner , TC Memo. 2011-238. In the reversal the Tax Court observed its practice of following the precedent of the U.S Court of Appeals to which a case may be appealed, first established in Golsen v. Commissioner, 54 T.C. 742 (1970).

In 2002, the taxpayers, Mr. Friedberg and Ms. Moss, purchased a townhouse in Manhattan’s Upper East Side Historic District for $9,400,000. In 2003, the National Architectural Trust (NAT) contacted Mr. Friedberg and asked him to donate a façade easement. Mr. Friedberg agreed and contacted an appraiser, recommended by NAT, who appraised the value of the easement. The appraisal concluded that the total loss of value, including the easement and the value of unused development rights, was $3,775,000. The taxpayers deducted that amount on their 2003 tax return as a charitable donation of a qualified conservation easement. The Commissioner challenged the deduction with a statutory notice of deficiency. The taxpayers filed a petition in the Tax Court.

The Tax Court issued an opinion following cross-motions on summary judgment. One of the questions decided in favor of respondent was that the taxpayers had failed to provide a qualified appraisal under Treas. Reg. §1.170A-13(c)(3)(ii). In reaching that determination, the Court followed its findings in Scheidelman v. Commissioner, T.C. Memo. 2010-151 (Scheidelman I) where it found that

“the mechanical application of a percentage diminution to the fair market value before donation of a façade easement does not constitute a method of valuation as contemplated under section 1.170A-13(c)(3)(ii).”

Though Friedberg and Moss lost on that issue, not all of the argued issues were decided, including whether the appraisal was “qualified” as to the valuation of the unused development rights. The parties continued discovery on that question.

Meanwhile, in Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012) (Scheidelman II), the Second Circuit vacated the Tax Court on the qualified appraisal standard referenced in the Friedberg opinion. The Court of Appeals held that Huda Scheidelman had obtained a qualified appraisal under the regulations because her appraisal adequately specified the appraiser’s method of, and basis for, determining the easement’s fair market value.

Friedberg and Moss were still hashing out interrogatories and depositions when the Second Circuit decided Ms. Scheidelman’s case. They filed a motion for reconsideration of the Court’s earlier ruling under Tax Court Rule 161. The Tax Court granted the motion.

On reconsideration, the Tax Court found that the appellate opinion “specifically alter[ed] the underlying law” applied in the 2011 Friedberg decision. The Tax Court held that under Scheidelman II

“any evaluation of accuracy is irrelevant for purposes of deciding whether the appraisal is qualified pursuant to section 1.170A-13(c)(3)(ii)(J), Income Tax Regs.”

Accordingly, the Court re-examined the two elements necessary for a qualified appraisal under Treas. Reg. §1.170A-13(c)(3): (1) a method of valuation and (2) a specific basis for the valuation. With regard to the first element, the Court found that Mr. Freidberg’s appraiser provided sufficient information to enable the Commissioner to evaluate his underlying methodology. Thus it included a method of valuation. The Court then considered and found that the appraisal included “some research and analysis” which was enough to establish a specific basis for the appraisal. The legal standard met, the Court reversed its holding in favor of the government and granted summary judgment for the taxpayers on the question of whether they had obtained a qualified appraisal.

The case is hardly over for Friedberg and Moss though. The Court specifically did not opine on the reliability and accuracy of the appraisal, reserving that factual determination for trial. Nonetheless, the Court’s reconsideration reversed its legal ruling in favor of the government and re-established the appraisal as qualified under the regulations. Whether the merits of the appraisal will withstand the scrutiny of a trial remains to be determined.

Read the opinion here:
Friedberg v. Commissioner, TC Memo. 2013-224

IRS is Keeping a Light On for You: Oct. 15 Filing Deadline Not Changed by Shutdown

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IRS_logoWe recently explained the persistence of the federal tax law as it applies to the U.S. Tax Court during the government shutdown. The same rule applies to tax filing deadlines. The continuing government shutdown does not affect the federal tax law and all taxpayers should continue to meet their normal tax filing obligations.

The Internal Revenue Service issued a recent press release reminding us that the October 15 deadline remains in effect for taxpayers who requested a six-month extension to file their tax return. As required by law, individuals and businesses should keep filing their tax returns and making deposits with the IRS, even if there might not be anybody there to respond to your call.

October 15 is the last day for most people to file, but some groups still have more time, including members of the military and others serving in Afghanistan or other combat zone locales. These folks typically have 180 days after they leave the combat zone to both file returns and pay any taxes due.

Taxpayers in parts of Colorado affected by flooding, landslides and mudslides, and who already filed for the automatic extension, also have more time – until Dec. 2, 2013 – to file and pay.

Taxpayers can still file their returns electronically using IRS e-file or the Free File system. Payments accompanying paper and e-filed tax returns will be accepted and processed as the IRS receives them. However, if you’re expecting a refund they will have to get back to you. Tax refunds will not be issued until normal government operations resume.

While you must still file, and may file electronically, you will not be able to reach live IRS personnel for assistance on the phones at Taxpayer Assistance Centers. If it’s any consolation, IRS.gov and most automated toll-free telephone applications will remain operational.

Tax Court Filing Deadlines during Government Shutdown

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us_tax_courtFacing a deadline to file a petition to challenge your Statutory Notice of Deficiency or seek a Redetermination of Collection Due Process Hearing while the federal government is shut down?

Your deadline is not extended.

Statutory Filing Deadlines

The Tax Court lacks the authority to extend statutory filing deadlines imposed in the Internal Revenue Code. So, even though you may not hand deliver the petition to the Tax Court (since it is closed), you still must file by the statutory deadline.

Accomplish your filing and preserve your rights by timely mailing the petition. The post office is still open during the shutdown.

You may also deliver the petition by an approved private express delivery company (FedEx, UPS, etc.). Note that the standard for determining compliance with the deadline by mail is a timely USPS postmark. However, the standard for timely filing for express companies is a certificate of delivery. Confirm that the delivery company you are using will deliver or issue a certificate of delivery to an office that is closed, such as the Tax Court, before relying on that option to file your petition.

Other Tax Court Due Dates Extended

Due dates previously set by Tax Court Rule or Order for filing a document, completing discovery, or any other act shall be extended. All such due dates on or after October 1, 2013, shall be extended by the number of days that Court operations are suspended, up to a maximum extension of 5 days from the date the Court resumes operations. If the extended due date falls on a Saturday, Sunday, or a “legal holiday”, the due date shall then be the next succeeding day that is not a Saturday, Sunday, or a legal holiday.

Read the Tax Court guidance here:
Tax Court Government Shutdown Public Statement

Tax Court: Business Expense Deductions Still Require…a Business

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bowling-w-fred-flintstoneIn a case that would have Fred Flintstone rolling over in his grave, the Tax Court reminded us that expenses incurred while pursuing a hobby cannot be claimed as deductions – no matter how you see it.

Bruce Phillips was a career postal worker. He was also a self-taught bowler. Until 2004, he worked the night shift and spent a far amount of time at the bowling alley.

2000 was a very good year for Mr. Phillips. He won over $50,000 in bowling tournaments. It seemed his pastime might be lucrative enough to become a business. He invested heavily in the bowling venture – to the tune of $30,000 per year. He was not an overnight sensation though. He only won more than $10,000 in a year once more. He nonetheless continued to view bowling as his business.

That brings us to 2008. In 2008, Mr. Philips was working days for the post office and apparently found less time to bowl. Even though he had not won a tournament in three years, he continued to devote substantial resources to his bowling endeavors – or at least he claimed that he did on his 2008 tax return. Mr. Phillips claimed earnings of $67,171 from the postal service and deductions for business expenses of $28,243 related to his bowling endeavors in 2008. (Credit Mr. Phillips’ accountant who refused to sign the return.)

The IRS denied Mr. Phillips’ business expenses and he challenged the Commissioner’s determinations by filing a pro se petition in Tax Court. The Tax Court walked through the nine factors in Treas. Reg. §1.183-2(b), which defines activities not engaged in for profit, concluding that Mr. Phillips satisfied none of them. The Court’s conclusion probably had as much to do with Mr. Phillips’ failure to produce evidence that he even participated a bowling tournament in 2008 as it did with his failure to show that he carried out his bowling venture in any kind of business-like manner. It seems from the evidence and testimony recounted in the opinion that he did neither.

Mr. Phillips’ business expense deductions were denied in full and he found himself subject to an accuracy-related penalty of 20%. Gutter ball.

Read the entire opinion here:
Phillips v. Commissioner, TC Memo. 2013-215

IRS Recognizes Same-Sex Marriages in All States

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irs-sealThe U.S. Department of the Treasury and the Internal Revenue Service (IRS) today ruled that legally married same-sex couples will be treated as married for federal tax purposes. In other words, all marriages will be treated identically for all federal tax purposes. The ruling is in response to the June 26 decision in U.S. v. Windsor that invalidated section 3 of the Defense of Marriage Act (DOMA).

The ruling applies regardless of the residence of the married couple – whether that is in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.

The ruling applies to federal tax provisions where the terms “marriage”, “spouse”, “husband”, “wife”, or “husband and wife” is a factor. Examples of such instances include filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit. The IRS will begin applying the guidance on September 16, 2013.

Any same-sex marriage legally entered into in any state, the District of Columbia, a U.S. territory or a foreign country will be covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.

Legally-married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status. Couples may also file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations.

The IRS indicated that further guidance will be released to allow streamlined procedures for employers who wish to file refund claims for payroll taxes paid on previously-taxed health insurance and fringe benefits provided to same-sex spouses. Additional guidance will also be forthcoming on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before the September 16 effective date.

Read the Revenue Ruling here: Revenue Ruling 2013-17

Read the IRS FAQ here.