United States v. Clarke: Supreme Court Upholds Integrity of IRS Summons Process

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us-supreme-courtIn a unanimous decision, the U.S. Supreme Court upheld the integrity of IRS summons enforcement proceedings.  In United States v. Clarke, 573 U.S.        (No. 13-301, June 20, 2014), the high court rejected the IRS position and held that a taxpayer has the right to conduct an examination of IRS officials regarding their reasons for issuing a summons when the taxpayer shows facts raising a plausible inference of bad faith.

The IRS sought to disregard taxpayer affidavits attesting that the IRS issued the summonses to punish the taxpayer for refusing to extend the statute of limitations and that the summons enforcement action was designed to evade limitations on Tax Court discovery. The IRS characterized the taxpayer’s claims as bare assertions.

For more about the underlying matter and the parties’ positions, please see our article in the current issue of the Federal Lawyer: Bare Assertions, Naked Allegations, & Improper Purposes.

The Supreme Court rejected the IRS arguments and established the appropriate standard for reviewing the proper purpose required to enforce an IRS summons. The Court ruled that the taxpayer is entitled to examine an IRS agent as part of a summary enforcement proceeding when the taxpayer “can point to specific facts or circumstances plausibly raising an inference of bad faith.” Stated differently, “the taxpayer need only make a showing of facts that give rise to a plausible inference of improper motive.”

Though the Court dismissed the IRS arguments, it also found the intermediate decision of the 11th Circuit in favor of the taxpayers lacking. The Supreme Court found the 11th Circuit’s brief opinion potentially too far ranging in its result and remanded the matter for a more specific findings on the errors adduced to the district court. It also suggested that certain legal issues discussed in the district court opinion, specifically those related to the interplay between summons enforcement and Tax Court discovery, might be subject to review by the 11th Circuit. So while the taxpayer has secured a certain victory, there likely will be more clarification to come on this issue.

Read the U.S. Supreme Court’s opinion here:
U.S. v. Clarke, 573 U.S. ___ (No. 13-301, June 20, 2014)

Second Circuit Affirms Importance of Proper Valuations for Facade Easements

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Second Circuit Court of AppealsOn Wednesday, June 18, 2014, the Second Circuit Court of Appeals affirmed the U.S. Tax Court’s ruling in Scheidelman v. Commissioner, TC Memo 2013-18.

This is Scheidelman’s second, and likely final, visit to the Second Circuit Court of Appeals. See our previous discussion of the Second Circuit’s decision to vacate and remand the case back to the U.S. Tax Court.

Read the full opinion here:  Scheidelman v. Commissioner, No. 13-2650 (2d. Cir., June 18, 2014).

Famous Fridays: Nicolas Cage, Spending A Fortune In Sixty Seconds

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nicolas-cage-240

Regardless of your opinions on his talent as an actor, Nicolas Cage amassed a fortune for his consistent roles in movies since 1981. Cage won an Oscar for his performance in Leaving Las Vegas, but he may be best known for his roles in adventure movies Con Air, Face/Off, Gone in Sixty Seconds, Lord of War, and Ghost Rider. He earned more than $150 million from acting between 1996 and 2011, and found a way to spend almost all of it.

Cage accumulated 15 personal homes between 2000 and 2007 ranging from a castle in England to a Bel Air mansion that was taken off the market when nobody could meet Cage’s $35 million asking price. He also spent $7 million on a private island in the Bahamas, purchased 4 yachts, and a $30 million private jet. His car collection would have made Memphis Raines proud with nine Rolls Royces, 30 motorcycles, a $500,000 Lamborghini, and a $1 million Ferrari Enzo.

He earned $40 million and was the fifth-highest paid actor by Forbes in 2009, but on the whole it was a bad year financially for Cage. Even this income wasn’t enough to sustain Cage’s lifestyle. His Bel-Air mansion was foreclosed upon by each of the six lenders supplying six mortgages totaling nearly $20 million. The IRS placed a lien on his New Orleans home to collect over $13 million in unpaid taxes and penalties for tax years from 2002-2007. A large part of the bill stemmed from using a company he owned to write off $3.3 million in personal expenses including costs for limos, meals, gifts, travel, and his private jet. Among other things, the IRS adjusted his taxable income from $430,000 to $1.9 million in 2003 and from $17 million to $18.5 million in 2004. The IRS reduced the expenses for his private jet by over $500,000 in several other tax years.

He fired and sued his business advisor and began making headway on his back taxes by selling some of his properties, a dinosaur skull worth over $250,000 and Action Comics #1 for $2.16 million. In 2012, Cage made a payment of over $6.2 million to the IRS cutting his debt in half. His marketability as an actor and the rumored National Treasure 3, should put Cage well on his way to paying off the IRS.

 

Conservation Easement Yields New Rule on Reasonable Cause Penalty Defense

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us_Tax_Court_fasces-with-red-ribbonThe Tax Court disallowed another charitable deduction for the donation of a façade easement in Boston’s South End Historic District. This time the decision was based on valuation principles, not technical foot faults, and the taxpayers were able to avoid certain penalties.

In Chandler v. Commissioner, 142 TC No. 16 (2014), the taxpayers owned two homes in Boston’s South End Historic District, the Claremont Property and the West Newton Property. The homes were purchased in 2003 and 2005, respectively. The taxpayers entered into an agreement in 2004 to grant the National Architectural Trust (“NAT”) a façade easement on the Claremont Property. They then executed a similar arrangement when they purchased the West Newton Property in 2005.

The taxpayers used an NAT recommended expert to value the easements. He valued the Claremont easement at $191,400 and the West Newton easement at $371,250. The taxpayers took charitable deductions related to the easements of more than $450,000 between 2004 and 2006.

The IRS did not challenge the easements’ compliance with §170(h). However, the IRS did allege that the easements had no value because they did not meaningfully restrict the taxpayers’ properties beyond the provisions under local law. The taxpayers’ countered that the easement restrictions were broader than local law because they limited construction on the entire exterior of the home and required the owners to make repairs. Local law only restricted construction on portions of the property visible from a public way and did not require owners to make repairs. The taxpayers’ also noted that the easement subjected the property to stricter monitoring and enforcement of the restrictions. The Tax Court, citing its recent opinion in Kaufman v. Commissioner, T.C. Memo 2014-52, (discussed below), rejected the taxpayers’ arguments because “buyers do not perceive any difference between the competing sets of restrictions.”

The only remaining issue was valuation. The taxpayers abandoned their original appraisals and presented new expert testimony at trial. The taxpayers’ new expert used the comparable sales approach to calculate a before value of $1,385,000 for the Claremont Property and $2,950,000 for the West Newton Property. The taxpayers’ expert chose seven properties for comparison: four properties in Boston and three properties in New York City. On the basis of data from these properties, he estimated that the taxpayers’ easements diminished the value of both properties by 16%.

The Tax Court found the taxpayers’ expert unpersuasive. The Court dismissed the three New York City comparables because they “tell us little about easement values in Boston’s unique market.” The court also found that three of the four Boston properties were “obviously flawed.” The Court took particular exception to the expert’s use of a comparable unencumbered property that was not actually unencumbered. The Court stated that the “error undermines [the expert’s] credibility concerning not only this comparison, but the entire report.”

The Tax Court also found the respondent’s expert report unpersuasive. The respondent’s expert examined nine encumbered Boston properties that sold between 2005 and 2011. He compared the sales prices immediately before and after the imposition of the easements. Each property sold for more after it had been encumbered by the easement. However, the expert failed to account for significant renovations that took place on many of the properties after they were encumbered. Thus, the Court found the expert’s analysis unpersuasive because “it does not isolate the effect of easements on the properties in his sample.” However, in the final analysis, the Court sided with the IRS and disallowed the taxpayer’s deductions.

However, the Court did accept the taxpayers’ reasonable cause defense for gross valuation misstatement penalties in 2004 and 2005. Unfortunately, the reasonable cause exception for gross valuation misstatements of charitable contribution property was eliminated with the Pension Protection Act of 2006, so the Court denied the taxpayers’ reasonable cause defense for the 2006 tax period.

Read the full opinion here: Chandler v. Commissioner, 142 T.C. No. 16

Reliance on Tax Attorney & Licensed Appraiser Helps Taxpayer Preserve Deductions & Avoid Penalties

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us_tax_courtIn Palmer Ranch v. Commissioner, a TEFRA partnership avoided accuracy-related penalties even though the Tax Court reduced the fair market value of its conservation easement by $3.98 million.

The taxpayer claimed a $23.94 million charitable contribution deduction on its 2006 partnership return. The IRS disallowed $16.97 million of the value under exam. At trial, the parties presented valuation experts who relied upon the comparable sales method to set the before and after value of the property. The taxpayer’s expert valued the land at $307,000 per acre, while the IRS expert came in at at $94,000 per acre. The Tax Court reviewed the four properties used by both experts and compared the property’s then-current use with its highest and best use. The taxpayers’ contended that 360 multifamily dwelling units could be developed on the 82-acre parcel. The IRS disagreed, emphasizing: a failed rezoning history; environmental concerns; limited access to outside roads; and neighborhood opposition. The Court rejected each of these arguments and found that “there is a reasonable probability that [the parcel] could have been successfully rezoned to allow for the development of multifamily dwellings.”

The IRS also argued that the real estate market was softening in 2006. Judge Goeke accepted the idea of a declining real estate market and reduced the taxpayer’s pre-encumbrance appraisal of the land from $25.2 million to $21 million. Using the same “after” value percentage (5% of the unencumbered property) the Court found that the fair market value of the conservation easement was $19.96 million.

Following the framework set forth in the U.S. Supreme Court’s recent decision in United States v. Woods, the Court determined that it had jurisdiction to consider the IRC § 6662 penalties. The Court then accepted the taxpayers’ reasonable cause defense and disallowed the 20% penalty because the taxpayer: retained a tax attorney to advise them on the tax aspects of the easement donation; hired a credible, licensed appraiser, and made a good-faith attempt to determine the easement value.

Read the Tax Court opinion here: Palmer Ranch v. Commissioner, T.C. Memo. 2014-79

Tax Court Rejects Expert Value, Imposes Penalties

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us_Tax_Court_fasces-with-red-ribbonIn what may be the last word on Kaufman v. Commissioner, the Tax Court sustained the IRS’s complete disallowance of charitable deductions claimed for the donation of a façade easement. The case returned to the Tax Court on remand from the First Circuit Court of Appeals to determine the value of the easement and the application of accuracy-related penalties.

The taxpayers’ owned a 150 year-old row house in a designated historic district in Boston, Massachusetts subject to the South End Landmark District Residential Standards (“South End Standards”). In 2003, taxpayers’ entered into an agreement with the NAT to donate a façade easement over the property. The taxpayers 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 the unused development rights, was $220,800. The taxpayers deducted that amount on their 2004 and 2005 tax returns as a charitable donation of a qualified conservation easement. The Commissioner challenged the deductions with a statutory notice of deficiency.

In Kaufman v. Commissioner, 134 T.C. 182 (2010) (Kaufman I), the Tax Court ruled for the IRS in a motion for partial summary judgment. The Court held that the conservation easement failed to satisfy the “in perpetuity” requirements of the Treasury Regulations. The Court then issued a second opinion making additional findings, disallowing other items and imposing penalties on the remaining issues (Kaufman II). The taxpayers’ appealed. The U.S. Court of Appeals for the First Circuit rejected the Tax Court’s ruling that the taxpayers’ mortgage lender agreement undercut the regulation’s “in perpetuity” requirement as a matter of law (Kaufmann III) and remanded for further consideration of the taxpayers’ charitable contribution deductions under the facts.

The primary issue on remand was the proper valuation of the façade easement. The taxpayers’ valuation expert used a sales comparison analysis with data from three comparable properties. Using the before-and-after method, he determined that the value of the property was $1,840,000 before the grant of the easement. The expert used a “method unique to him and not a generally accepted appraisal or valuation method” to determine that the total value of the property was reduced by 12% or $220,800 when encumbered by the façade easement.

The IRS’s expert discredited the taxpayer’s valuation stating that it was “the fruit of an inappropriate valuation methodology employing a wholly unsupported adjustment factor.” Notably, both the IRS expert and the taxpayer’s expert agreed, “neither the preservation agreement nor the preexisting restrictions hamper the potential for developing the property to its highest and best use…as a single family home.”

The Tax Court gave no weight to the taxpayers’ expert because of his close relationship with NAT, his limited experience appraising façade easements, and his use of a “unique” valuation methodology. The Court also conducted its own comparison of the façade easement restrictions and the South End Standards. The Tax Court found that the agreements were “basically duplicative” and there were no significant additional restrictions placed on the property by the façade easement.

The Court held in favor of the IRS finding that the façade easement had no fair market value when conveyed to NAT. The Tax Court also upheld the IRS’s imposition of accuracy-related penalties.

Read the full opinion here: Kaufman v. Commissioner, T.C. Memo. 2014-52

IRS Releases Guidance on Convertible Virtual Currency: Bitcoin Treated As Property for Federal Tax Purposes

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opengraphThe IRS released Notice 2014-21 on Tuesday, March 25th to provide guidance on the treatment of convertible virtual currencies, like Bitcoin, as property, not currency, for Federal tax purposes.

The IRS distinguishes between virtual currency, a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value, and convertible virtual currency, which has an equivalent value in real currency or can act as a substitute for real currency. The Notice specifically mentions Bitcoin as an example of a convertible virtual currency.

Notice 2014-21 only applies to convertible virtual currency. The Notice provides additional instructions for determining basis, calculating gain or loss, and necessary forms for reporting transactions using convertible virtual currency.

You can read the full Notice here:
IRS Notice 2014-21

U.S. Supreme Court Reverses Sixth Circuit on FICA Withholding for Severance Payments

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Seal_of_the_United_States_Supreme_Court.svgOn Tuesday, March 25, 2014, the United States Supreme Court reversed the Sixth Circuit Court of Appeals decision in U.S. v. Quality Stores, Inc.

Find earlier discussion of the Sixth Circuit decision here.

Read the full opinion here:
United States v. Quality Stores, No. 12-1408 (March 25, 2014)

North Dakota Conservation Easements Prohibited by State Law

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us_tax_courtIn a case that highlights the potential conflict between state law and the requirements for the deductible donation of a conservation easement, the Tax Court in Wachter v. Commissioner held that a North Dakota conservation easement failed the “in perpetuity” requirement under IRC § 170(h)(2)(C) because North Dakota state law limits the duration of an easement to 99 years.

The taxpayers, comprised of two sets of couples filing joint returns for the tax years in question, owned varying interests in two partnerships, WW Ranch and Wind River, LLC. The partnerships entered into a cooperative agreement with the Commodity Credit Corporation and the American Foundation for Wildlife to sell conservation easements on multiple parcels from 2004 through 2006.

The taxpayers made three cash gifts to the North Dakota Natural Resource Trust (NRT) totaling $485,650 from 2004-2006. On its partnership returns, WW Ranch reported bargain sales of conservation easements as charitable contributions of $349,000 for 2004, $247,550 for 2005, and $162,500 for 2006. The parties obtained two appraisals to each contributed parcel. Each appraisal valued the property according to a different land use, and the taxpayers used the difference in appraised values to determine the value of the conservation easements.

The IRS issued notices of deficiency disallowing the charitable contribution deductions for both the cash payments to NRT and the property contributions. The IRS filed a motion for partial summary judgment.

Under IRC § 170(h)(1) a contribution of real property is a qualified conservation contribution if:

  1. The property is a “qualified property interest”,
  2. The contributee is a “qualified organization”, and
  3. The contribution is “exclusively for conservation purposes.”

The IRS argued that because the North Dakota state law restricts easements to 99 years the conservation easements cannot satisfy the first and third requirements of IRC § 170(h)(1). The parties agreed that the state law here is unique; it is the only state with a statute that provides for a maximum duration that may not be overcome by agreement.

Under IRC 170(h)(2)(c) a “qualified property interest” means “a restriction (granted in perpetuity) on the use which may be made of the real property. The taxpayers argued that the possibility that the land would revert back to them, WW Ranch, or their successors in interest is the same as a remote future event under Treas. Reg. § 1.170A-14(g)(3) that will not prevent the easements from being perpetual.

A remote future event under Treas. Reg. § 1.170A-14(g)(3) if “on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.” The Tax Court cited its opinion in 885 Inv. Co. v. Commissioner, defining “so remote as to be negligible” as “a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction.”

The Court granted partial summary judgment on the conservation easement issue in favor of the IRS finding that “on the dates of the donations it was not only possible, it was inevitable that AFW would be divested of its interests in the easements by operation of North Dakota law.” The case will continue to trial on the deductibility of cash contributions to NRT.

Read the full opinion here: Wachter v. Commissioner, 142 T.C. No. 7