Rent-A-Center v. Commissioner: Significant Win for Captive Insurance Companies

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In Rent-A-Center, Inc. v. Commissioner, the majority court affirmed deductions for premiums paid to the taxpayer’s Bermuda captive insurance subsidiary, finding that the captive was adequately capitalized with qualified assets that meaningfully shifted risk.  The dissenting judges disagreed with the majority’s conclusions on the facts and the law finding that Rent-A-Center’s captive arrangement did not constitute insurance for tax purposes.  Split decisions in the Tax Court are infrequent and an appeal may be in store.

Read the full opinion here:
Rent-A-Center, Inc. v. Commissioner, 142 T.C. No. 1 (2014)

U.S. Supreme Court Grants Certiorari in IRS Summons Case

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us-supreme-courtOn January 10, 2014, the U.S. Supreme Court granted a writ of certiorari to hear arguments in a IRS Summons enforcement proceeding that originated in the 11th Circuit Court of Appeals. At issue is whether a taxpayer is entitled to an evidentiary hearing to determine whether an IRS Summons was issued for an improper purpose.

An IRS Summons is issued in good faith when it meets the four part test set forth in United States v. Powell, 379 U.S. 48, 57-58 (1964), to wit: (1) “the investigation will be conducted pursuant to a legitimate purpose”; (2) “the inquiry may be relevant to the purpose”; (3) “the information sought is not already within the Commissioner’s possession”; and (4) “the administrative steps required by the [Internal Revenue] Code have been followed.”

Respondents (taxpayers) argued that IRS issued the Summons for an improper purpose and requested discovery and an evidentiary hearing. The District Court found that respondents made no meaningful allegation of improper purpose and ordered enforcement. The taxpayers appealed.

In an unpublished, per curium opinion, the 11th Circuit reversed the trial court holding that it had abused its discretion when it declined to hold an evidentiary hearing. The appellate court relied on its prior decision in Nero Trading, LLC v. U.S. Dep’t of Treasury, 570 F.3d 1244, 1248 (11th Cir. 2009) quoting from that opinion: “in situations such as this, requiring the taxpayer to provide factual support for an allegation of an improper purpose, without giving the taxpayer a meaningful opportunity to obtain such facts, saddles the taxpayer with an unreasonable circular burden, creating an impermissible ‘Catch 22.’”

While the unpublished opinion which prompted the petition for certiorari was of no precedential value (only published opinions may be relied upon in the 11th Circuit), the government argued that the decision created a split in the Circuits. The high court may be in agreement because it granted the petition for certiorari.

Read the Government’s Petition for Certiorari: Government’s Petition for Writ of Certiorari

Read the Respondents’ Brief in Opposition: Respondent’s Brief in Opposition to Writ of Certiorari

Famous Fridays: Wesley Snipes, A Lesson in Listening to Bad Advice

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1336381705Wesley Snipes was at the center of one of the most publicized tax trials of the last twenty years. Snipes got his start on the small screen with appearances on Miami Vice and in Michael Jackson’s “Bad” music video. His star rose quickly after he appeared as Willie Mays Hayes in the baseball spoof, Major League. He was probably best known for playing the comic book action hero Blade.

Snipes was indicted in 2006 for tax fraud and failure to file returns. His tax problems traced back to the advice of his accountants/tax advisors, Eddie Ray Kahn and Douglas Rosile, who came up with an argument that most of Snipes’ income was exempt from tax. Kahn and Rosile claimed that U.S. citizens could only be taxed on income earned from certain foreign-based activities and not on money made in the U.S. They relied upon a facetious argument which cited IRC § 861 to exclude income earned in the United States by U.S. citizens. This well worn tax protester argument wasn’t new to the courts having been struck down by the Tax Court as early as 1993. See, Solomon v. Commissioner, TC Memo. 1993-509.

Ignoring IRC § 61, and most of the rest of the Internal Revenue Code, Snipes’ advisors argued that only income derived from “taxable activities” is taxable income. They looked to Treas. Reg. § 1.861-8T(d)(2)(iii) to define taxable activities and maintained that, as a United States citizen, Snipes and other clients were not subject to tax on wages derived from sources within the United States. Snipes and his advisors faced a difficult battle given the large volume of Court cases rejecting the IRC § 861 argument and the identification of the argument as a legally frivolous tax return position under IRC § 6702(a).

Snipes pursued his argument in a big way. Snipes filed tax returns though 1999, when presumably he was approached by Kahn and Rosile. He filed amended tax returns seeking $12 million in refunds on taxes he paid in 1996 and 1997. Claiming he had no wages, Snipes stopped filing altogether from 1999 through 2004 – tallying over $15 million in back taxes.

The Department of Justice already had a line on Snipes advisors, having issued a restraining order against Rosile in 2002 for promoting this scheme. After gathering evidence on Snipes, Rosile, and Kahn, the Department of Justice indicted Snipes in 2006. He pleaded not guilty to all counts.

The case went to trial in 2008 with Snipes facing over 16 years in prison. Confident in their case, the defense team did not call any witnesses and rested after less than an hour. Snipes was found not guilty of felony tax fraud, but was convicted of three misdemeanor counts of failing to file tax returns.

In a gesture of good will, Snipes wrote three checks amounting to $5 million to the U.S. Treasury prior to his sentencing. The payments were accepted, but Snipes was still sentenced to three years in prison – the maximum sentence requested by federal prosecutors. He began serving his sentence in 2010 after his appeal requesting a new trial was denied. Kahn and Rosile were not as fortunate. They were sentenced to 10 and 4.5 years, respectively.

Snipes was released from prison in April 2013 to serve the remainder of his three year sentence under house arrest. It looks like he landed on his feet, as he’ll have a role in the movie Expendables 3 slated for release in 2014. Hopefully, he’ll look to § 61 to report his income moving forward.

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.