SCOTUS Reports

Tag: 2017

  • Trimmer v. Commissioner, 148 T.C. No. 14 (2017): Hardship Waiver of 60-Day Rollover Requirement

    John C. Trimmer and Susan Trimmer v. Commissioner of Internal Revenue, 148 T. C. No. 14 (2017)

    In Trimmer v. Commissioner, the U. S. Tax Court ruled that the IRS Examination Division had the authority to consider a hardship waiver of the 60-day rollover requirement for retirement account distributions. The court found that John Trimmer’s major depressive disorder, which began after his retirement and prevented him from completing timely rollovers, qualified for such a waiver under I. R. C. sec. 402(c)(3)(B). This decision highlights the court’s ability to review IRS discretion in granting hardship waivers and underscores the importance of equitable considerations in tax administration.

    Parties

    John C. Trimmer and Susan Trimmer were the petitioners in this case, challenging the Commissioner of Internal Revenue, the respondent, over a notice of deficiency issued on August 18, 2014, by the IRS.

    Facts

    John Trimmer, a retired New York City police officer, received two distributions totaling $101,670 from his retirement accounts in May and June 2011. Shortly after retiring, Trimmer began experiencing symptoms of major depressive disorder, which significantly impacted his ability to manage his affairs. The checks from the distributions remained uncashed on his dresser until July 5, 2011, when he deposited them into a joint bank account. Trimmer did not roll over the funds into an IRA until March 29, 2012, after being advised by his tax preparer. During this period, Trimmer’s depression severely affected his daily functioning and decision-making capabilities. The Trimmers reported these distributions as nontaxable on their 2011 tax return. Upon IRS examination, they requested a hardship waiver of the 60-day rollover requirement, which was denied, leading to the notice of deficiency.

    Procedural History

    The IRS issued a Notice CP2000 to the Trimmers on December 16, 2013, proposing changes to their 2011 tax return, including the taxation of the retirement distributions. The Trimmers responded to this notice on April 30, 2014, requesting a hardship waiver due to Trimmer’s depression. The IRS denied this request on June 6, 2014, and subsequently issued a notice of deficiency on August 18, 2014. The Trimmers timely petitioned the U. S. Tax Court for review. The court reviewed the IRS’s denial of the hardship waiver and the imposition of additional tax under I. R. C. sec. 72(t) on early distributions, as well as the determination of unreported dividend income.

    Issue(s)

    Whether the IRS Examination Division had the authority to consider the Trimmers’ request for a hardship waiver under I. R. C. sec. 402(c)(3)(B)?

    Whether the Tax Court has jurisdiction to review the IRS’s denial of the hardship waiver request?

    Whether the Trimmers are entitled to a hardship waiver under I. R. C. sec. 402(c)(3)(B) due to John Trimmer’s major depressive disorder?

    Whether the Trimmers are liable for the additional tax under I. R. C. sec. 72(t) on early distributions?

    Whether the Trimmers failed to report $40 of dividend income in 2011?

    Rule(s) of Law

    I. R. C. sec. 402(c)(3)(B) allows the Secretary to waive the 60-day rollover requirement “where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement. “

    Rev. Proc. 2003-16, as modified by Rev. Proc. 2016-47, provides guidance on applying for hardship waivers and confirms that the IRS Examination Division has the authority to consider such waivers during the examination process.

    Holding

    The Tax Court held that the IRS Examination Division had the authority to consider the Trimmers’ request for a hardship waiver. The court further held that it had jurisdiction to review the IRS’s denial of the hardship waiver request. The court granted the Trimmers a hardship waiver under I. R. C. sec. 402(c)(3)(B) due to John Trimmer’s major depressive disorder, finding that denying the waiver would be against equity or good conscience. The court did not sustain the IRS’s imposition of the additional tax under I. R. C. sec. 72(t) on early distributions but sustained the determination that the Trimmers failed to report $40 of dividend income.

    Reasoning

    The court reasoned that the IRS had the authority to consider hardship waivers during examinations, as evidenced by Rev. Proc. 2003-16 and its modification by Rev. Proc. 2016-47. The court found that the IRS’s initial denial of the Trimmers’ request was an abuse of discretion because it failed to consider the specific facts and circumstances outlined in Trimmer’s letter, including his major depressive disorder. The court concluded that Trimmer’s illness constituted a disability under I. R. C. sec. 402(c)(3)(B), significantly impairing his ability to complete the rollover within the 60-day period. The court also considered the objective factors listed in Rev. Proc. 2003-16, such as the use of the distributed funds and the time elapsed since the distribution, which were favorable to the Trimmers. The court’s review of private letter rulings showed that the IRS had granted waivers in similar circumstances, supporting the court’s decision to grant a waiver in this case. The court rejected the IRS’s arguments against judicial review, finding that the denial of a hardship waiver directly affected the deficiency determination and was subject to review under the court’s deficiency jurisdiction.

    Disposition

    The court overruled the IRS’s denial of the hardship waiver and granted the Trimmers’ request for a waiver under I. R. C. sec. 402(c)(3)(B). The court did not sustain the imposition of the additional tax under I. R. C. sec. 72(t) but sustained the determination of unreported dividend income. An appropriate order was issued, and a decision was entered under Rule 155.

    Significance/Impact

    This case clarifies the IRS’s authority to consider hardship waivers during examinations and the Tax Court’s jurisdiction to review such denials. It emphasizes the importance of equitable considerations in tax administration, particularly in cases involving mental health issues that impair a taxpayer’s ability to comply with tax requirements. The decision may encourage taxpayers to seek hardship waivers in similar circumstances and highlights the need for the IRS to carefully consider such requests based on the specific facts and circumstances of each case. The case also reaffirms the court’s role in reviewing IRS discretion and ensuring fair application of tax laws.

  • Estate of McKelvey v. Comm’r, 148 T.C. No. 13 (2017): Tax Treatment of Variable Prepaid Forward Contract Extensions

    Estate of McKelvey v. Commissioner of Internal Revenue, 148 T. C. No. 13 (2017)

    In a significant ruling on variable prepaid forward contracts (VPFCs), the U. S. Tax Court held that extending settlement dates in VPFCs does not trigger taxable events under IRC sections 1001 and 1259. This decision clarifies the tax treatment of VPFCs, affirming that open transaction status persists until the delivery of underlying stock, impacting how taxpayers and financial institutions structure these complex financial instruments.

    Parties

    The Estate of Andrew J. McKelvey, represented by Bradford G. Peters as Executor, was the petitioner. The Commissioner of Internal Revenue was the respondent. The case was appealed to the United States Tax Court after a notice of deficiency was issued by the IRS.

    Facts

    Andrew J. McKelvey, the deceased, entered into variable prepaid forward contracts (VPFCs) with Bank of America (BofA) and Morgan Stanley & Co. International plc (MSI) in September 2007. Under these contracts, McKelvey received upfront cash payments in exchange for his obligation to deliver a variable number of Monster Worldwide, Inc. (Monster) shares or their cash equivalent on specified future dates in September 2008. In July 2008, McKelvey extended the settlement dates of both VPFCs until February 2010 for BofA and January 2010 for MSI, paying additional consideration for these extensions. McKelvey died in November 2008, before the extended settlement dates. The estate settled the VPFCs by delivering Monster shares in 2009.

    Procedural History

    The IRS issued a notice of deficiency to McKelvey’s estate in August 2014, asserting a $41,257,103 deficiency in federal income tax for 2008. The IRS argued that the VPFC extensions constituted taxable exchanges and constructive sales of the pledged Monster stock. The estate disputed this determination and filed a petition with the U. S. Tax Court. The case was submitted fully stipulated and without trial under Tax Court Rules 50(a) and 122(a).

    Issue(s)

    Whether the extensions of the VPFCs in 2008 resulted in taxable exchanges under IRC section 1001?

    Whether the extensions of the VPFCs in 2008 resulted in constructive sales of the pledged Monster stock under IRC section 1259?

    Rule(s) of Law

    Under IRC section 1001, gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis. IRC section 1001(c) mandates recognition of the entire amount of gain or loss on the sale or exchange of property unless otherwise provided. IRC section 1259 treats certain transactions as constructive sales of appreciated financial positions, including entering into a forward contract to deliver substantially fixed amounts of property for a substantially fixed price. Revenue Ruling 2003-7 holds that VPFCs meeting specific criteria are open transactions, with no immediate recognition of gain or loss until the delivery of the underlying stock.

    Holding

    The Tax Court held that the extensions of the VPFCs did not constitute taxable exchanges under IRC section 1001 nor constructive sales under IRC section 1259. The court determined that the original VPFCs were open transactions under Revenue Ruling 2003-7, and the extensions merely postponed the settlement dates without altering the open transaction status. Thus, no taxable event occurred upon the execution of the extensions.

    Reasoning

    The court’s reasoning was multifaceted. Firstly, it determined that the VPFCs were not “property” to McKelvey at the time of extension; they were obligations to deliver. The court rejected the IRS’s argument that McKelvey possessed valuable rights in the VPFCs, such as the right to cash prepayments, settlement method choice, and collateral substitution, finding these to be procedural mechanisms rather than property rights.

    Secondly, the court upheld the open transaction treatment of the original VPFCs under Revenue Ruling 2003-7. The extensions did not change the uncertainty regarding the amount and nature of the property to be delivered at settlement, which is the rationale behind open transaction treatment. The court analogized VPFCs to options, noting that the option premium’s tax treatment remains uncertain until exercise or expiration.

    Thirdly, the court addressed the constructive sale argument under IRC section 1259. It noted that the original VPFCs did not trigger constructive sales because they involved the delivery of stock subject to significant variation. Since the extensions did not constitute a new contract or an exchange under section 1001, they could not trigger a constructive sale.

    The court emphasized the importance of maintaining the open transaction status until the actual delivery of stock, consistent with the principles of tax fairness and accuracy in determining gain or loss. It also considered the legislative intent behind section 1259, which aimed to prevent tax avoidance through complex financial transactions, but found that the VPFC extensions did not fall within the scope of this concern.

    Disposition

    The Tax Court entered a decision for the petitioner, affirming that no taxable event occurred upon the VPFC extensions and that the open transaction treatment continued until the delivery of Monster shares.

    Significance/Impact

    This case is doctrinally significant as it provides clarity on the tax treatment of VPFC extensions, affirming that they do not constitute taxable events or constructive sales. It reinforces the open transaction doctrine as applied to VPFCs under Revenue Ruling 2003-7, which is crucial for taxpayers and financial institutions engaging in such contracts. The decision impacts the structuring of VPFCs, allowing for extensions without triggering immediate tax liabilities. Subsequent courts have referenced this case when addressing similar financial instruments, and it continues to guide tax planning and compliance in the realm of complex financial transactions.

  • Whistleblower 16158-14W v. Commissioner of Internal Revenue, 148 T.C. No. 12 (2017): Interpretation of Collected Proceeds under Section 7623(b)(1)

    Whistleblower 16158-14W v. Commissioner of Internal Revenue, 148 T. C. No. 12, 2017 U. S. Tax Ct. LEXIS 13 (U. S. Tax Ct. 2017)

    In a significant ruling, the U. S. Tax Court clarified that whistleblower awards under Section 7623(b)(1) do not include proceeds from a taxpayer’s voluntary compliance for years not examined by the IRS. The court rejected the whistleblower’s claim that a corporation’s change in withholding tax reporting after an IRS examination should count as “collected proceeds,” affirming that only proceeds from direct IRS actions are eligible for awards. This decision underscores the narrow scope of whistleblower awards and emphasizes the importance of direct IRS action in determining eligibility.

    Parties

    The petitioner, Whistleblower 16158-14W, sought an award from the respondent, the Commissioner of Internal Revenue, for information provided regarding a taxpayer’s alleged failure to withhold and pay over taxes. The case was heard by the United States Tax Court.

    Facts

    In January 2009, the whistleblower submitted a Form 211 to the IRS, alleging that a corporation failed to withhold taxes on payments of interest and dividends to foreign persons for the years 2006 through 2008. The whistleblower, an employee of the corporation, later supplemented the submission to include the years 2009 through 2014. The IRS expanded an ongoing audit for 2006 through 2008 to address the whistleblower’s allegations but concluded the examination with a “no change” letter, indicating no adjustments were made. The IRS did not conduct an examination for the subsequent years, despite the whistleblower’s additional submissions. The corporation updated its recordkeeping system after 2008, which the whistleblower claimed led to collected proceeds. The IRS Whistleblower Office denied the whistleblower’s award claim, prompting the petition to the Tax Court.

    Procedural History

    The whistleblower timely petitioned the U. S. Tax Court upon receiving a determination letter from the IRS Whistleblower Office denying an award. The Commissioner filed a motion for summary judgment, arguing that the whistleblower was not entitled to an award due to the lack of collected proceeds. The whistleblower contended that the corporation’s change in reporting for years after the IRS examination should be considered “collected proceeds. ” The court held a hearing and ordered briefs, ultimately granting the Commissioner’s motion for summary judgment.

    Issue(s)

    Whether amounts collected by the IRS as a result of a taxpayer’s voluntary change in reporting for years not examined by the IRS constitute “collected proceeds” under Section 7623(b)(1) of the Internal Revenue Code?

    Rule(s) of Law

    Section 7623(b)(1) of the Internal Revenue Code provides that a whistleblower shall receive an award of 15% to 30% of the collected proceeds resulting from an administrative or judicial action based on information provided by the whistleblower. The term “collected proceeds” is not defined in the statute but has been interpreted by the court as “all proceeds collected by the Government from the taxpayer” resulting from such actions.

    Holding

    The court held that amounts collected by the IRS due to a taxpayer’s voluntary change in reporting for years not examined by the IRS do not constitute “collected proceeds” under Section 7623(b)(1). Therefore, the whistleblower was not entitled to an award for the years 2006 through 2008, as there were no collected proceeds from those years, nor for the subsequent years, as no administrative or judicial action was taken by the IRS for those years.

    Reasoning

    The court’s reasoning focused on the statutory requirement that an award under Section 7623(b)(1) must be based on collected proceeds resulting from an IRS action. The court noted that the IRS did not take any action for the years after 2008, and thus, any changes in the taxpayer’s reporting for those years were not attributable to an IRS action. The court emphasized that “collected proceeds” are limited to those resulting directly from IRS actions, not from a taxpayer’s voluntary compliance. The court also considered the administrative burden and speculative nature of attributing voluntary compliance to IRS actions, rejecting the whistleblower’s argument that the IRS should monitor changes in reporting post-examination. Furthermore, the court found no evidence of a “related action” or an “implied settlement” that would justify including the subsequent years’ proceeds as part of the award.

    Disposition

    The court granted the Commissioner’s motion for summary judgment, affirming that the whistleblower was not entitled to an award under Section 7623(b)(1) for the years in question.

    Significance/Impact

    This decision clarifies the scope of “collected proceeds” under Section 7623(b)(1), emphasizing that only proceeds resulting from direct IRS actions are eligible for whistleblower awards. The ruling may impact future whistleblower claims by limiting awards to proceeds directly resulting from IRS examinations, rather than from voluntary compliance or changes in taxpayer behavior post-examination. It also underscores the importance of the IRS taking specific actions in response to whistleblower information, as opposed to merely monitoring taxpayer behavior. This case may influence how whistleblowers and the IRS approach future claims and the interpretation of related regulations and Internal Revenue Manual provisions.

  • Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11 (2017): Disclosure of Taxpayer Information in Judicial Tax Proceedings

    Mescalero Apache Tribe v. Commissioner, 148 T. C. No. 11 (U. S. Tax Ct. 2017)

    In a significant ruling, the U. S. Tax Court held that third-party taxpayer information can be disclosed in judicial proceedings to absolve an employer of withholding tax liabilities under IRC section 3402(d). The Mescalero Apache Tribe sought discovery of its workers’ tax payment records to prove they had independently paid their taxes, potentially relieving the Tribe of its tax liability. The court’s decision clarifies the scope of IRS confidentiality under IRC section 6103 and supports broader discovery rights in tax disputes.

    Parties

    The petitioner in this case was the Mescalero Apache Tribe, a recognized sovereign government under the Indian Reorganization Act of 1934, located in New Mexico. The respondent was the Commissioner of Internal Revenue, representing the U. S. government.

    Facts

    The Mescalero Apache Tribe classified several hundred workers as independent contractors during the tax years 2009-11. The Commissioner audited the Tribe and reclassified these workers as employees, resulting in a significant tax bill for the Tribe under IRC section 3402(a), which requires employers to withhold income tax on wages. The Tribe attempted to prove that its workers had paid their taxes independently by obtaining Form 4669 from them but was unable to contact 70 of these workers due to their remote locations and lack of communication services. The Tribe sought discovery of the IRS’s records to determine if these workers had reported their income and paid their taxes, which could absolve the Tribe of its withholding tax liability under IRC section 3402(d).

    Procedural History

    The Tribe initially filed a motion to compel discovery of the IRS’s records, which was denied without prejudice as premature. After unsuccessful attempts at informal discovery, the Tribe filed another motion to compel, which was denied due to noncompliance with Rule 71(c) of the U. S. Tax Court Rules of Practice and Procedure. The Tribe then filed a compliant motion to compel discovery, leading to the court’s decision on the issue of whether an employer could discover its workers’ IRS records to reduce its tax liability under IRC section 3402(d).

    Issue(s)

    Whether an employer may take discovery of its workers’ IRS records to reduce its own tax liability under IRC section 3402(d)?

    Whether the disclosure of third-party taxpayer information to absolve an employer of its IRC section 3402(a) tax liabilities is barred under IRC section 6103?

    Rule(s) of Law

    IRC section 3402(a) requires employers to deduct and withhold income tax from wages paid to employees. IRC section 3402(d) provides that if an employer fails to withhold and the employee subsequently pays the tax, the employer is relieved of the withholding tax liability. IRC section 6103 generally prohibits the disclosure of tax returns and return information, but section 6103(h)(4) allows such disclosure in judicial and administrative tax proceedings if certain conditions are met.

    Holding

    The court held that the disclosure of third-party taxpayer information to absolve an employer of its IRC section 3402(a) tax liabilities is not barred under IRC section 6103(h). Furthermore, the court held that the burden of proof on the employer to show that its workers paid income tax does not make their confidential return information nondiscoverable.

    Reasoning

    The court’s reasoning focused on the interpretation of IRC section 6103 and its exceptions. It followed the Tenth Circuit’s precedent, which allows the disclosure of third-party tax-return information in judicial and administrative tax proceedings to persons other than government officials under IRC section 6103(h)(4), provided that the information directly relates to the resolution of an issue in the proceeding. The court found that the workers’ tax payment records directly relate to the transactional relationship between the Tribe and its workers, which affects the resolution of the issue of the Tribe’s tax liability. The court also considered the burden of proof, noting that under Rule 70(b) of the U. S. Tax Court Rules, the burden of proof does not affect the obligation to comply with appropriate discovery requests. The court concluded that the requested information was both disclosable and discoverable, and thus granted the Tribe’s motion to compel discovery.

    The court addressed the Commissioner’s objections, including the argument that the burden of proof under IRC section 3402(d) should prevent discovery. However, the court emphasized that the burden of proof does not preclude discovery and that the requested information was relevant to the case’s resolution. The court also considered the Commissioner’s claim that producing the information would be burdensome but found that the request was not unreasonably voluminous and that the Tribe had exhausted other means of obtaining the information.

    Disposition

    The court granted the Tribe’s motion to compel discovery of the IRS’s records regarding the workers’ tax payments.

    Significance/Impact

    This case has significant implications for tax litigation and the scope of discovery in tax disputes. It clarifies that third-party taxpayer information can be disclosed in judicial proceedings to resolve issues related to an employer’s tax liability, expanding the interpretation of IRC section 6103(h)(4). The decision supports the rights of taxpayers to access relevant information held by the IRS, which may be crucial in defending against tax assessments. The ruling may influence future cases involving worker classification and withholding tax liabilities, potentially affecting how employers and the IRS approach such disputes. The decision also highlights the importance of the burden of proof in discovery requests and may lead to more robust discovery practices in tax litigation.

  • Good Fortune Shipping SA v. Commissioner, 148 T.C. No. 10 (2017): Validity of Bearer Share Regulations under Chevron Deference

    Good Fortune Shipping SA v. Commissioner, 148 T. C. No. 10 (2017)

    The U. S. Tax Court upheld regulations that disallowed a foreign corporation, Good Fortune Shipping SA, from using bearer shares to establish ownership under IRC sec. 883(c)(1) for tax exemptions on shipping income. The court applied the Chevron two-step test, finding the regulations valid and consistent with congressional intent to prevent abuse by ensuring identifiable ownership.

    Parties

    Good Fortune Shipping SA, the petitioner, was a foreign corporation organized under the laws of the Republic of the Marshall Islands. The respondent was the Commissioner of Internal Revenue. The case was heard before the United States Tax Court.

    Facts

    Good Fortune Shipping SA (Petitioner) was incorporated in 2002 under the laws of the Republic of the Marshall Islands and issued its shares in bearer form. In 2007, Petitioner filed a U. S. Income Tax Return of a Foreign Corporation (Form 1120-F) claiming an exclusion from gross income and exemption from U. S. taxation of its U. S. source gross transportation income (USSGTI) under IRC sec. 883(a)(1). Petitioner asserted it was not described under IRC sec. 883(c)(1), which would have denied the exclusion and exemption if 50% or more of its stock value was owned by individuals not residing in a country granting equivalent exemptions to U. S. corporations. Petitioner maintained that regulations disallowing the use of bearer shares to establish ownership for these purposes were invalid. The Commissioner challenged Petitioner’s claims, leading to cross-motions for summary judgment.

    Procedural History

    The case was brought before the United States Tax Court on cross-motions for summary judgment filed by Petitioner and the Commissioner. The court reviewed the case de novo, applying the Chevron two-step analysis to determine the validity of the regulations under IRC sec. 883. The court found no genuine dispute as to any material fact and proceeded to analyze the legal issues presented.

    Issue(s)

    Whether the regulations under IRC sec. 883, which disallow the use of bearer shares to establish ownership for the purposes of determining eligibility for tax exemptions under IRC sec. 883(a)(1), are valid under the Chevron two-step analysis?

    Rule(s) of Law

    IRC sec. 883(a)(1) excludes from gross income and exempts from U. S. taxation gross income from the international operation of ships by a foreign corporation if the foreign country in which it is organized grants an equivalent exemption to U. S. corporations. IRC sec. 883(c)(1) denies this exclusion and exemption if 50% or more of the value of the foreign corporation’s stock is owned by individuals who are not residents of a country granting an equivalent exemption. The Chevron test requires courts to defer to an agency’s interpretation of a statute if Congress has not directly addressed the precise question at issue and the agency’s interpretation is reasonable.

    Holding

    The court held that the regulations disallowing the use of bearer shares to establish ownership under IRC sec. 883(c)(1) were valid under the Chevron two-step analysis. The court found that Congress did not directly address how ownership through bearer shares should be treated under IRC sec. 883(c)(1), and the regulations were a reasonable interpretation of the statute.

    Reasoning

    The court’s reasoning followed the Chevron framework. Under step one, the court found that IRC sec. 883(c)(1) and its legislative history were silent on how ownership through bearer shares should be established, creating a gap that the Treasury Secretary was authorized to fill. Under step two, the court determined that the regulations were a reasonable interpretation of the statute, given the difficulty in reliably demonstrating the true ownership of bearer shares. The court noted the potential for abuse and the intent of Congress to prevent such abuse by ensuring identifiable ownership. The court rejected Petitioner’s argument that the regulations conflicted with the plain language of IRC sec. 883(c)(1), which simply used the term “owned” without specifying how ownership should be established. The court emphasized that the regulations did not deny ownership but rather disallowed the use of bearer shares for establishing ownership under IRC sec. 883(c)(1). The court also considered the Treasury Department’s notice-and-comment procedures and the international concerns about the anonymity of bearer shares as factors supporting the validity of the regulations.

    Disposition

    The court granted the Commissioner’s motion for summary judgment, denied Petitioner’s motion for partial summary judgment, and entered a decision for the Commissioner.

    Significance/Impact

    The case reaffirmed the application of the Chevron deference in tax law, emphasizing the authority of the Treasury Department to promulgate regulations to fill statutory gaps. It also highlighted the challenges posed by bearer shares in tax administration, particularly in the context of international shipping income. The decision underscores the importance of clear ownership identification to prevent tax abuse and supports the Treasury Department’s efforts to address these issues through regulations. Subsequent courts have cited this case in upholding similar regulations and in discussions of Chevron deference in tax law.

  • Amazon.com, Inc. & Subsidiaries v. Commissioner of Internal Revenue, 148 T.C. No. 8 (2017): Transfer Pricing and Cost Sharing Arrangements Under Section 482

    Amazon. com, Inc. & Subsidiaries v. Commissioner of Internal Revenue, 148 T. C. No. 8 (2017), United States Tax Court.

    In a landmark decision, the U. S. Tax Court ruled on the transfer pricing and cost sharing arrangements between Amazon and its Luxembourg subsidiary under Section 482. The court rejected the IRS’s valuation method, which used a discounted cash flow approach, and instead applied the comparable uncontrolled transaction (CUT) method. This ruling significantly impacted how multinational corporations structure their international operations and allocate costs for tax purposes, emphasizing the need for arm’s-length transactions and detailed documentation of cost-sharing arrangements.

    Parties

    Amazon. com, Inc. & Subsidiaries (Petitioner) v. Commissioner of Internal Revenue (Respondent). Petitioner, a U. S. -based company, is the parent of a group of affiliated corporations and foreign subsidiaries, collectively referred to as Amazon. The Commissioner of Internal Revenue, representing the IRS, is the respondent in this case.

    Facts

    In 2005, Amazon entered into a cost sharing arrangement (CSA) with its Luxembourg subsidiary, Amazon Europe Holding Technologies SCS (AEHT), to transfer intangible assets required to operate its European website business. The CSA required AEHT to make an upfront “buy-in payment” to Amazon for pre-existing intangible assets and ongoing cost sharing payments to cover intangible development costs (IDCs). The IRS challenged the buy-in payment, asserting it was not determined at arm’s length and proposing a significantly higher payment based on a discounted cash flow (DCF) methodology.

    Procedural History

    The IRS issued a notice of deficiency to Amazon for 2005 and 2006, asserting deficiencies in federal income tax. Amazon challenged these adjustments in the U. S. Tax Court. The court’s decision followed extensive discovery, expert testimony, and analysis of the valuation methodologies used by both parties. The court applied a de novo standard of review for the legal issues and the “arbitrary, capricious, or unreasonable” standard for the Commissioner’s factual determinations.

    Issue(s)

    1. Whether the IRS’s determination of the buy-in payment using a discounted cash flow methodology was arbitrary, capricious, or unreasonable?
    2. Whether the comparable uncontrolled transaction (CUT) method should be used to determine the buy-in payment for the transferred intangible assets?
    3. Whether the IRS abused its discretion in determining that 100% of the costs in the Technology and Content category constitute IDCs?
    4. Whether stock-based compensation should be included in the IDC pool under the cost sharing agreement?

    Rule(s) of Law

    Section 482 of the Internal Revenue Code authorizes the IRS to allocate income and deductions among controlled entities to prevent tax evasion or clearly reflect income. The cost sharing regulations under Section 1. 482-7 of the Income Tax Regulations require that the buy-in payment for pre-existing intangibles be determined at arm’s length. The best method rule, set forth in Section 1. 482-1(c), seeks the most reliable measure of an arm’s-length result, with no strict priority among methods.

    Holding

    1. The IRS’s determination of the buy-in payment using the DCF methodology was arbitrary, capricious, and unreasonable because it improperly included the value of subsequently developed intangibles and treated short-lived assets as having perpetual value.
    2. The CUT method, with appropriate adjustments, is the best method to determine the buy-in payment for the transferred intangible assets.
    3. The IRS abused its discretion in determining that 100% of the Technology and Content costs constitute IDCs, as these costs include mixed costs that must be allocated on a reasonable basis.
    4. Stock-based compensation should be included in the IDC pool under the terms of the cost sharing agreement, pending final resolution of related litigation.

    Reasoning

    The court’s reasoning focused on the following key points:
    – The DCF methodology used by the IRS was rejected because it valued short-lived intangibles as if they had perpetual life, contravening the requirement that the buy-in payment reflect only pre-existing intangibles.
    – The CUT method was favored for valuing the website technology, marketing intangibles, and customer information, as it provided reliable comparables and adhered to the arm’s-length standard.
    – The Technology and Content costs were found to be mixed costs, requiring allocation between IDCs and other activities based on a reasonable formula, which the court adjusted from the petitioner’s method.
    – The inclusion of stock-based compensation in the IDC pool was upheld based on the terms of the CSA, subject to potential future adjustments if related regulations are invalidated.
    The court applied legal tests from the cost sharing regulations, considered policy implications, and analyzed precedential cases, particularly Veritas Software Corp. v. Commissioner, to reach its conclusions.

    Disposition

    The court ruled in favor of Amazon on the buy-in payment and cost allocation issues, rejecting the IRS’s DCF methodology and affirming the use of the CUT method. The court ordered a recalculation of the buy-in payment and cost sharing payments based on the CUT method and the adjusted cost allocation formula. The case was remanded for further proceedings consistent with the court’s opinion.

    Significance/Impact

    This case has significant implications for transfer pricing and cost sharing arrangements under Section 482. It reinforces the importance of using the CUT method for valuing intangible assets and emphasizes the need for detailed documentation and reasonable allocation methods for mixed costs. The decision also highlights the challenges of valuing intangible assets in rapidly evolving industries and the limitations of the DCF methodology in such contexts. Subsequent courts and multinational corporations have looked to this case for guidance on structuring international operations and complying with transfer pricing regulations.

  • Whistleblower 12568-16W v. Commissioner of Internal Revenue, 148 T.C. No. 7 (2017): Balancing Anonymity and Public Interest in Whistleblower Actions

    Whistleblower 12568-16W v. Commissioner of Internal Revenue, 148 T. C. No. 7, 2017 U. S. Tax Ct. LEXIS 8 (U. S. Tax Ct. 2017)

    In a significant ruling on whistleblower anonymity, the U. S. Tax Court allowed a whistleblower to proceed anonymously in an action concerning a taxpayer’s alleged $3 billion tax fraud. The court weighed the whistleblower’s risks of retaliation and harm against the public’s right to know who uses the courts, granting anonymity at this stage but leaving open the possibility of future disclosure if circumstances change. This decision underscores the delicate balance between protecting whistleblowers and maintaining transparency in judicial proceedings.

    Parties

    Whistleblower 12568-16W, the Petitioner, sought review of the Commissioner of Internal Revenue’s denial of a whistleblower award. The Commissioner of Internal Revenue was the Respondent in this action before the United States Tax Court.

    Facts

    The Petitioner, previously employed by an entity related to the taxpayer, filed a whistleblower action claiming the taxpayer had engaged in tax fraud resulting in an unpaid tax liability exceeding $3 billion. The Petitioner sought to proceed anonymously, asserting that disclosure of their identity would expose them to retaliation, physical harm, social and professional stigma, and economic distress. The Petitioner supported their motion with a declaration detailing their employment history, the nature of the taxpayer’s violations, and the potential consequences of identity disclosure.

    Procedural History

    The Petitioner filed a motion to proceed anonymously under Rule 345(a) of the U. S. Tax Court Rules of Practice and Procedure, concurrent with the filing of the petition. The Respondent did not object to the motion. The court held a telephone conference to discuss the motion and subsequently considered the Petitioner’s supplemental declaration and exhibits. The court granted the motion to proceed anonymously, subject to potential future review.

    Issue(s)

    Whether the Petitioner’s interest in anonymity outweighs the public’s interest in knowing the identity of persons using the courts, given the risks of retaliation, harm, and stigma asserted by the Petitioner?

    Rule(s) of Law

    The U. S. Tax Court’s Rule 345(a) allows petitioners in whistleblower actions to move for permission to proceed anonymously. A whistleblower may proceed anonymously if they present a sufficient showing of harm that outweighs counterbalancing societal interests in knowing the whistleblower’s identity. The court’s discretion includes the ability to condition anonymity on appropriate conditions and to reconsider the balance as the case progresses.

    Holding

    The court held that, at this early stage of the action, the Petitioner’s interest in anonymity outweighed the public’s interest in knowing the Petitioner’s identity. The court granted the Petitioner’s motion to proceed anonymously, subject to potential future reconsideration as the case develops.

    Reasoning

    The court’s reasoning focused on balancing the Petitioner’s asserted risks of harm against the public’s interest in judicial transparency. The court accepted the Petitioner’s claims of potential retaliation, physical harm, and professional and personal consequences as credible for the purposes of the motion. The court cited prior cases, such as Whistleblower 14106-10W v. Commissioner, to establish the legal framework for assessing anonymity requests. The court noted that the balance between anonymity and public interest may shift as the case progresses, particularly given the significant tax liability and potential whistleblower award involved. The court drew parallels to other federal courts’ approaches to pseudonymity in civil complaints, emphasizing the need for flexibility in balancing these interests. The court’s decision to grant anonymity was provisional, acknowledging that future developments in the case could necessitate reconsideration.

    Disposition

    The court granted the Petitioner’s motion to proceed anonymously, with the caveat that the court may revisit this decision as the case progresses.

    Significance/Impact

    This case underscores the U. S. Tax Court’s approach to balancing the competing interests of whistleblower protection and public access to judicial proceedings. The decision reaffirms the court’s authority to grant anonymity in whistleblower actions while maintaining the flexibility to reassess this balance as cases evolve. The case also highlights the potential for significant whistleblower awards to influence the court’s consideration of anonymity, particularly in cases involving substantial tax fraud allegations. The decision may encourage whistleblowers to come forward in tax fraud cases, knowing that their identities can be protected at least initially, while also serving as a reminder that such protection is not absolute and may be subject to future review based on changing circumstances.

  • Liljeberg et al. v. Commissioner, 148 T.C. No. 6 (2017): Deductibility of Expenses for Nonresident Aliens Participating in Summer Work Travel Program

    Liljeberg et al. v. Commissioner, 148 T. C. No. 6 (2017)

    In a landmark decision, the U. S. Tax Court ruled that nonresident aliens participating in the Summer Work Travel Program (SWTP) cannot deduct travel and living expenses under IRC sec. 162(a)(2) due to not being ‘away from home’ in the pursuit of a trade or business. The court upheld the Commissioner’s denial of deductions for airfare, meals, and entertainment, but allowed deductions for program and visa fees, and conditionally for health insurance under IRC sec. 213(a). This ruling clarifies the tax treatment for foreign students working temporarily in the U. S. and impacts future claims for deductions by nonresident aliens.

    Parties

    Richard Liljeberg, Anna V. Zolotareva, and Enda Conway, nonresident alien petitioners, filed their cases in the United States Tax Court against the Commissioner of Internal Revenue, the respondent. The cases were consolidated under docket numbers 20796-14, 22042-14, and 23061-14.

    Facts

    In 2012, petitioners, who were full-time students at foreign universities, participated in the U. S. Department of State’s Summer Work Travel Program (SWTP). This program allowed them to come to the United States for no more than four months during the summer to engage in cultural exchange, domestic travel, and temporary or seasonal work. Petitioners sought to deduct expenses related to their participation in the SWTP, including airfare, program and visa fees, travel health insurance, and meals and entertainment. The Commissioner denied these deductions, although he later conceded the deductibility of program and visa fees. Petitioners conceded that fees paid by Zolotareva in 2011 were not deductible for 2012.

    Procedural History

    The Commissioner issued notices of deficiency to petitioners for the 2012 tax year, denying their claimed deductions for travel and living expenses. Petitioners filed petitions with the U. S. Tax Court, which consolidated their cases for trial, briefing, and opinion. The cases were submitted fully stipulated for decision without trial under Tax Court Rule 122. The standard of review applied was de novo, given the absence of trial.

    Issue(s)

    Whether nonresident aliens participating in the Summer Work Travel Program (SWTP) may deduct expenses for airfare, meals, and entertainment under IRC sec. 162(a)(2), given that they were not ‘away from home’ in the pursuit of a trade or business?

    Whether expenses for travel health insurance paid by SWTP participants are deductible under IRC sec. 162(a)(2) or IRC sec. 213(a)?

    Rule(s) of Law

    IRC sec. 162(a)(2) allows deductions for traveling expenses, including meals and lodging, while ‘away from home’ in the pursuit of a trade or business. For such expenses to be deductible, they must be ordinary and necessary, incurred while away from home, and in the pursuit of a trade or business.

    IRC sec. 213(a) permits deductions for medical expenses, including amounts paid for health insurance, to the extent such expenses exceed 10% of a taxpayer’s adjusted gross income and are not compensated for by insurance or otherwise.

    IRC sec. 871(b)(1) subjects nonresident aliens engaged in trade or business within the United States to taxation on income effectively connected with that trade or business.

    Holding

    The U. S. Tax Court held that petitioners could not deduct their expenses for airfare, meals, and entertainment under IRC sec. 162(a)(2) because they were not ‘away from home’ in the pursuit of a trade or business. The court followed the precedent set in Hantzis v. Commissioner, 638 F. 2d 248 (1st Cir. 1981), emphasizing that petitioners lacked a business connection to their home countries during their participation in the SWTP.

    Further, the court held that petitioners could not deduct their expenses for travel health insurance under IRC sec. 162(a)(2) but could deduct these expenses under IRC sec. 213(a) to the extent they satisfied its requirements.

    Reasoning

    The court’s reasoning centered on the interpretation of ‘away from home’ under IRC sec. 162(a)(2). It emphasized that for expenses to be deductible, the taxpayer must have a business justification for maintaining a residence away from the principal place of employment. Petitioners, being full-time students without business ties to their home countries during their U. S. employment, did not meet this criterion. The court distinguished between temporary employment and the necessity of maintaining a separate residence, citing Hantzis to support its conclusion that petitioners were not ‘away from home’.

    Regarding health insurance, the court reasoned that such expenses are primarily personal and thus not deductible under IRC sec. 162(a)(2). It followed established precedent that health insurance expenses, even if required by an employer or law, are deductible only under IRC sec. 213(a).

    The court also considered the policy implications of allowing deductions for nonresident aliens that might not be available to domestic taxpayers, reinforcing its decision to deny the claimed deductions under IRC sec. 162(a)(2).

    Disposition

    The court’s decision will be entered under Tax Court Rule 155, allowing for the computation of the amount of the deficiencies in accordance with the court’s findings.

    Significance/Impact

    This case sets a significant precedent for the tax treatment of expenses incurred by nonresident aliens participating in cultural exchange programs like the SWTP. It clarifies that such participants cannot deduct travel and living expenses under IRC sec. 162(a)(2) due to the lack of a business connection to their home countries during their U. S. employment. The ruling may influence future tax planning for nonresident aliens and could impact how the IRS and courts view similar cases involving temporary employment and the deductibility of expenses.

    The decision also reinforces the distinction between business and personal expenses, particularly regarding health insurance, which remains deductible only under IRC sec. 213(a). This aspect of the ruling underscores the personal nature of health insurance and could affect how taxpayers approach deductions for such expenses.

  • Izen v. Comm’r, 148 T.C. No. 5 (2017): Substantiation Requirements for Charitable Contributions of Used Vehicles

    Izen v. Comm’r, 148 T. C. No. 5 (2017)

    In Izen v. Comm’r, the U. S. Tax Court ruled that Joe Alfred Izen, Jr. was not entitled to a $338,080 charitable contribution deduction for donating a 50% interest in a 40-year-old aircraft to a museum. The court held that Izen failed to comply with the strict substantiation requirements of I. R. C. § 170(f)(12), which mandates a contemporaneous written acknowledgment (CWA) from the donee for contributions of used vehicles valued over $500. This decision underscores the importance of adhering to detailed substantiation rules to claim charitable deductions, impacting how taxpayers must document such contributions.

    Parties

    Joe Alfred Izen, Jr. (Petitioner) filed a petition against the Commissioner of Internal Revenue (Respondent) in the United States Tax Court. Izen sought a charitable contribution deduction for the tax year 2010, which was challenged by the Commissioner through cross-motions for partial summary judgment.

    Facts

    In December 2007, Joe Alfred Izen, Jr. , and On Point Investments, LLP, purchased a 1969 model Hawker-Siddley DH125-400A private jet for $42,000, with each paying $21,000 for a 50% undivided interest. The aircraft was stored at an airfield in Montgomery County, Texas, for three years. On December 31, 2010, Izen and On Point allegedly donated their respective 50% interests to the Houston Aeronautical Heritage Society, a tax-exempt organization under I. R. C. § 501(c)(3), operating a museum at the William P. Hobby Airport. Izen claimed a charitable contribution deduction of $338,080 on his amended 2010 tax return filed on April 14, 2016, based on an appraisal dated April 7, 2011, which valued his interest at that amount as of December 30, 2010.

    Procedural History

    Izen timely filed his 2010 tax return on October 17, 2011, claiming the standard deduction and no charitable contribution. The IRS examined Izen’s 2009 and 2010 returns and issued a notice of deficiency on August 17, 2012, disallowing certain deductions. Izen petitioned the Tax Court, initially challenging the disallowance of Schedule C and Schedule E deductions. On March 28, 2014, Izen filed a motion for leave to amend his petition to include the charitable contribution deduction, which was granted on April 1, 2014. The court denied Izen’s initial motion for partial summary judgment on March 9, 2016, due to disputes of material fact regarding substantiation. Subsequently, both parties filed cross-motions for partial summary judgment, with the Commissioner arguing that Izen failed to substantiate the charitable contribution under I. R. C. § 170(f)(12).

    Issue(s)

    Whether Joe Alfred Izen, Jr. is entitled to a charitable contribution deduction of $338,080 for his alleged donation of a 50% interest in a 1969 model Hawker-Siddley DH125-400A private jet to the Houston Aeronautical Heritage Society in 2010, given his compliance with the substantiation requirements of I. R. C. § 170(f)(12)?

    Rule(s) of Law

    I. R. C. § 170(f)(12) stipulates that no deduction shall be allowed for contributions of used motor vehicles, boats, and airplanes valued over $500 unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment (CWA) from the donee organization that meets the requirements of I. R. C. § 170(f)(12)(B). The CWA must be included with the taxpayer’s return claiming the deduction and must contain specific information, including the donor’s name and taxpayer identification number, the vehicle identification number, a certification of the intended use or material improvement of the vehicle, and a statement about any goods or services provided in exchange for the vehicle.

    Holding

    The court held that Joe Alfred Izen, Jr. was not entitled to the claimed charitable contribution deduction of $338,080 because he failed to include with his amended 2010 tax return a contemporaneous written acknowledgment that complied with the requirements of I. R. C. § 170(f)(12)(B).

    Reasoning

    The court applied the legal test outlined in I. R. C. § 170(f)(12), which requires strict compliance with substantiation requirements for contributions of used vehicles valued over $500. The court identified several deficiencies in the documentation provided by Izen: (1) the acknowledgment letter included with the return was addressed to Philippe Tanguy, not Izen, and did not contain the required information; (2) the Aircraft Donation Agreement, while containing some required information, was not signed by Izen or On Point, failing to establish a completed gift; (3) the Agreement did not include Izen’s taxpayer identification number, a statutory requirement; and (4) it lacked a detailed certification of the intended use and duration of use by the donee organization, as required by I. R. C. § 170(f)(12)(B)(iv)(I). The court rejected Izen’s argument for substantial compliance, citing previous holdings that the doctrine does not apply to excuse noncompliance with the strict substantiation requirements of I. R. C. § 170(f)(8) and (12). The court also considered the legislative intent behind the statute, which aimed to address tax compliance issues related to charitable contributions of used vehicles, and concluded that the strict statutory requirements must be met to claim the deduction.

    Disposition

    The court granted the Commissioner’s motion for partial summary judgment and denied Izen’s motion for partial summary judgment.

    Significance/Impact

    Izen v. Comm’r reinforces the stringent substantiation requirements for charitable contributions of used vehicles under I. R. C. § 170(f)(12). The decision highlights the necessity for taxpayers to strictly adhere to the statutory requirements, including providing a contemporaneous written acknowledgment that meets all specified criteria. This case serves as a reminder to taxpayers and tax professionals of the importance of detailed documentation and the potential consequences of failing to comply with these requirements. Subsequent courts have consistently upheld the strict application of these rules, impacting the practice of claiming charitable deductions for used vehicles and emphasizing the need for meticulous record-keeping and adherence to IRS guidelines.

  • Jacobson v. Commissioner, 148 T.C. 4 (2017): Voluntary Dismissal in Whistleblower Award Cases

    Jacobson v. Commissioner, 148 T. C. 4 (2017)

    In Jacobson v. Commissioner, the U. S. Tax Court allowed Elizabeth M. Jacobson to voluntarily dismiss her petition for review of the IRS’s denial of her whistleblower award claim. The court applied principles from Wagner v. Commissioner, finding no prejudice to the IRS from the dismissal. This ruling underscores the court’s discretion to grant voluntary dismissals in whistleblower cases, ensuring that the IRS’s original decision to deny the award remains binding on the petitioner.

    Parties

    Elizabeth M. Jacobson was the petitioner at the trial level in the United States Tax Court. The respondent was the Commissioner of Internal Revenue.

    Facts

    Elizabeth M. Jacobson, a Maryland resident, filed a Form 211 with the IRS Whistleblower Office in October 2011, seeking a whistleblower award. On May 11, 2015, the IRS issued a preliminary decision denying her claim, to which Jacobson responded with comments on July 10, 2015. Following review of her comments, the IRS issued a final determination on July 17, 2015, denying her claim on the grounds that no action was taken based on the information provided by Jacobson. Subsequently, on August 17, 2015, Jacobson filed a timely petition for review under I. R. C. sec. 7623(b)(4). On November 18, 2016, she moved to withdraw her petition, which the court treated as a motion for voluntary dismissal.

    Procedural History

    Jacobson filed her petition for review in the United States Tax Court on August 17, 2015, following the IRS’s final determination on July 17, 2015. On November 18, 2016, she filed a motion to withdraw her petition, which was treated as a motion for voluntary dismissal. The Commissioner did not object to this motion. The court, applying the principles from Wagner v. Commissioner, 118 T. C. 330 (2002), and considering the lack of prejudice to the Commissioner, granted Jacobson’s motion for voluntary dismissal on February 8, 2017.

    Issue(s)

    Whether the United States Tax Court should grant the petitioner’s motion for voluntary dismissal of her whistleblower award case, where the respondent does not object and would suffer no prejudice from such dismissal.

    Rule(s) of Law

    The court applied the principle established in Wagner v. Commissioner, 118 T. C. 330 (2002), which allows for voluntary dismissal of cases where no prejudice to the respondent would result. Specifically, the court noted that under Fed. R. Civ. P. 41(a)(2), dismissal is permitted at the discretion of the court unless the defendant will suffer clear legal prejudice.

    Holding

    The United States Tax Court held that because the Commissioner would suffer no prejudice from the dismissal of Jacobson’s petition for review of her whistleblower award claim, the court would grant her motion for voluntary dismissal.

    Reasoning

    The court’s reasoning was grounded in the principle established in Wagner v. Commissioner, which allows for voluntary dismissal when no prejudice to the respondent would result. The court considered that the IRS would not face duplicative litigation, as the time for seeking judicial review of the IRS’s determination had expired. Additionally, the court noted that the IRS’s original determination to deny Jacobson’s claim would remain binding on her post-dismissal. The court also referenced Davidson v. Commissioner, 144 T. C. 273 (2015), which extended Wagner’s logic to other types of cases, reinforcing the court’s discretion in granting voluntary dismissals. The court weighed the equities and found no clear legal prejudice to the Commissioner, thus exercising its discretion to grant the dismissal.

    Disposition

    The United States Tax Court granted Jacobson’s motion for voluntary dismissal, and an appropriate order of dismissal was entered.

    Significance/Impact

    The Jacobson case reaffirms the United States Tax Court’s discretion to grant voluntary dismissals in whistleblower award cases, aligning with precedents set in Wagner and Davidson. This ruling clarifies that petitioners may withdraw their petitions without prejudice to the respondent, provided the respondent does not object and would suffer no legal prejudice. The decision has practical implications for legal practitioners and whistleblowers, as it underscores the importance of considering the timing and implications of filing petitions for review of IRS determinations. It also highlights the binding nature of the IRS’s original decision upon dismissal, ensuring that petitioners are aware of the consequences of withdrawing their claims.