SCOTUS Reports

Tag: United States Tax Court

  • DelPonte v. Commissioner, 158 T.C. No. 7 (2022): Authority of IRS Counsel in Innocent Spouse Relief

    DelPonte v. Commissioner, 158 T. C. No. 7 (2022)

    In DelPonte v. Commissioner, the U. S. Tax Court ruled that IRS Chief Counsel retains the authority to concede or settle innocent-spouse relief claims raised as an affirmative defense in deficiency proceedings, not the IRS’s Cincinnati Centralized Innocent Spouse Operation (CCISO). This decision clarifies the roles within the IRS regarding innocent-spouse relief when it is first raised in Tax Court, impacting how such claims are processed and potentially resolved.

    Parties

    Michelle DelPonte, the petitioner, sought innocent-spouse relief in deficiency proceedings against the Commissioner of Internal Revenue, the respondent. DelPonte was the petitioner throughout the litigation in the Tax Court.

    Facts

    Michelle DelPonte, formerly Michelle Goddard, was married to William Goddard. During their marriage, they filed joint tax returns for the years 1999, 2000, and 2001. Goddard, a lawyer, engaged in tax-avoidance schemes with his business partner David Greenberg, leading to IRS notices of deficiency issued to the couple. DelPonte was unaware of these notices until November 2010. Goddard had filed petitions on her behalf, claiming innocent-spouse relief under I. R. C. § 6015(c), without her knowledge. Upon discovering the litigation, DelPonte hired her own legal representation and ratified the petitions. The IRS’s Cincinnati Centralized Innocent Spouse Operation (CCISO) reviewed DelPonte’s request for relief and determined she was entitled to it. However, the IRS’s Chief Counsel sought further information and did not accept CCISO’s determination, prompting DelPonte to move for entry of decision granting her relief.

    Procedural History

    DelPonte’s case began with deficiency notices issued to her and Goddard for the tax years in question. Goddard filed petitions on her behalf, asserting innocent-spouse relief. DelPonte later ratified these petitions. The IRS referred her claim to CCISO, which concluded she was entitled to relief under § 6015(c). Despite this, the IRS Chief Counsel sought additional information and did not adopt CCISO’s conclusion. DelPonte then moved for entry of decision in her favor based on CCISO’s determination. The Tax Court treated this motion as one for partial summary judgment.

    Issue(s)

    Whether the IRS Chief Counsel has the authority to concede or settle an innocent-spouse relief claim raised as an affirmative defense in a deficiency proceeding, or whether such authority lies with the Cincinnati Centralized Innocent Spouse Operation (CCISO).

    Rule(s) of Law

    The Commissioner of Internal Revenue, through delegation to the Chief Counsel, has the authority to administer and enforce internal revenue laws, including making determinations about innocent-spouse relief under I. R. C. § 6015. The Chief Counsel Notice CC-2009-021 instructs attorneys to request CCISO’s determination on innocent-spouse relief claims raised for the first time in deficiency proceedings, but such determinations are advisory, not binding.

    Holding

    The Tax Court held that the IRS Chief Counsel has the authority to concede or settle innocent-spouse relief claims raised as an affirmative defense in deficiency proceedings, and that CCISO’s determinations are not binding on the Chief Counsel.

    Reasoning

    The court’s reasoning centered on the statutory and regulatory framework governing the IRS’s authority. The court noted that the Commissioner’s broad powers to administer the tax laws are delegated to the Chief Counsel in cases pending before the Tax Court. The court reviewed the history of innocent-spouse relief, noting that such claims have been raised as defenses in deficiency proceedings long before the current administrative processes were established. The court analyzed Chief Counsel Notices and the Internal Revenue Manual (IRM), concluding that while CCISO provides determinations on innocent-spouse relief, these are advisory in nature when the claim is first raised in a deficiency case. The court rejected DelPonte’s argument that principles of fairness required CCISO’s determinations to be binding, stating that the statutory scheme clearly allocates authority to the Chief Counsel in such litigation contexts. The court also considered and dismissed the possibility that Chief Counsel Notice CC-2009-021 constituted a redelegation of authority to CCISO, as CCISO is not within the Office of the Chief Counsel. The court’s decision emphasized the distinction between administrative determinations and litigation decisions, affirming the Chief Counsel’s discretion in the latter.

    Disposition

    The Tax Court denied DelPonte’s motion for entry of decision, affirming the Chief Counsel’s authority to decide whether to concede or settle her innocent-spouse relief claim.

    Significance/Impact

    This case clarifies the delineation of authority within the IRS regarding innocent-spouse relief claims raised in deficiency proceedings. It reinforces the Chief Counsel’s role in litigation decisions, potentially affecting how taxpayers approach such claims and the procedural steps they must follow. The decision may influence future cases where innocent-spouse relief is sought in deficiency proceedings, emphasizing the need for taxpayers to engage with the Chief Counsel directly when such relief is contested. The ruling also highlights the advisory nature of CCISO’s role in deficiency cases, which could impact the strategic considerations of both taxpayers and IRS attorneys in handling these claims.

  • Bats Global Markets Holdings, Inc. v. Commissioner, 158 T.C. No. 5 (2022): Domestic Production Gross Receipts under I.R.C. § 199

    Bats Global Markets Holdings, Inc. v. Commissioner, 158 T. C. No. 5 (2022)

    The U. S. Tax Court ruled that Bats Global Markets Holdings, Inc. could not claim transaction, routing, and logical port fees as domestic production gross receipts (DPGR) under I. R. C. § 199. The court determined these fees were derived from services rather than direct use of software, thus not qualifying for the deduction. This decision clarifies the scope of DPGR, impacting how software-related services are treated for tax purposes.

    Parties

    Bats Global Markets Holdings, Inc. and its subsidiaries (Petitioner) v. Commissioner of Internal Revenue (Respondent). Bats Global Markets Holdings, Inc. was the petitioner throughout the litigation in the United States Tax Court.

    Facts

    Bats Global Markets Holdings, Inc. (Bats Global), a Delaware corporation, operated national securities exchanges and developed proprietary computer software for these exchanges. Bats Global charged customers fees for transaction execution, routing to external markets, and logical port connectivity. These fees, collectively referred to as the Fees, were claimed as domestic production gross receipts (DPGR) for the purpose of calculating deductions under I. R. C. § 199 for the tax years 2011-2013. The Commissioner of Internal Revenue determined that none of these fees qualified as DPGR.

    Procedural History

    The Commissioner issued a notice of deficiency to Bats Global, determining deficiencies for the tax years 2011, 2012, and 2013. Bats Global timely sought redetermination in the U. S. Tax Court. After concessions by Bats Global regarding certain fees, the remaining issue was whether the Fees qualified as DPGR. The case proceeded to trial, and the Tax Court issued its opinion on March 31, 2022, under a de novo standard of review.

    Issue(s)

    Whether the Fees charged by Bats Global for transaction execution, routing to external markets, and logical port connectivity qualify as domestic production gross receipts (DPGR) under I. R. C. § 199 and Treasury Regulation § 1. 199-3(i)(6)(iii)?

    Rule(s) of Law

    Under I. R. C. § 199, a taxpayer may claim a deduction based on domestic production gross receipts (DPGR), which includes gross receipts derived from the disposition of qualifying production property (QPP), such as computer software, manufactured, produced, grown, or extracted by the taxpayer in the United States. Treasury Regulation § 1. 199-3(i)(6)(iii) provides that gross receipts derived from providing customers access to computer software for direct use while connected to the internet or other networks are treated as DPGR if the taxpayer or a third party derives gross receipts from the disposition of the same or substantially identical software in a tangible medium or by download.

    Holding

    The Tax Court held that Bats Global’s Fees do not qualify as DPGR under Treasury Regulation § 1. 199-3(i)(6)(iii) because they were derived from services provided to customers rather than from providing customers direct access to computer software for their use. Additionally, the court found that Bats Global did not meet the third-party comparable exception under Treasury Regulation § 1. 199-3(i)(6)(iii)(B), as the software offered by third parties was not substantially identical to Bats Global’s software.

    Reasoning

    The court analyzed the nature of the Fees and found that they were payments for services related to trade execution, routing, and connectivity rather than for the direct use of software by customers. The court emphasized that the logical port fees provided connectivity to the exchanges, the routing fees were for services performed by Bats Trading, Inc. , and the transaction fees were for trade execution services. The court rejected Bats Global’s argument that these fees were derived from the use of its trading software, as customers did not directly use this software but rather interacted with the exchanges through it.

    The court also considered whether Bats Global met the third-party comparable exception. To qualify, a third party must derive gross receipts from the disposition of substantially identical software. The court determined that the software offered by third parties (e. g. , NYSE Technologies, Cinnober, and MillenniumIT) was not substantially identical to Bats Global’s software because it was used to operate exchanges, whereas Bats Global’s customers used the software to trade on the exchanges. The court interpreted “substantially identical” to mean software that achieves the same functional result from a customer’s perspective and has a significant overlap of features or purpose.

    The court’s interpretation was guided by the plain meaning of the regulation and the specific context of the third-party comparable exception. The court also considered the regulatory examples and the safe harbor for computer software games, which did not apply to Bats Global’s situation. The court concluded that the Fees were not eligible for the DPGR deduction because they were derived from services, and Bats Global did not meet the requirements for the third-party comparable exception.

    Disposition

    The Tax Court’s decision was entered under Rule 155, meaning the court ruled against Bats Global’s claim that the Fees qualified as DPGR, and the case was closed with instructions for the parties to compute the tax liability based on the court’s findings.

    Significance/Impact

    The decision in Bats Global Markets Holdings, Inc. v. Commissioner clarifies the scope of DPGR under I. R. C. § 199 and the application of Treasury Regulation § 1. 199-3(i)(6)(iii). It emphasizes that for fees to qualify as DPGR, they must be derived from the direct use of software by customers, not merely from services facilitated by software. This ruling impacts how companies that use software to provide services, particularly in regulated industries like securities exchanges, can claim deductions under § 199. The decision also provides guidance on the interpretation of “substantially identical software” under the third-party comparable exception, which may influence future cases involving software-related deductions. Subsequent courts and taxpayers will likely refer to this case when determining the eligibility of fees for DPGR status.

  • Estate of Marion Levine v. Commissioner, 158 T.C. No. 2 (2022): Split-Dollar Life Insurance and Estate Tax Valuation

    Estate of Marion Levine v. Commissioner, 158 T. C. No. 2 (2022)

    The U. S. Tax Court ruled that the cash surrender values of life insurance policies funded through a split-dollar arrangement were not includible in the decedent’s estate. The court held that the estate’s valuation of the split-dollar receivable, rather than the policies’ cash values, was correct under sections 2036, 2038, and 2703 of the Internal Revenue Code, due to the fiduciary duties of the investment committee member and the absence of restrictions on the receivable itself.

    Parties

    The petitioner was the Estate of Marion Levine, with Robert L. Larson serving as the personal representative. The respondent was the Commissioner of Internal Revenue.

    Facts

    Marion Levine, before her death in 2009, entered into a split-dollar life insurance arrangement. Her revocable trust paid premiums for life insurance policies on the lives of her daughter Nancy and son-in-law Larry, held by an irrevocable trust (the Insurance Trust). The Insurance Trust’s beneficiaries were Levine’s children and grandchildren. The arrangement stipulated that Levine’s revocable trust had the right to receive the greater of the total premiums paid or the cash surrender value of the policies upon termination or the death of the insureds. Bob Larson, a family friend and business associate, was the sole member of the investment committee managing the irrevocable trust. Levine’s children, Nancy and Robert, and Larson also served as attorneys-in-fact under her power of attorney.

    Procedural History

    The IRS audited Levine’s estate and issued a notice of deficiency, asserting that the estate’s reported value of the split-dollar receivable was too low. The Commissioner argued that the cash surrender value of the insurance policies should be included in the estate’s valuation. The case was heard by the U. S. Tax Court, with the parties stipulating that the fair market value of the split-dollar receivable was $2,282,195 if the estate prevailed. The court focused on the applicability of sections 2036, 2038, and 2703 of the Internal Revenue Code.

    Issue(s)

    Whether the cash surrender value of the life insurance policies held by the Insurance Trust should be included in Levine’s gross estate under sections 2036(a), 2038(a)(1), or 2703 of the Internal Revenue Code?

    Rule(s) of Law

    Sections 2036(a) and 2038(a)(1) of the Internal Revenue Code include in a decedent’s gross estate the value of any transferred property if the decedent retained certain rights or powers over it. Section 2036(a)(1) applies if the decedent retained possession or enjoyment of, or the right to income from, the property. Section 2036(a)(2) applies if the decedent retained the right, alone or with others, to designate who shall possess or enjoy the property or its income. Section 2038(a)(1) applies if the decedent retained the power, alone or with others, to alter, amend, revoke, or terminate the enjoyment of the property. Section 2703 requires property to be valued without regard to certain options, agreements, or restrictions. The regulations under section 1. 61-22 govern the tax consequences of split-dollar life insurance arrangements.

    Holding

    The Tax Court held that the cash surrender values of the life insurance policies were not includible in Levine’s gross estate under sections 2036(a), 2038(a)(1), or 2703. The court found that Levine did not retain any rights to the policies themselves and that the split-dollar receivable, valued at $2,282,195, was the only asset to be included in her estate.

    Reasoning

    The court’s reasoning focused on the specific terms of the split-dollar arrangement and the fiduciary duties of Larson as the sole member of the investment committee. The court rejected the Commissioner’s argument that Levine retained rights to the cash surrender value of the policies under sections 2036(a) and 2038(a)(1), as only the Insurance Trust had the unilateral right to terminate the arrangement. The court distinguished this case from others like Estate of Strangi and Estate of Powell, where fiduciary duties were owed essentially to the decedent. Here, Larson owed enforceable fiduciary duties to all beneficiaries of the Insurance Trust, including Levine’s grandchildren, which would be breached if the policies were surrendered prematurely. The court also held that section 2703 did not apply, as it only pertains to property owned by the decedent at death, and there were no restrictions on the split-dollar receivable held by Levine’s estate. The court emphasized that general contract law principles allowing for modification do not constitute a retained power under sections 2036 or 2038, citing Helvering v. Helmholz and Estate of Tully.

    Disposition

    The Tax Court ruled in favor of the Estate, holding that the value of the split-dollar receivable, not the cash surrender values of the insurance policies, should be included in Levine’s gross estate. The court ordered a decision to be entered under Rule 155.

    Significance/Impact

    This case clarifies the treatment of split-dollar life insurance arrangements under the estate tax provisions of the Internal Revenue Code. It highlights the importance of the specific terms of the arrangement and the fiduciary duties of those managing the trust in determining whether a decedent retains rights to the property transferred. The decision reinforces the principle that only property owned by the decedent at death is subject to valuation under section 2703, and that general contract law principles do not automatically constitute retained powers for estate tax purposes. This ruling may influence future estate planning involving split-dollar life insurance, particularly in ensuring that the terms of the arrangement and the fiduciary duties of trust managers are clearly defined to avoid unintended estate tax consequences.

  • Stein v. Commissioner, 156 T.C. No. 11 (2021): Discretionary Dismissal in Tax Court Proceedings

    Stein v. Commissioner, 156 T. C. No. 11 (2021)

    In Stein v. Commissioner, the U. S. Tax Court held that it has discretion to grant a motion for voluntary dismissal in a case involving a petition for review of the IRS’s denial of administrative costs under I. R. C. § 7430(f)(2). The court’s decision underscores its authority to dismiss cases not related to deficiency determinations without entering a formal decision, emphasizing the distinction between various types of Tax Court jurisdiction and the procedural flexibility available in non-deficiency cases.

    Parties

    Robert Stein and Elaine Stein, as petitioners, brought this action against the Commissioner of Internal Revenue, the respondent, in the United States Tax Court, docket number 22695-18.

    Facts

    The Steins filed a petition in the U. S. Tax Court seeking review of the IRS’s decision denying their application for an award of reasonable administrative costs under I. R. C. § 7430(a)(1). After the Commissioner filed an answer, the Steins moved to voluntarily dismiss their case. The Commissioner did not object to the dismissal, and the period for filing a petition for review of the IRS’s decision had apparently expired.

    Procedural History

    The Steins initiated the action by filing a petition in the U. S. Tax Court pursuant to I. R. C. § 7430(f)(2), challenging the IRS’s denial of their application for administrative costs. Following the Commissioner’s answer, the Steins filed a motion to dismiss the case voluntarily. The Commissioner did not oppose this motion, and the court considered the motion in light of prior cases addressing similar issues.

    Issue(s)

    Whether the U. S. Tax Court has the discretion to grant a motion for voluntary dismissal in a case involving a petition for review of an IRS decision under I. R. C. § 7430(f)(2) without entering a decision?

    Rule(s) of Law

    The U. S. Tax Court has jurisdiction to review IRS decisions regarding administrative costs under I. R. C. § 7430(f)(2). Unlike cases involving deficiency determinations under I. R. C. § 6213(a), where I. R. C. § 7459(d) mandates entry of a decision, there is no similar provision requiring a decision upon dismissal in cases under § 7430(f)(2). The court may look to the Federal Rules of Civil Procedure for guidance on voluntary dismissals, as there is no specific Tax Court rule governing such motions.

    Holding

    The U. S. Tax Court held that it has discretion to grant the Steins’ motion for voluntary dismissal without entering a decision, as the case did not involve a deficiency determination and thus was not subject to I. R. C. § 7459(d).

    Reasoning

    The court reasoned that its jurisdiction under I. R. C. § 7430(f)(2) is distinct from its deficiency jurisdiction under § 6213(a). The court cited prior cases, such as Mainstay Bus. Sols. v. Commissioner, Jacobson v. Commissioner, Davidson v. Commissioner, and Wagner v. Commissioner, which established that the court has discretion to grant motions for voluntary dismissal in cases involving various types of IRS administrative determinations. The court emphasized that I. R. C. § 7459(d) applies only to deficiency cases and does not extend to other types of cases, such as those under § 7430(f)(2). In exercising its discretion, the court considered whether the Commissioner would be prejudiced by the dismissal and found that the lack of objection from the Commissioner indicated no prejudice. The court also noted that the period for filing a petition for review of the IRS’s decision had likely expired, further reducing the likelihood of prejudice to the Commissioner.

    Disposition

    The U. S. Tax Court granted the Steins’ motion for voluntary dismissal without entering a decision.

    Significance/Impact

    This case clarifies the U. S. Tax Court’s discretion to grant voluntary dismissals in cases not involving deficiency determinations, reinforcing the distinction between different types of Tax Court jurisdiction. It highlights the procedural flexibility available to petitioners in non-deficiency cases and underscores the importance of considering the specific statutory context when determining the court’s authority to dismiss cases. The decision may influence how taxpayers and their representatives approach litigation strategy in Tax Court proceedings related to administrative determinations.

  • Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. No. 10 (2020): Validity of Treasury Regulation on Conservation Easement Extinguishment Proceeds

    Oakbrook Land Holdings, LLC v. Commissioner, 154 T. C. No. 10 (2020) (United States Tax Court, 2020)

    In Oakbrook Land Holdings, LLC v. Commissioner, the U. S. Tax Court upheld the validity of a Treasury regulation concerning the allocation of proceeds from the judicial extinguishment of conservation easements. The regulation requires that upon extinguishment, the donee must receive a proportionate share of the proceeds based on the easement’s value at the time of donation, not considering subsequent improvements by the donor. This ruling ensures that conservation purposes remain protected in perpetuity, as mandated by the Internal Revenue Code, and impacts the validity of numerous conservation easement deductions.

    Parties

    Oakbrook Land Holdings, LLC (Oakbrook), with William Duane Horton as Tax Matters Partner, was the petitioner. The Commissioner of Internal Revenue was the respondent. The case proceeded from the trial court to the U. S. Tax Court.

    Facts

    In December 2007, Oakbrook purchased 143 acres near Chattanooga, Tennessee, for $1,700,000. In December 2008, Oakbrook donated a conservation easement over 106 acres of this tract to the Southeast Regional Land Conservancy (SRLC), claiming a charitable contribution deduction of $9,545,000 for 2008. The easement deed included a provision that, in the event of judicial extinguishment, SRLC would receive a share of the proceeds equal to the fair market value (FMV) of the easement at the time of donation, minus the value of any improvements made by Oakbrook post-donation. The Internal Revenue Service (IRS) disallowed the deduction, arguing that this extinguishment clause violated the requirement that the conservation purpose be protected in perpetuity under I. R. C. § 170(h)(5).

    Procedural History

    Oakbrook’s 2008 tax return was selected for examination by the IRS, which issued a notice of final partnership administrative adjustment on December 6, 2012, disallowing the charitable contribution deduction. Oakbrook’s tax matters partner petitioned the U. S. Tax Court for readjustment. The case was tried before Judge Holmes in 2016, and concurrently, a separate memorandum opinion was issued, holding that the easement did not satisfy the perpetuity requirement due to the extinguishment clause. The current opinion addressed Oakbrook’s challenge to the validity of the Treasury regulation governing extinguishment proceeds.

    Issue(s)

    Whether Treasury Regulation § 1. 170A-14(g)(6) was properly promulgated under the Administrative Procedure Act (APA)?

    Whether the regulation’s construction of I. R. C. § 170(h)(5) is valid under the Chevron two-step test?

    Rule(s) of Law

    I. R. C. § 170(h)(5)(A) requires that a conservation purpose be protected in perpetuity for a charitable contribution deduction to be allowed. Treasury Regulation § 1. 170A-14(g)(6) stipulates that upon judicial extinguishment, the donee must receive a portion of the proceeds “at least equal to that proportionate value of the perpetual conservation restriction,” calculated based on the easement’s value at the time of the gift.

    Holding

    The Tax Court held that Treasury Regulation § 1. 170A-14(g)(6) was properly promulgated under the APA and valid under the Chevron two-step test. The regulation’s requirement for the donee to receive a proportionate share of extinguishment proceeds, without reduction for donor improvements, was upheld as a permissible interpretation of I. R. C. § 170(h)(5).

    Reasoning

    The Court found that Treasury complied with APA notice-and-comment rulemaking procedures. Despite receiving comments on the proposed regulation, including concerns about the treatment of donor improvements, the Court concluded that Treasury considered all relevant comments and provided a sufficient basis and purpose for the final rule. The Court rejected the argument that Treasury failed to respond to significant comments, noting that agencies are not required to address every comment received.

    Under Chevron step one, the Court determined that Congress did not directly address how to handle extinguishment proceeds, leaving an ambiguity that Treasury was authorized to fill. Under step two, the Court found the regulation to be a reasonable interpretation of the statute, ensuring that the conservation purpose remains protected in perpetuity. The Court reasoned that the regulation’s proportionate value approach prevents the donor from reaping a windfall in case of future property value increases and ensures the donee’s share remains constant relative to the property’s value at the time of donation.

    Disposition

    The Tax Court upheld the regulation’s validity, affirming the IRS’s disallowance of Oakbrook’s charitable contribution deduction based on the easement deed’s failure to comply with the regulation.

    Significance/Impact

    The decision affirms the Treasury’s authority to interpret the perpetuity requirement of I. R. C. § 170(h)(5) and impacts the validity of many conservation easement deductions that do not comply with the regulation. The ruling underscores the importance of ensuring that conservation purposes remain protected in perpetuity, potentially affecting future easement agreements and IRS enforcement actions.

  • Liu v. Commissioner, T.C. Memo. 2020-31: Classification of S Corporation Income as Ordinary Income

    Liu v. Commissioner, T. C. Memo. 2020-31, United States Tax Court, 2020

    In Liu v. Commissioner, the U. S. Tax Court ruled that income from an S corporation must be reported as ordinary income, not as qualified dividends. Mark Y. Liu and Ginger Y. Bian, deceased, had misreported their income from LB Education Corp. , leading to tax deficiencies. The court upheld the IRS’s determination, emphasizing the legal classification of S corporation income. This decision clarifies the tax treatment of S corporation distributions, affecting how shareholders report such income on their returns.

    Parties

    Mark Y. Liu and Ginger Y. Bian, deceased, with Mark Y. Liu as surviving spouse, were the petitioners. The Commissioner of Internal Revenue was the respondent.

    Facts

    Mark Y. Liu and Ginger Y. Bian, who was deceased at the time of filing, each owned a 50% interest in LB Education Corp. , an S corporation operating Cypress Montessori School. For the tax years 2012 and 2013, LB Education Corp. reported ordinary income of $251,021 and $181,977, respectively, on its Forms 1120S. Liu and Bian filed joint Federal income tax returns for these years, reporting the income received from LB Education Corp. as qualified dividends on Forms 1099-DIV and Schedules K-1. The IRS examined their returns and determined that the income should be classified as ordinary income, leading to tax deficiencies of $29,156 and $26,751 for 2012 and 2013, respectively. Liu and Bian paid the total deficiency amount on June 23, 2018.

    Procedural History

    The IRS issued notices of deficiency on January 6, 2016, determining deficiencies and section 6663 penalties for the years in issue. Liu and Bian filed a petition with the U. S. Tax Court on April 13, 2016, which was treated as timely filed. The IRS conceded the section 6663 penalties during the proceedings. The Tax Court had jurisdiction under section 6213(a) to review the deficiencies. The IRS filed a notice of Federal tax lien (NFTL) on September 26, 2016, and later released it on December 7, 2018, and July 12, 2019, acknowledging the erroneous filing.

    Issue(s)

    Whether the income received by petitioners from LB Education Corp. should be classified and reported as ordinary income rather than qualified dividends for the tax years 2012 and 2013?

    Rule(s) of Law

    An S corporation’s items of income, gain, loss, deduction, and credit flow through to its shareholders, who report their pro rata shares on their respective returns. The character of an S corporation item allocated to a shareholder is determined as if the item were realized directly by the shareholder. See I. R. C. § 1366(a), (b). Qualified dividend income includes dividends received from a domestic corporation and is taxed as net capital gain. See I. R. C. § 1(h)(11)(B)(i)(I).

    Holding

    The court held that the income received by petitioners from LB Education Corp. for the tax years 2012 and 2013 must be classified and reported as ordinary income rather than qualified dividends.

    Reasoning

    The court’s reasoning focused on the statutory framework governing S corporations. The court noted that S corporations are not subject to Federal income tax at the entity level, and their income flows through to shareholders as ordinary income. The court referenced I. R. C. § 1363(a) and § 1366(a), (b), which dictate that the character of income from an S corporation is determined as if the shareholder realized it directly. The court found that the petitioners misreported the income as qualified dividends, which are subject to a different tax treatment under I. R. C. § 1(h)(11)(B)(i)(I). The court emphasized that the IRS’s determination of ordinary income was correct based on the nature of the income reported by LB Education Corp. on its Forms 1120S. The court also addressed the petitioners’ contention regarding interest on the deficiencies, clarifying that the Tax Court’s jurisdiction does not extend to interest under I. R. C. § 6601 in deficiency proceedings.

    Disposition

    The court entered a decision for the respondent with respect to the deficiencies and for the petitioners with respect to the section 6663 penalties.

    Significance/Impact

    Liu v. Commissioner reinforces the principle that income from an S corporation must be reported as ordinary income by shareholders, clarifying the tax treatment of such distributions. This decision impacts how shareholders of S corporations classify and report their income, ensuring compliance with the Internal Revenue Code. It also highlights the Tax Court’s limited jurisdiction over interest issues in deficiency proceedings, guiding future litigation strategies in similar cases. The case’s treatment of the erroneous NFTL filing underscores the importance of accurate IRS administrative actions and their timely correction.

  • Pierson M. Grieve v. Commissioner of Internal Revenue, T.C. Memo. 2020-28: Valuation of Noncontrolling Interests in Family Investment Entities

    Pierson M. Grieve v. Commissioner of Internal Revenue, T. C. Memo. 2020-28 (United States Tax Court, 2020)

    In a dispute over gift tax valuation, the U. S. Tax Court upheld Pierson M. Grieve’s valuations of noncontrolling interests in two family investment LLCs, Rabbit 1, LLC and Angus MacDonald, LLC. The court rejected the IRS’s higher valuations, which relied on a speculative purchase of controlling interests. This decision reinforces the use of traditional valuation methods for noncontrolling interests, emphasizing the importance of excluding speculative future events in determining fair market value.

    Parties

    Pierson M. Grieve, the Petitioner, filed a petition against the Commissioner of Internal Revenue, the Respondent, in the United States Tax Court. Throughout the litigation, Grieve was represented by William D. Thomson and James G. Bullard, while the Commissioner was represented by Randall L. Eager, Jr. , and Christina L. Cook.

    Facts

    Pierson M. Grieve transferred noncontrolling interests in two family investment entities to trusts as part of his estate planning. Rabbit 1, LLC (Rabbit) was formed in July 2013 and held Ecolab stock and cash. Angus MacDonald, LLC (Angus) was formed in August 2012 and held a diversified portfolio of investments including cash, limited partnership interests, venture capital funds, and promissory notes. Grieve transferred a 99. 8% nonvoting interest in Rabbit to a Grantor Retained Annuity Trust (GRAT) on October 9, 2013, and a similar interest in Angus to an Irrevocable Trust on November 1, 2013. Both entities were managed by Pierson M. Grieve Management Corp. (PMG), controlled by Grieve’s daughter, Margaret Grieve.

    Procedural History

    The Commissioner issued a notice of deficiency on January 29, 2018, asserting that Grieve had undervalued the gifts, resulting in a deficiency in his 2013 federal gift tax and an accuracy-related penalty. Grieve timely filed a petition in the United States Tax Court contesting the deficiency. The court considered the case, including expert testimony from both parties, and ruled on the fair market values of the transferred interests.

    Issue(s)

    Whether the fair market value of the 99. 8% nonvoting interests in Rabbit 1, LLC and Angus MacDonald, LLC, transferred by Pierson M. Grieve to the GRAT and Irrevocable Trust, respectively, should be determined by traditional valuation methods or by considering the speculative purchase of the controlling 0. 2% interests?

    Rule(s) of Law

    The fair market value of property for gift tax purposes is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. (See United States v. Cartwright, 411 U. S. 546, 551 (1973); sec. 25. 2512-1, Gift Tax Regs. ) Elements affecting value that depend on speculative future events should be excluded from consideration. (See Olson v. United States, 292 U. S. 246, 257 (1934). )

    Holding

    The Tax Court held that the fair market values of the 99. 8% nonvoting interests in Rabbit and Angus should be determined using traditional valuation methods, rejecting the IRS’s approach which considered the speculative purchase of the 0. 2% controlling interests. The court adopted the valuations and discounts provided in the Value Consulting Group (VCG) reports, which Grieve had relied upon in his gift tax return.

    Reasoning

    The court reasoned that the IRS’s expert, Mr. Mitchell, based his valuations on the hypothetical purchase of the 0. 2% controlling interests, which was deemed speculative and contrary to established valuation principles. The court emphasized that future events, while possible, must be reasonably probable to be considered in valuation, and the IRS provided no empirical data or legal precedent to support Mitchell’s methodology. Conversely, Grieve’s expert, Mr. Frazier, utilized traditional asset-based valuation methods, which were consistent with prior court decisions and did not rely on speculative future events. The court found the lack of control and marketability discounts used by VCG to be within acceptable ranges based on prior cases, and thus adopted these valuations.

    Disposition

    The Tax Court rejected the IRS’s proposed adjustments to the fair market values of the transferred interests and upheld Grieve’s valuations as reported in his gift tax return. The decision was entered under Rule 155, allowing for further proceedings to determine the exact tax liability based on the court’s valuation findings.

    Significance/Impact

    This decision reaffirms the importance of traditional valuation methods in determining the fair market value of noncontrolling interests for gift tax purposes. It underscores the principle that speculative future events should not be considered in valuation unless they are reasonably probable. The ruling may impact future valuation disputes by emphasizing the need for empirical support and adherence to established valuation principles. Additionally, it highlights the challenges the IRS faces in contesting taxpayer valuations without concrete evidence supporting alternative valuation methodologies.

  • Le v. Commissioner, T.C. Memo. 2020-27: Fraud and Unreported Income in Tax Law

    Le v. Commissioner, T. C. Memo. 2020-27 (United States Tax Court, 2020)

    In Le v. Commissioner, the U. S. Tax Court upheld fraud penalties against Dung T. Le for tax evasion spanning 2004 to 2006, stemming from his deliberate underreporting of income from nail salons and structuring of bank deposits. The court’s decision underscores the severity of civil fraud penalties and the significance of accurate income reporting, setting a precedent for handling similar cases of tax evasion.

    Parties

    Dung T. Le and Nghia T. Tran (Petitioners) v. Commissioner of Internal Revenue (Respondent). Le was the primary defendant in a related criminal proceeding for tax evasion for 2006, to which he pleaded guilty. The case then proceeded to the Tax Court for civil tax determinations and penalties.

    Facts

    Dung T. Le and Nghia T. Tran owned and operated two nail salons in Lincoln, Nebraska: CA Nails and Cali Nails. During the tax years 2004, 2005, and 2006, Le diverted substantial amounts of business income by depositing customer checks into his personal savings account and making structured cash deposits to avoid currency transaction reporting requirements. Le was indicted and pleaded guilty to tax evasion for 2006 under 26 U. S. C. § 7201, resulting in criminal restitution. The IRS later assessed deficiencies for all three years and imposed fraud penalties on Le and accuracy-related penalties on both Le and Tran.

    Procedural History

    Le was criminally convicted for tax evasion in 2006 and agreed to a plea deal, resulting in dismissed charges for 2004 and 2005. The IRS issued a notice of deficiency for the tax years 2004 through 2006, assessing additional taxes and fraud penalties against Le, and accuracy-related penalties against both petitioners. The case was appealed to the U. S. Tax Court, where the standard of review was de novo for factual findings and abuse of discretion for penalty imposition.

    Issue(s)

    1. Whether the doctrine of collateral estoppel bars the Commissioner from relitigating petitioners’ tax liability for 2006?

    2. Whether petitioners failed to report gross receipts from their nail salon businesses for 2004, 2005, and 2006?

    3. Whether petitioners are entitled to Schedule C deductions for 2004, 2005, and 2006, in excess of the amounts the Commissioner allowed?

    4. Whether petitioners received additional State tax refunds in 2004 and 2006 which they failed to report?

    5. Whether Le is liable for civil fraud penalties under 26 U. S. C. § 6663 for each year in issue, or alternatively, accuracy-related penalties under 26 U. S. C. § 6662(a)?

    6. Whether Tran is liable for accuracy-related penalties under 26 U. S. C. § 6662(a)?

    Rule(s) of Law

    The court applied principles of tax law related to gross income reporting under 26 U. S. C. § 61(a), business expense deductions under 26 U. S. C. § 162(a), and civil fraud penalties under 26 U. S. C. § 6663. The court also considered the doctrine of collateral estoppel and the IRS’s use of the bank deposits method to reconstruct income.

    Holding

    The court held that: (1) collateral estoppel did not bar relitigation of Le’s 2006 tax liability as the criminal restitution amount was not essential to the judgment; (2) petitioners failed to report gross receipts from their nail salons in the amounts of $45,567. 92, $33,200. 89, and $84,475. 01 for 2004, 2005, and 2006, respectively; (3) petitioners were not entitled to additional Schedule C deductions beyond those allowed by the Commissioner; (4) petitioners failed to report additional State tax refunds for 2004 and 2006; (5) Le was liable for civil fraud penalties for all three years under 26 U. S. C. § 6663; and (6) Tran was not liable for accuracy-related penalties under 26 U. S. C. § 6662(a) due to the fraud penalties imposed on Le.

    Reasoning

    The court reasoned that Le’s actions constituted an intentional scheme to evade taxes, evidenced by his consistent underreporting of income, inadequate record-keeping, implausible explanations, concealment of income, non-cooperation with the IRS, involvement in illegal activities (culminating in a guilty plea), and extensive cash dealings. The court rejected the application of collateral estoppel, noting that the criminal restitution amount was not essential to the judgment of conviction. The court found that the IRS’s use of the bank deposits method was a valid approach to reconstruct income, and Le’s failure to substantiate his claims of non-taxable income from gifts or loans was dispositive. The court also addressed the issue of unreported State tax refunds, deeming them conceded by petitioners. The imposition of fraud penalties on Le was based on clear and convincing evidence of his fraudulent intent, while Tran was spared accuracy-related penalties due to the non-stackability of penalties under 26 U. S. C. § 6662(b).

    Disposition

    The court affirmed the deficiencies in income tax and the imposition of fraud penalties against Le for 2004, 2005, and 2006, and accuracy-related penalties for unreported State tax refunds for 2004 and 2006. The court declined to impose accuracy-related penalties on Tran.

    Significance/Impact

    Le v. Commissioner reinforces the IRS’s authority to assess civil tax liabilities and penalties independent of criminal proceedings and restitution orders. It highlights the importance of accurate income reporting and the severe consequences of fraud, including substantial penalties. The case also underscores the IRS’s ability to use indirect methods like the bank deposits method to reconstruct income when taxpayers fail to maintain adequate records. The decision serves as a cautionary tale for taxpayers about the risks of engaging in tax evasion and the potential for significant civil penalties in addition to criminal consequences.

  • Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T.C. Memo. 2020-26: Personal Guarantees and At-Risk Rules in Tax Deduction Cases

    Rock Bordelon and Torie Bordelon v. Commissioner of Internal Revenue, T. C. Memo. 2020-26 (United States Tax Court, 2020)

    In a significant tax ruling, the U. S. Tax Court held that personal guarantees can establish sufficient at-risk amounts to allow deductions for losses from business activities. The decision affirmed that Rock Bordelon’s guarantees for loans to his business entities, Many LLC and Kilgore LLC, made him personally liable, thus enabling him to claim over $1. 5 million in previously disallowed losses. This ruling clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d), offering guidance for taxpayers and tax professionals on the deductibility of business losses.

    Parties

    Rock Bordelon and Torie Bordelon, as petitioners, against the Commissioner of Internal Revenue, as respondent. The Bordelons were the taxpayers seeking redetermination of tax deficiencies determined by the Commissioner.

    Facts

    Rock Bordelon was engaged in the healthcare business, owning Allegiance Health Management, Inc. (AHM), a medical services company, and Allegiance Hospital of Many, LLC (Many LLC), which he formed to purchase and own a hospital in Louisiana. In 2008, Many LLC and AHM borrowed a $9. 9 million loan (Many Loan) from Union Bank, secured by the hospital and its equipment, with Bordelon executing a personal guarantee as required by the USDA. Many LLC was treated as a disregarded entity for federal tax purposes, with its income and expenses reported on Bordelon’s Schedule C. Bordelon also owned a 90% interest in Allegiance Specialty Hospital of Kilgore, LLC (Kilgore LLC), a partnership, which borrowed $550,000 in 2011 (Kilgore Loan) from Home Federal Bank, with Bordelon as the sole guarantor. The IRS challenged Bordelon’s claimed loss deductions for 2008 related to Many LLC and Kilgore LLC, asserting he was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d).

    Procedural History

    The IRS issued notices of deficiency for the tax years 2008-2011, disallowing loss deductions related to Many LLC and Kilgore LLC on the grounds that Bordelon was not at risk under I. R. C. § 465 and lacked sufficient basis in Kilgore LLC under I. R. C. § 704(d). The Bordelons timely filed petitions with the U. S. Tax Court seeking redetermination of the deficiencies. The Commissioner raised the at-risk issue regarding the Kilgore Loan at trial. The court held that Bordelon’s personal guarantees established sufficient amounts at risk and increased his basis in Kilgore LLC, allowing him to deduct the previously disallowed losses.

    Issue(s)

    Whether Rock Bordelon’s personal guarantees for the Many Loan and the Kilgore Loan established sufficient amounts at risk under I. R. C. § 465 and increased his basis in Kilgore LLC under I. R. C. § 704(d) to allow him to deduct the losses related to Many LLC for 2008 and Kilgore LLC for 2011?

    Rule(s) of Law

    Under I. R. C. § 465, a taxpayer’s loss deductions are limited to the amount for which the taxpayer is considered “at risk,” which includes amounts borrowed with respect to the activity, to the extent the taxpayer is personally liable for repayment or has pledged non-activity property as security. I. R. C. § 465(b)(2)(A), (B). A taxpayer is not considered at risk for amounts protected against loss through nonrecourse financing or guarantees. I. R. C. § 465(b)(4). Under I. R. C. § 704(d), a partner’s loss deduction is limited to his adjusted basis in the partnership, which is increased by the partner’s share of partnership liabilities to the extent the partner bears the economic risk of loss for the liability. 26 C. F. R. § 1. 752-1(a)(1), Income Tax Regs.

    Holding

    The Tax Court held that Bordelon’s personal guarantee of the Many Loan established sufficient amounts at risk under I. R. C. § 465, entitling him to deduct the losses related to Many LLC for 2008. Furthermore, Bordelon’s personal guarantee of the Kilgore Loan increased his basis in Kilgore LLC under I. R. C. § 704(d) and established amounts at risk under I. R. C. § 465, entitling him to deduct for 2011 his share of suspended losses disallowed for 2008.

    Reasoning

    The court applied the “worst-case scenario” analysis to determine whether Bordelon was personally liable for the Many Loan and the Kilgore Loan under I. R. C. § 465(b)(2)(A). The court found that Bordelon was the “obligor of last resort” for both loans, as he had no right to meaningful reimbursement from the primary obligors (Many LLC and AHM for the Many Loan, and Kilgore LLC for the Kilgore Loan) in the event of default. The court also considered the “realistic possibility” of economic loss under I. R. C. § 465(b)(4) and found that Bordelon was not protected against loss, as there were no other guarantors or recourse obligations for the loans. For the Kilgore Loan, the court applied the “constructive liquidation” test under 26 C. F. R. § 1. 752-2(b), Income Tax Regs. , and found that Bordelon’s guarantee made the loan recourse to him, increasing his basis in Kilgore LLC under I. R. C. § 704(d). The court’s reasoning relied on prior case law, including Brand v. Commissioner, 81 T. C. 821 (1983), Abramson v. Commissioner, 86 T. C. 360 (1986), and Melvin v. Commissioner, 88 T. C. 63 (1987), which established the principles for determining personal liability and protection against loss under the at-risk rules.

    Disposition

    The Tax Court ruled in favor of the Bordelons, allowing them to deduct the disallowed 2008 Many LLC loss deductions and the 2011 Kilgore LLC loss deductions. Decisions were to be entered under Rule 155.

    Significance/Impact

    This decision clarifies the application of the at-risk rules under I. R. C. § 465 and the impact of personal guarantees on a taxpayer’s basis in partnerships under I. R. C. § 704(d). It provides guidance for taxpayers and tax professionals on the deductibility of business losses, particularly in cases involving personal guarantees of business loans. The ruling emphasizes the importance of the “worst-case scenario” and “realistic possibility of economic loss” analyses in determining whether a taxpayer is at risk for borrowed amounts. The decision also highlights the significance of the “constructive liquidation” test in determining whether a partnership liability is recourse to a partner, affecting the partner’s basis in the partnership. This case may influence future tax planning and litigation involving personal guarantees and the at-risk rules.

  • Hubert W. Chang v. Commissioner of Internal Revenue, T.C. Memo. 2020-19: Timeliness of Collection Due Process Hearing Requests

    Hubert W. Chang v. Commissioner of Internal Revenue, T. C. Memo. 2020-19 (United States Tax Court, 2020)

    In a significant ruling on tax procedure, the U. S. Tax Court dismissed Hubert W. Chang’s petition for lack of jurisdiction due to untimely requests for Collection Due Process (CDP) hearings. Chang sought review of IRS collection actions for tax years 1999 to 2014 but failed to request a hearing within the required 30-day period following notices of lien and levy. The court’s decision underscores the strict adherence to statutory deadlines in tax collection disputes, reinforcing the importance of timely filing in administrative tax proceedings.

    Parties

    Hubert W. Chang, the petitioner, represented himself pro se. The respondent, Commissioner of Internal Revenue, was represented by David Lau and Trent D. Usitalo. The case was heard in the United States Tax Court, docketed as No. 307-18L.

    Facts

    Hubert W. Chang sought a collection due process (CDP) review for tax years 1999 to 2014 following notices of lien and levy from the IRS. On October 6, 2015, the IRS filed a notice of Federal tax lien and sent Chang a Letter 3172, advising him of his right to a CDP hearing by November 13, 2015. Chang did not request a hearing within this period. On January 12, 2016, the IRS sent Chang a Letter 1058, informing him of its intent to levy regarding his 2003 and 2008 tax liabilities and advising him of his right to a CDP hearing within 30 days, which expired on February 11, 2016. Chang claimed to have mailed requests for CDP hearings on February 11, 2016, but the IRS received them on February 16, 2016. The envelopes lacked postmarks, and USPS barcode data indicated they were processed on February 13, 2016.

    Procedural History

    Chang previously petitioned the Tax Court regarding a notice of determination for tax years 1996 through 2002, which was resolved in Chang v. Commissioner, T. C. Memo. 2007-100. In the current case, following his alleged late requests for CDP hearings, the IRS conducted equivalent hearings and issued decision letters on November 30, 2017. Chang timely filed a petition with the Tax Court on January 4, 2018, challenging the IRS’s determination that his requests for CDP hearings were untimely. The Commissioner moved to dismiss for lack of jurisdiction, asserting that no valid notice of determination under sections 6320 or 6330 was issued because Chang’s requests were late.

    Issue(s)

    Whether the Tax Court has jurisdiction over Chang’s petition given that his requests for Collection Due Process hearings were not timely filed under sections 6320 and 6330 of the Internal Revenue Code?

    Rule(s) of Law

    The Internal Revenue Code sections 6320 and 6330 provide taxpayers with the right to a CDP hearing upon receiving notices of lien filing or intent to levy, with a 30-day period to request such a hearing. The Tax Court’s jurisdiction under section 6330(d) is contingent upon the taxpayer timely requesting a CDP hearing and receiving a notice of determination from the IRS. The burden of proving jurisdiction lies with the petitioner. David Dung Le, M. D. , Inc. v. Commissioner, 114 T. C. 268, 270 (2000).

    Holding

    The Tax Court held that it lacked jurisdiction over Chang’s petition because his requests for CDP hearings were not timely filed within the 30-day period specified by sections 6320 and 6330 of the Internal Revenue Code. The court found that Chang’s requests, received by the IRS after the deadline, did not confer jurisdiction upon the court, and the subsequent equivalent hearings and decision letters issued by the IRS did not constitute a notice of determination under section 6330(d).

    Reasoning

    The court’s reasoning focused on the statutory requirement for timely filing of CDP hearing requests. It noted that Chang’s testimony regarding the mailing date of his requests was contradictory and ultimately unconvincing. The absence of postmarks on the envelopes and the USPS barcode data indicating processing on February 13, 2016, supported the conclusion that the requests were mailed after the deadline. The court rejected Chang’s speculation about possible postal delays, emphasizing the strict interpretation of statutory deadlines in tax law. The court also distinguished between a notice of determination, which would confer jurisdiction, and the decision letters issued after equivalent hearings, which did not. The court’s decision reflects a commitment to upholding statutory time limits as essential to the orderly administration of tax collection processes.

    Disposition

    The Tax Court granted the Commissioner’s motion to dismiss for lack of jurisdiction and entered an appropriate order and decision.

    Significance/Impact

    The decision in Hubert W. Chang v. Commissioner reinforces the strict enforcement of statutory deadlines in tax collection proceedings, particularly the 30-day period for requesting CDP hearings. It serves as a reminder to taxpayers of the importance of timely action in response to IRS notices of lien or levy. The case may influence future litigation by clarifying the jurisdictional requirements under sections 6320 and 6330 and the distinction between notices of determination and decision letters following equivalent hearings. Practitioners must advise clients to strictly adhere to these deadlines to preserve their rights to judicial review.