Taxpayer's Tax Debt Discharged Where IRS Missed Window to Assess; IRS Issues Proposed Regs on Definition of an Acquiring Corporation; Intent to Live Elsewhere Was Irrelevant in Determining Eligibility for FTHBC ...
Third Circuit Opens the Door for Reasonable Cause Defense to Late-Payment Penalty
Reversing the district court, the Third Circuit held that a taxpayer's reliance on the advice of a tax expert may be reasonable cause for failing to timely pay a tax if the taxpayer can also show either an inability to pay or undue hardship from paying by the deadline. Estate of Thouron v. U.S., 2014 PTC 228 (3d Cir. 5/13/14).
Seller Who Reacquired Principal Residence Must Recognize Previously Excluded Gain
A taxpayer who excluded $500,000 of gain under Code Sec, 121 on an installment sale of his principal residence, and then three years later reacquired the property when the buyer defaulted, had to recognize long-term capital gain on the reacquisition of the property, including the gain he had previously excluded under Code Sec. 121. Debough v. Comm'r, 142 T.C. No. 17 (5/19/14)
Final Regs Require Estates and Trusts to Unbundle Fees; Beneficiaries Could See Tax Increases
Final regulations provide guidance on which costs incurred by estates or nongrantor trusts are subject to the 2-percent floor on miscellaneous itemized deductions. T.D. 9664 (5/9/14).
Eighth Circuit Reverses Tax Court on IRA Rollover, Chastises IRS for "Appalling" Arguments
Reversing the Tax Court, the Eighth Circuit agreed with the taxpayer's contention that he rolled over an IRA distribution within 60 days and thus was not taxable on a $120,000 distribution. Haury v. Comm'r, 2014 PTC 227 (8th Cir. 5/12/14).
Where a settlement agreement between a taxpayer and several mortgage lenders resulted in the taxpayer receiving a check for $10,000 from one of the mortgage lenders followed by a requirement to then transmit that amount to the two other mortgage lenders, the taxpayer's receipt of the $10,000 was not taxable income under the step transaction doctrine. Kadir v. Comm'r, T.C. Summary 2014-43 (5/6/14).
The Tax Court held that a taxpayer was not entitled to the filing status of married filing jointly where, after he had filed a joint return but before the return's due date, his wife filed a separate return. Accordingly, the court found he was not entitled to dependency exemption deductions for his two children, the child tax credit, the additional child tax credit, or the earned income credit. Bruce v. Comm'r, T.C. Summary 2014-46 (5/12/14).
Because the taxpayers failed to prove their donated easements had any value, they were not entitled to charitable contribution deductions for the donations and were liable for a 40 percent gross valuation misstatement penalty for one of the three years at issue because the rules in effect when they filed their 2006 return did not provide a reasonable cause exception. Chandler v. Comm'r, 142 T.C. No. 16 (5/14/14).
While noting that the taxpayer's teenage children and nephew would suffer emotionally from her incarceration, the court still affirmed a 51-month prison sentence for a return preparer that filed false returns. U.S. v. Williams-Ogletree, 2014 PTC 226 (7th Cir. 5/12/14).
Third Circuit Opens the Door for Reasonable Cause Defense to Late-Payment Penalty; Highlights Split in Circuits
Reversing the district court, the Third Circuit held that a taxpayer's reliance on the advice of a tax expert may be reasonable cause for failing to timely pay a tax if the taxpayer can also show either an inability to pay or undue hardship from paying by the deadline. Estate of Thouron v. U.S., 2014 PTC 228 (3d Cir. 5/13/14).
Summary
In Estate of Thouron v. U.S., the issue was whether an estate could rely on a tax expert to avoid a failure to pay penalty under the reasonable cause exception. In the case, an executor sought the advice of a tax attorney for the administration of an estate. The attorney and the estate had discussed Code. Sec. 6166, an election to pay the estate tax liability in installments over a period of a few years. On the date the estate return was due, the estate requested an extension to file and remitted a portion of the estimated liability. The estate ultimately did not make a Code Sec. 6166 election for installment payments. Upon the expiration of the filing extension, the estate timely filed its return and also sought an extension to pay the tax due. The IRS denied the extension to pay and imposed a failure to pay penalty because the estate failed to pay the entire liability on the date the return was originally due; an extension to file only extends the filing deadline. The estate proceeded through the administrative process and initiated a refund claim in district court.
Before the district court, the estate argued and lost on the position that a valid defense to the failure to pay penalty is the reasonable cause exception as established in U.S. v. Boyle, 469 U.S. 241 (1985), because the estate relied on erroneous legal advice of an expert regarding have to pay the total liability on the original due date of the return. The court held that under Boyle, expert reliance for a defense of reasonable cause is an invalid excuse for failure to file and pay because the deadlines are clear. The estate appealed.
The Third Circuit reversed the district court reasoning that Boyle was applied too widely and that there are actually three categories of late file/pay cases which Boyle discussed. The court held that reasonable cause could be a valid defense, supported by expert reliance, in cases where legal advice is provided, not merely reliance on the expert for performance of a ministerial task, such as the act of filing a return. The circuit court vacated the district court's decision for further factual inquiry into whether there was expert reliance.
Practice Tip: While the court's decision applies to an estate that failed to pay its taxes on time, it has broad implications for all taxpayers. To the extent a taxpayer has paid a late-payment or late-filing penalty because the taxpayer's reliance on a tax professional was deemed not to be reasonable cause to avoid the penalty, amended returns should be considered.
Background
On February 6, 2007, John Thouron died at age 99. He was predeceased by his wife and only child and was survived by two grandchildren who were not familiar with his financial affairs. Thouron's will appointed Charles Norris as the estate's personal representative. Norris hired attorney Cecil Smith to provide legal services regarding tax compliance of the estate.
The estate's tax return and payment were initially due by November 6, 2007. On that date, the estate requested an extension of time to file its return and made a payment of $6.5 million, which was much less than it would ultimately owe. According to the estate, it did not pay the balance of its liability or, in the alternative, request an extension of time to pay at least in part of the liability, because of advice from Smith relating to the possibility of electing to defer certain liabilities under Code Sec. 6166. This provision allows qualifying estates to elect to pay a portion of their tax liability in installments over several years. As requested, the estate received an automatic six-month extension of time to file the return, which put the filing deadline at May 6, 2008.
The estate timely filed its return in May 2008 and on the same day requested an extension of time to pay the taxes due. It made no election to defer taxes under Code Sec. 6166 because, by that time, it had conclusively determined it did not qualify. The IRS denied as untimely the estate's request for an extension of time to pay and subsequently imposed a failure-to-pay penalty, which the estate unsuccessfully appealed administratively. After losing the administrative appeal, the estate paid all outstanding amounts, including a penalty of approximately $1 million. Three months later, it requested a refund of the penalty and subsequently filed suit in district court arguing that it had reasonable cause i.e., the reliance on a tax expert to avoid the late-payment penalty.
Boyle Decision
In the Boyle case, Robert Boyle was the executor of his mother's estate and he hired an attorney, Ronald Keyser, on behalf of the estate. Boyle relied on Keyser for instruction and guidance. Although Boyle repeatedly checked in with Keyser on the status of the estate's return, the attorney forgot to file the return because of a clerical oversight in omitting the filing date from his master calendar. As a result, the return was not filed until almost three months after the deadline and a late-filing penalty was assessed. When the IRS would not abate the penalty, the estate took the case to court where it lost before the Supreme Court. The Court opined that executors have a fixed and clear duty to ensure that returns are timely filed and that duty cannot be discharged by delegating responsibility to an attorney or accountant. According to the Court, that the attorney, as the executor's agent, was expected to attend to the matter did not relieve Boyle of his duty to comply with the statute.
The District Court's Opinion
The district court, in Estate of Thouron, found in favor of the IRS. Citing Boyle, the lower court rejected the estate's argument that it had reasonable cause for the late tax payment because of its reliance on the erroneous advice of a hired tax professional. According to the district court, the Supreme Court's decision precluded any finding of reasonable cause for the late payment of taxes or the late filing of a return based on reliance on an expert or other agent.
The district court noted that when an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers, the court observed, are not competent to discern error in the substantive advice of an accountant or attorney. By contrast, the court said, one does not have to be a tax expert to know that tax returns have fixed filing dates and taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is common, the court noted; but that reliance cannot function as a substitute for compliance with an unambiguous statute.
The district court also cited a more recent decision of the Ninth Circuit that applied the reasoning in Boyle to a case involving the failure to pay a tax on time. In Baccei v. U.S., 632 F.3d 1140 (9th Cir. 2011), Ronald Baccei was appointed as the trustee for a revocable trust upon Eda Pucci's death on September 17, 2005. Baccei hired a CPA to prepare and file the estate tax return. On June 16, 2006, the CPA mailed to the IRS a Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate Taxes, to extend the filing deadline. The accountant completed three of the four sections of Form 4768, but failed to complete Part II, entitled Extension of Time to Pay. The CPA's cover letter enclosing Form 4768 stated that the estate was seeking this extension of time to pay as well as asking that no penalty be assessed. Because the estate did not pay its tax by the June 2006 deadline, the IRS assessed a penalty and interest.
The Ninth Circuit upheld the penalty based on the Boyle decision. The court explained its' rational for applying Boyle in the context of a failure to timely pay a tax as follows:
We extend these determinations of reasonable cause under Sec. 6651(a)(1) to determinations of reasonable cause under Sec. 6651(a)(2). There is no reason to distinguish between reasonable cause for a failure to timely file an estate tax return and reasonable cause for a failure to timely pay an estate tax, and we refuse to do so. Accordingly, we affirm the district court's finding that [the taxpayer's] reliance upon [a professional] to competently file a payment extension request does not constitute reasonable cause excusing [the taxpayer's] failure to timely pay the estate taxes owed.
Baccei v. U.S., 632 F.3d 1140 (9th Cir. 2011).
Third Circuit's Analysis
The Third Circuit had a different take on the Boyle decision. Under its reading of the decision, Boyle identified three distinct categories of late-filing or, by extension, late-payment cases. In the first category, a taxpayer relies on an agent for the ministerial task of filing or paying a tax. In the second category, in reliance on the advice of an accountant or attorney, the taxpayer files a return after the actual due date but within the time the adviser erroneously said was available. In the third category, an accountant or attorney advises a taxpayer on a matter of tax law.
By its facts, the Third Circuit said, Boyle fit into the first category. Thus, when the Supreme Court reached the holding relied on by the district court, the relevant "reliance on an agent" was for the administrative act of filing the return. The Supreme Court specifically did not reach a conclusion regarding the remaining categories. In fact, the Third Circuit observed, the Supreme Court noted a split of authority as to the second category and explicitly declined to resolve the issue.
Observation: In a footnote, the Third Circuit noted that the definitions of "reasonable cause" for failure to file and failure to pay are not identical. Citing Reg. Sec. 301.6651-1(c)(1), the court said that reasonable cause for failure to file is shown where the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time. On the other hand, reasonable cause excuses failure to pay to the extent the taxpayer has made a satisfactory showing that he or she exercised ordinary business care and prudence in providing for payment of the tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship, as described in Reg. Sec. 1.6161-1(b), if he or she paid on the due date.
The Third Circuit concluded that a taxpayer's reliance on the advice of a tax expert may be reasonable cause for failure to pay by the deadline if the taxpayer can also show either an inability to pay or undue hardship from paying at the deadline. The court found at least a genuine dispute of material fact as to whether that reliance occurred with respect to the Thouron estate and sent the case back to the district court to apply the law in light of this analysis.
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Seller Who Reacquired Principal Residence Must Recognize Previously Excluded Gain
While cases dealing with the exclusion of gain on the sale of a principal residence under Code Sec. 121 are not uncommon, cases dealing with the reacquisition of property under Code Sec. 1038 are relatively rare. Code Sec. 1038 provides rules for computing gain when a seller repossesses real property in satisfaction of a debt secured by that real property. It generally restores the seller to his position before the sale of the property by ignoring gain or loss upon repossession. However, if the seller has received money and other property as payments before the repossession, Code Sec. 1038 taxes the seller on gain attributable to these payments to the extent the amounts were not previously reported as income. On May 19, 2014, the Tax Court handed down a decision involving a unique issue the interaction of Code Sec. 121 and Code Sec. 1038.
In Debough v. Comm'r, 142 T.C. No. 17 (5/19/14), the taxpayer sold his principal residence in an installment sale and excluded, under Code Sec. 121, $500,000 in gain on the sale. Three years later, the buyers defaulted and the taxpayer reacquired the property. The IRS determined that, under Code Sec. 1038, the taxpayer was taxable on all the gain previously excluded from income, including the $500,000 excluded under Code Sec. 121. While there is an exception in Code Sec. 1038(e) to recognizing income on the reacquisition of a personal residence, that exception applies only if the reacquired property is resold within one year. The taxpayer argued that Code Sec. 121 takes precedence over Code Sec. 1038 and, thus, he was entitled to exclude the $500,000 from the gain reportable under Code Sec. 1038. The Tax Court disagreed, holding that the petitioner was required to include the $500,000 in income.
Facts
Marvin Debough purchased his home in 1966 for $25,000. In 2006, he agreed to sell the property for $1,400,000. The contract provided that Marvin would receive $250,000 immediately and then receive the balance in annual and semi-annual payments. The buyer's debt was secured by the residence. On his tax return for that year, Marvin and his deceased wife excluded $500,000 of gain under Code Sec. 121. Marvin reported installment sale gain for 2006 of $28,178. In 2007 and 2008, Marvin reported taxable gain of $28,178 and $564, respectively.
In 2009, the buyer defaulted, and Marvin reacquired the property. On his tax return for 2009, Marvin treated the reacquisition as a reacquisition of property in full satisfaction of debt under Code Sec. 1038 and recognized approximately $97,000 in long-term capital gain.
The IRS determined that Marvin was required to recognize approximately $448,000 in long-term capital gain on the sale and reacquisition. This was calculated by subtracting the gain Marvin reported for 2006 through 2008 from the total $505,000 in cash Marvin had received over those same years.
Taxpayer and IRS Arguments
While Marvin and the IRS agreed that Code Sec. 1038(e) did not apply in Marvin's situation, they disagreed about the significance of the provision. The IRS argued that Code Sec. 1038(e) confirms that Congress was aware of the interplay between Code Sec. 1038 and Code Sec. 121 and drafted Code Sec. 1038(e) as a limited response thereto; the absence of a more generous provision regarding the overlap of Code Sec. 1038 and Code Sec. 121, the IRS argued, confirmed that Congress intended for taxpayers in Marvin's situation to be taxed under the general rules of Code Sec. 1038. As a result, because Marvin did not meet the requirements for special treatment under Code Sec. 1038(e), the IRS said he was governed by the general rule under Code Sec. 1038(b) requiring him to recognize gain upon repossession of the property to the extent of money and other property received before repossession.
Marvin countered that if Congress had intended to completely nullify the Code Sec. 121 exclusion upon reacquisition of a taxpayer's principal residence, it would have drafted a provision explicitly so stating.
Tax Court's Analysis
The Tax Court sided with the IRS, saying that by its terms, Marvin's sale of his principal residence and subsequent reacquisition in satisfaction of indebtedness secured by the property fell squarely within the rules of Code Sec. 1038. The only inquiry left, the court said, was whether Marvin had to recognize gain previously excluded by reason of Code Sec. 121.
The court stated two important conclusions regarding Code Sec. 121: (1) Code Sec. 1038(e) expressly contemplates the sale and subsequent reacquisition of a seller's principal residence, and; (2) other than Code Sec. 1038(e), Code Sec. 1038 does not contain any provision that would allow a taxpayer to exclude Code Sec. 121 gain resulting from a sale and subsequent reacquisition of a principal residence. The fact that Code Sec. 1038(e) is titled "Principal residences" indicated to the court that Congress foresaw the potential interaction of Code Sec. 1038 and Code Sec. 121. Thus, the court stated, Code Sec. 1038(e) operates as an exception to the general rule of Code Sec. 1038 when the subject property is the seller's principal residence. Sellers fulfilling the requirements of Code Sec. 1038(e) by reselling the principal residence within one year are essentially allowed to collapse the initial sale and subsequent resale into one transaction.
The court observed that there is no indication in the legislative history as to why Congress limited the exception to sellers who resell property within one year of reacquisition. Nonetheless, Code Sec. 1038(e) is clearly limited to those sellers who resell their principal residences within one year of reacquisition. Since Marvin did not resell the property within one year of reacquisition, the court concluded that he was ineligible for the Code Sec. 1038(e) exception and thus had to recognize gain in accordance with the general rules of Code Sec. 1038.
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Final Regs Require Estates and Trusts to Unbundle Fees; Beneficiaries Could See Tax Increases
Final regulations provide guidance on which costs incurred by estates or nongrantor trusts are subject to the 2-percent floor on miscellaneous itemized deductions. T.D. 9664 (5/9/14).
Summary
There has been considerable controversy over which costs incurred by estates and nongrantor trusts are subject to the 2-percent floor on miscellaneous itemized deductions. Under Code Sec. 67(e), costs that would not have been incurred if the property to which the costs relate were not held in such trusts or estates are deductible in full. Otherwise, the costs follow the normal rule under Code Sec. 67(a) and are deductible only to the extent all aggregated costs exceed 2 percent of the estate or trust's adjusted gross income (AGI).
The recently finalized regulations could mean higher taxes for the beneficiaries of estates and trusts due to changes in the taxing of bundled fees. The regulations now require that bundled fees - i.e., fiduciary fees paid by an estate or nongrantor trust that include both costs subject to the 2-percent of AGI limitation and those that are not - must be unbundled. This requirement is effective for tax years beginning after May 9, 2014. Previously, the entire bundle was deductible in full. As a result, beneficiaries may now see the pass-through of expenses that are not deductible for alternative minimum tax (AMT) purposes.
Practice Tip: Practitioners and fiduciaries should consider proactively warning beneficiaries of the possible negative AMT consequences resulting from the pass-through of miscellaneous itemized deductions that are not deductible for AMT purposes.
Additionally, the unbundling of investment advisory fees may impact the estate or trust's net investment income tax. This is because the 3.8 percent tax imposed on such entities under Code Sec. 1411 is calculated on net investment income; that is, investment income reduced by investment expenses. To the extent previously bundled fees were deductible from investment income in full and are now only partially deductible, the estate or trust may see an increase in its net investment income tax.
Background
Generally, under Code Sec. 67(a), miscellaneous itemized deductions incurred by an individual are deductible only to the extent the aggregate of those deductions exceeds 2 percent of AGI. Under Code Sec. 67(b), certain itemized deductions are excluded from the definition of miscellaneous itemized deductions. Code Sec. 67(e) provides that the AGI of an estate or nongrantor trust is computed in the same manner as an individual. However, the deduction for costs paid or incurred in connection with the administration of the estate or nongrantor trust that would not have been incurred if the property were not held in such estate or trust are deductible in arriving at AGI. Therefore, such deductions are not subject to the 2-percent-of-AGI floor.
Observation: The rule in Code Sec. 67(e) does not apply to expenses of grantor trusts because, under Reg. Sec. 1.67-2T(b)(1), such expenses are treated as miscellaneous itemized deductions of the grantor or other person treated as the owner of the trust. They are not treated as expenses of the trust itself.
The precursor proposed regulations, issued in 2007, implemented a "unique to an estate or trust" test for determining if a cost is subject to the 2-percent-of-AGI floor requirement. If a cost was not unique to an estate or trust, meaning that an individual could have incurred the cost, then that cost was subject to the 2-percent floor.
However, in Knight v. Comm'r, 2008 PTC 1 (2008), the Supreme Court rejected the IRS's "unique" interpretation of Code Sec. 67(e) in favor of exempting from the 2-percent floor costs that an individual "could not have incurred." The Court held that when Sec. 67(e) asks whether the expense "would not have been incurred if the property were not held in such trust", there must be an inquiry into whether a hypothetical individual who held the same property outside of a trust would "customarily"' or "commonly" incur such expenses. This, the Court noted, requires determining what would happen if a fact was changed. Such an exercise necessarily entails a prediction, the Court stated, and predictions are based on what would customarily or commonly occur. Thus, the Court concluded, in asking whether a particular type of cost would not have been incurred if the property were held by an individual, Code Sec. 67(e)(1) excepts from the 2-percent floor only those costs that it would be uncommon (or unusual, or unlikely) for such a hypothetical individual to incur.
The 2007 proposed regulations also addressed costs subject to the 2-percent floor that were part of a comprehensive fee paid by the trustee or executor (i.e., bundled fees). The proposed regulations provided that the estate or trust had to identify the portion (if any) of the fee that was unique to estates and trusts and was thus not subject to the 2-percent floor. Taxpayers were allowed to use any reasonable method to allocate the bundled expense between the costs unique to estates and trusts and costs that were not unique. The Court in Knight did not address bundled fees, as they were not at issue in the case. Nonetheless, considering the Court's holding, the IRS issued Notice 2008-32 to provide interim guidance on the treatment of bundled fees. Notice 2008-32, and subsequent extensions of that notice, provided that, until the effective date of final regulations, fiduciaries did not have to allocate bundled fees.
In 2011, IRS withdrew the 2007 proposed regulations and issued new proposed regulations (REG-128224-06 (9/7/11)). Those regulations adopted the Knight holding providing that costs incurred commonly or customarily by individuals include expenses that do not depend on the identity of the payor. Additionally, the 2011 proposed regulations kept the requirement to unbundle fees and allocate them between those subject to the 2-percent limitation and those not subject to the limitation. In response through the comment process, practitioners challenged the regulatory authority to require this unbundling and argued that the administrative and recordkeeping expense required to break down specific expenses would be overly burdensome. A practitioner also accused the IRS of trying to expand costs subject to the 2-percent floor by having the regulations focus on the identity of the payor rather than an inquiry as to what costs an individual would customarily or commonly occur.
Final Regulations
On May 9, 2014, the IRS withdrew the 2011 proposed regulations and issued final regulations in T.D. 9664. The regulations eliminated some of the requirements in the proposed regulations, clarified other provisions, added new provisions, and, unfortunately for taxpayers, kept the requirement to unbundle certain fees (but afforded some flexibility).
Commonly or Customarily Incurred Expenses - In General
One of the complaints practitioners had with the 2011 proposed regulations was that they did not contain an inquiry into what expenses a hypothetical individual who held the same property outside of an estate or trust would "customarily" or "commonly" incur. Instead, the proposed regulations provided that costs were considered commonly incurred by individuals if they did not depend on the identity of the payor. Some practitioners found this interpretation overly broad and inconsistent with the Knight decision.
In response to this comment, the final regulations eliminated the reference to costs that do not depend on the identity of the payor.
Ownership Costs
The proposed regulations provided that, for purposes of Code Sec. 67(e), ownership costs were costs commonly or customarily incurred by a hypothetical individual owner of such property. Therefore, the proposed regulations said, ownership costs are subject to the 2-percent floor. The proposed regulations defined ownership costs as costs that are chargeable to or incurred by an owner of property simply by reason of being the owner of the property, such as condominium fees, real estate taxes, insurance premiums, maintenance and lawn services, automobile registration and insurance costs, and partnership costs deemed to be passed through to and reportable by a partner.
Practitioners took issue with some of the examples used to illustrate ownership costs in the proposed regulations. First, they pointed out that real estate taxes used in one of the examples are not a miscellaneous itemized deduction because they are fully deductible under Code Sec. 62(a)(4) or Code Sec. 164(a). Second, practitioners asked that the final regulations clarify that costs incurred in connection with a trade or business or for the production of rents or royalties are fully deductible under Code Sec. 162 or Code Sec. 62(a)(4) and thus are not miscellaneous deductions. Third, practitioners requested that the final regulations clarify that the partnership costs reportable by a partner are subject to the 2-percent floor only if those costs are miscellaneous itemized deductions under Code Sec. 67(b). Thus, for example, a partnership cost that is fully deductible is not subject to the 2-percent floor.
The IRS adopted these suggestions in the final regulations.
Tax Return Preparation Costs
The proposed regulations provided that the application of the 2-percent floor to the cost of preparing tax returns on behalf of the estate, decedent, or nongrantor trust would depend on the particular tax return. The proposed regulations provided that all costs of preparing estate and generation-skipping transfer tax returns, fiduciary income tax returns, and the decedent's final individual income tax returns were not subject to the 2-percent floor. However, the proposed regulations also provided that costs of preparing other individual income tax returns, gift tax returns, and tax returns for a sole proprietorship or a retirement plan, for example, were costs commonly and customarily incurred by individuals and thus were subject to the 2-percent floor. Several commentators pointed out that it would be very rare for a trust to pay for the preparation of the tax return of an individual other than the decedent. In the unlikely event that it did, such a cost would either be a deemed beneficiary distribution or would represent a breach of fiduciary duty. Further, practitioners noted, tax preparation fees for sole proprietorships and retirement plans would be fully deductible as business expenses under Code Sec. 162.
To resolve these ambiguities in the proposed regulations, the final regulations provide that the costs relating to all estate and generation-skipping transfer tax returns, fiduciary income tax returns, and the decedent's final individual income tax returns are not subject to the 2-percent floor. The costs of preparing all other tax returns (for example, gift tax returns) are costs commonly and customarily incurred by individuals and thus are subject to the 2-percent floor.
Observation: Some practitioners had suggested that the final regulations provide that the cost of preparing all gift tax returns are exempt from the application of the 2-percent floor. However, the IRS noted that gifts are made by individuals, and the gift tax returns required to report those gifts are commonly and customarily required to be prepared and filed by or on behalf of individuals. Therefore, it did not agree that gift tax returns should be included in the category of returns whose preparation costs are exempt from the 2-percent floor.
Investment Advisory Fees
The proposed regulations provided that fees for investment advice (including any related services that would be provided to any individual investor as part of an investment advisory fee) are incurred commonly or customarily by a hypothetical individual investor and, therefore, are subject to the 2-percent floor. However, the proposed regulations also provided flexibility regarding a special type of investment advice discussed by the Supreme Court in Knight.
In Knight, the Supreme Court noted that it was conceivable that a trust may have an unusual investment objective, or may require a specialized balancing of the interests of various parties, such that a reasonable comparison with individual investors would be improper. In such cases, the Court said, the incremental cost of expert advice beyond what would normally be required for the ordinary taxpayer is not subject to the 2-percent floor.
As a result, the final regulations provide that, to the extent a portion (if any) of an investment advisory fee exceeds the fee generally charged to an individual investor, and that excess is attributable to an unusual investment objective of the trust or estate or to a specialized balancing of the interests of various parties such that a reasonable comparison with individual investors would be improper, that excess is not subject to the 2-percent floor.
Appraisal Fees
In response to the proposed regulations, practitioners suggested that the final regulations include appraisal fees incurred by an estate or trust as a category of expense that is not subject to the 2-percent floor. Although individuals commonly or customarily would have assets appraised, estates and nongrantor trusts are required to undertake valuations for the maintenance and administration of these entities that an individual would not undertake. For example, Form 5227, Split-Interest Trust Information Return, requires taxpayers to determine the fair market value of the trust's assets for each tax year.
The IRS agreed with this suggestion, and the final regulations expressly provide that certain appraisal fees incurred by an estate or nongrantor trust are not subject to the 2-percent floor. Specifically, the regulation exempts appraisals needed to determine value as of the decedent's date of death (or the alternate valuation date), to determine the value of assets for purposes of making distributions, or as otherwise required to properly prepare the estate's or trust's tax returns. Appraisals for these purposes are not customarily obtained by individuals (unlike, for example, appraisals to determine the proper amount of insurance needed on certain property) and thus meet the requirements for exemption from the 2-percent floor under Code Sec. 67(e).
Certain Fiduciary Expenses
In response to practitioner requests, the final regulations added a provision that certain other fiduciary expenses are not commonly or customarily incurred by individuals, and thus are not subject to the 2-percent limitation. Such expenses include probate court fees and costs, fiduciary bond premiums, legal publication costs of notices to creditors or heirs, the cost of certified copies of the decedent's death certificate, and costs related to fiduciary accounts.
Bundled Fees
A bundled fee is a single fee, commission, or other expense (such as a fiduciary's commission, attorney's fee, or accountant's fee) for both costs that are subject to the 2-percent floor and costs (in more than a de minimis amount) that are not. The final regulations kept the requirement in the proposed regulations that a bundled fee must be allocated between costs that are subject to the 2-percent floor and costs that are not.
Observation: After the Knight decision, the IRS issued Notice 2008-32, which stated that taxpayers were not required to determine the portion of a bundled fee subject to the 2-percent floor for any tax year beginning before January 1, 2008. Subsequently, Notice 2008-116 extended the interim guidance provided in Notice 2008-32 to tax years beginning before 2009, Notice 2010-32 extended the interim guidance provided in Notice 2008-116 and Notice 2008-32 to tax years beginning before 2010, and Notice 2011-37 extended the existing interim guidance to tax years beginning before the effective date of final regulations. The effective date of the final regulations is May 9, 2014. Thus, the unbundling requirement applies for tax years beginning on or after May 9, 2014.
Practice Tip: In the preamble to the final regulations, the IRS suggested that future safe harbor rules regarding the unbundling of fees may be issued.
Under the final regulations, there is an exception to the allocation requirement for a bundled fee that was not computed on an hourly basis. For such a fee, only the portion attributable to investment advice (including any related services that would be provided to any individual investor as part of the investment advisory fee) is subject to the 2-percent floor.
Out-of-pocket expenses billed to the estate or nongrantor trust are treated as separate from the bundled fee. In addition, payments made from the bundled fee to third parties that would have been subject to the 2-percent floor if they had been paid directly by the estate or nongrantor trust are subject to the 2-percent floor. Similarly, the floor applies to any fees or expenses separately assessed by the fiduciary or other payee of the bundled fee (in addition to the usual or basic bundled fee) for services rendered to the estate or nongrantor trust that are commonly or customarily incurred by an individual.
The final regulations permit any reasonable method to determine allocation of a bundled fee between those costs that are subject to the 2-percent floor and those costs that are not, including without limitation the allocation of a portion of a fiduciary commission that is a bundled fee to investment advice. In response to the concerns raised about the difficulty of unbundling, the final regulation provides some guiding factors that may be considered in determining whether an allocation is reasonable include, but are not limited to: (1) the percentage of the value of the corpus subject to investment advice, (2) whether a third party advisor would have charged a comparable fee for similar advisory services, and (3) the amount of the fiduciary's attention to the trust or estate that is devoted to investment advice as compared to dealings with beneficiaries and distribution decisions and other fiduciary functions.
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Eighth Circuit Reverses Tax Court on IRA Rollover, Chastises IRS for "Appalling" Arguments
Reversing the Tax Court, the Eighth Circuit agreed with the taxpayer's contention that he rolled over an IRA distribution within 60 days and thus was not taxable on a $120,000 distribution. Haury v. Comm'r, 2014 PTC 227 (8th Cir. 5/12/14).
IRA Rollover Issue
Harry Haury developed proprietary technology in the late 1990s and licensed it to several companies for which he also worked as an employee and in which he held substantial ownership interest. By 2007, two of these companies were competing as subcontractors for a substantial government contract. To fund product development and working capital needs, Harry made secured loans to these companies in 2006 and 2007, and three loans in 2007 were funded using distributions withdrawn from Harry's IRA account. Harry was less than 59 1/2 years old, so his IRA distributions were taxable as ordinary income subject to a 10 percent additional tax. The following are the IRA transactions in 2007 that were at issue: (1) a withdrawal on February 15 of $120,000; (2) a withdrawal on April 9 of $168,000; and (3) a contribution on April 30 of $120,000. According to the IRS, all the 2007 IRA distributions were taxable and the $120,000 contribution was not a rollover of previously distributed funds. Read more...
Settlement Payment Is Excludable from Income under Step Transaction Doctrine
Where a settlement agreement between a taxpayer and several mortgage lenders resulted in the taxpayer receiving a check for $10,000 from one of the mortgage lenders followed by a requirement to then transmit that amount to the two other mortgage lenders, the taxpayer's receipt of the $10,000 was not taxable income under the step transaction doctrine. Kadir v. Comm'r, T.C. Summary 2014-43 (5/6/14).
Mohammed Kadir owned a home in Brooklyn Park, Minnesota. In August 2006, Mohammed decided to refinance his mortgage to try to lower his monthly payments. As a nonnative English speaker, Mohammed relied heavily on agents at GreenPoint Mortgage Funding, LLC (GreenPoint). He ended up with two mortgages, and GreenPoint originated both. But each of the new mortgages had a different mortgage servicer. The first mortgage for $172,000 used GMAC Mortgage, LLC (GMAC) as its servicer. The second mortgage for $21,500 used Specialized Loan Servicing, LLC (SLS). These two mortgages totaled $193,500. Although Mohammed's purpose in refinancing was to reduce his monthly mortgage payment, once all the refinancing was done, his monthly payments continued to rise. Though he was making "minimum payments" on his mortgages, the people that helped Mohammed refinance failed to adequately explain the concept of a negatively amortizing mortgage. The monthly payment that stops a negatively amortizing mortgage from increasing the principal amount of the debt is often well above the minimum payment that the mortgage requires.
In early 2009, after growing increasingly frustrated when his attempts to understand what was going on with his payments failed, Mohammed stopped making payments. He then sued GreenPoint, GMAC, and SLS, claiming they had lied to him when they promised his payments would go down and that they had made false promises and misleading statements, and had engaged in deceptive practices. In 2010, a settlement agreement was reached under which Mohammed got his debt both interest and principal reduced to what he could afford. In addition, the settlement agreement required GreenPoint to give Mohammed a check for $10,000 and required Mohammed to pay $5,700 to GMAC and $4,300 to SLS from the payment he received from GreenPoint.
As a result of receiving the $10,000 payment, Mohammed received a Form 1099-MISC, Miscellaneous Income, for his 2010 tax year. The 1099-MISC said that the $10,000 payment to Mohammed was nonemployment compensation. GMAC and SLS also sent Mohammed Forms 1099-C, Cancellation of Debt. These forms said that Mohammed had more than $35,000 in canceled debt and that the amount of the cancelled debt was includible in Mohammed's income. Mohammed didn't report either of these amounts. The IRS subsequently sent Mohammed a deficiency notice which stated only that he owed tax on the $10,000 that he received from GreenPoint.
In the Tax Court, the IRS made two arguments. Citing Worsham v. Comm'r, T.C. Memo. 2012-219, aff'd 531 Fed. Appx. 310 (4th Cir. 2013), the IRS argued that settlement proceeds are included in the broad definition of income unless they are damages received on account of personal injuries or sickness. Thus, Mohammed should have included the $10,000 settlement proceeds in income. Second, the IRS argued that Mohammed had cancellation-of indebtedness income as a result of the settlement agreement.
Because the settlement agreement required him to pay a total of $10,000 to GMAC and SLS, Mohammed argued that this provision in the agreement meant that he was like a mailman who picks up an envelope containing a $10,000 check and then delivers it to its final address.
The Tax Court quickly disposed of the IRS's cancellation-of-indebtedness argument, noting that the IRS had not raised that issue until the trial, which made it too late to consider. Thus, the court focused on the issue of the settlement proceeds.
The Tax Court held that the $10,000 Mohammed received under the settlement agreement was not taxable income. When a taxpayer receives money in settlement of a lawsuit, the court said, the question to be asked is: in lieu of what were the damages awarded? See Raytheon Prod. Corp. v. Commissioner , 144 F.2d 110 (1st Cir. 1944), aff'g 1 T.C. 952 (1943) (holding the recovery for damage to business and good will represents a return of capital; the fact that the suit ended in a compromise settlement does not change the nature of recovery). Here, Mohammed sued for the tort of fraud; but according to the court, that alone didn't answer the question of taxability. The Tax Court rejected the IRS's reliance on Worsham because that case involved "silly tax protester arguments" and the court had not meant to make a general rule of when settlement proceeds were taxable; rather, it was deciding only one taxpayer's case.
In the instant case, the court applied the step-transaction doctrine where independent steps are treated as one transaction if the steps are integrated to achieve a specific result. Penrod v. Commissioner , 88 T.C. 1415, 1428 (1987) (discussing the various tests employed in applying the step transaction doctrine and pointing to the importance of substance over form). Mohammed didn't get to just take the $10,000, the court noted. Because the settlement agreement required him to pay $5,700 GMAC and $4,300 to SLS, this meant that the money going to GMAC and SLS was the same money that was paid to Mohammed, all steps toward a particular result. Mohammed had a binding commitment to make those payments. The court was also struck by the fact that the promised payments had no relation to the amounts of the two loans that Mohammed was getting out of, and by the fact that the promised payments were going to GMAC and SLS, and not to Greenpoint. Apparently, GMAC and SLS were very concerned with how the settlement would be divided. The court was convinced that the settlement was intended to get some money from Greenpoint to GMAC and SLS even if $10,000 went into Mohammed's account for a moment.
For a discussion of the taxation of income from lawsuits, see Parker Tax ¶74,130.
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Husband's Joint Return Negated by Wife's Subsequently Filed Separate Return
The Tax Court held that a taxpayer was not entitled to the filing status of married filing jointly where, after he had filed a joint return but before the return's due date, his wife filed a separate return. Accordingly, the court found he was not entitled to dependency exemption deductions for his two children, the child tax credit, the additional child tax credit, or the earned income credit. Bruce v. Comm'r, T.C. Summary 2014-46 (5/12/14).
Jason Bruce and his former wife, Jazsmine, were married in 2008, and they had a son who was born in 2008. Jazsmine also had a daughter from a previous relationship. Jason had worked as a technician on an aircraft carrier in the U.S. Navy since 1997, and he was deployed on sea duty intermittently throughout 2010. His family lived in Navy housing in 2009. Jason, Jazsmine, and the children moved into Jazsmine's mother's house in January 2010. During 2010 Jason, Jazsmine, and the children mostly lived at Jazsmine's mother's house, but also spent time at Jason's mother's house. In March 2010, Jason initiated divorce proceedings. Jason continued to live with Jazsmine and the children at his mother-in-law's house at least until December 2010 when he moved out.
Jason and Jazsmine had filed a 2009 joint federal income tax return after their first year of marriage, claiming dependency exemption deductions for the two children and the child tax credit, the additional child tax credit, and the earned income credit. In January 2011, Jason electronically filed a 2010 return, claiming the status of married filing jointly. The return showed an overpayment of $4,581. In February 2011, Jason informed Jazsmine that he had filed a joint tax return for 2010 and that he intended to share the refund with her. Jazsmine did not object to the joint filing but indicated that she would consult her mother's friend who "does taxes" to claim deductions for certain school expenses. Jazsmine also provided her bank information to Jason after he mentioned sharing the refund. Also in February 2011, the Bruces' divorce was finalized. In March 2011, unbeknownst to Jason, Jazsmine filed a 2010 federal income tax return, claiming head of household filing status. She also claimed the two minor children as dependents.
In a deficiency notice dated July 11, 2012, the IRS determined that Jason was not entitled to the filing status of married filing jointly and adjusted his filing status to married filing separately. The IRS also disallowed his claimed dependency exemption deductions, the child tax credit, the additional child tax credit, and the earned income credit and imposed the accuracy-related penalty under Code Sec. 6662(a).
Code Sec. 6013(a) allows spouses to file a joint return. The married filing jointly status does not apply to a federal income tax return unless both spouses intend to make a joint return. However, the failure of one spouse to sign the return does not negate the intent of filing a joint return by the non-signing spouse. Where spouses file a joint return with respect to a tax year, neither spouse may thereafter elect married filing separately status for that tax year if the time for filing the tax return of either spouse has expired.
Code Sec. 151(c) allows an exemption deduction for each dependent claimed by a taxpayer. Code Sec. 152(a) defines dependent as a "qualifying child" or a "qualifying relative." Furthermore, under Code Sec. 152(c)(1), a qualifying child is as an individual: (1) who bears a designated relationship to the taxpayer; (2) who shares the same principal place of abode as the taxpayer; (3) who meets specific age requirements; (4) who has not provided over one-half of his or her own support; and (5) who has not filed a joint return. Generally, the residency test is satisfied if the individual has the same principal place of abode as the taxpayer for more than one-half of the tax year for which the dependency exemption deduction is claimed. Temporary absences due to special circumstances, such as military service, are not treated as absences for purposes of determining the residency requirement.
Where a child meets the qualifying test for more than one taxpayer, special tiebreaker rules come into play. The applicable rule for this case states that if an individual may be claimed as a qualifying child by one or both parents and they do not file a joint return, the child is treated as the qualifying child of the parent with whom the child lived for the longer period during the tax year. Code Sec. 152(c)(4)(B). Additionally, if the child lived with both parents for the same amount of time, the child is treated as the qualifying child of the parent with the higher AGI.
The Tax Court upheld the IRS's adjustment of Jason's filing status to married filing separately. According to the Tax Court, even if Jazsmine had tacitly agreed to filing a joint 2010 return, it was undisputed that she subsequently filed a separate tax return before the time for either spouse to file a return had expired. Since Jazsmine had timely filed a separate return in March 2011, Jason was not entitled to the filing status of married filing jointly for 2010.
The Tax Court then held that Jason was not entitled to the dependency exemption deductions for the children for 2010. While the court found that the children lived most of 2010 with both parents and thus meet the qualifying child test for both Jason and Jazsmine, it concluded that the children lived with Jazsmine for a slightly longer period during 2010. Thus, under the tiebreaker rules, the children were treated as Jazsmine's qualifying children for 2010. The court also concluded that, because Jason was not entitled to dependency exemption deductions with respect to the children for 2010, he was not entitled to the child tax credit or the additional child tax credit for each child for the 2010 tax year. Nor, the court said, was he entitled to the earned income credit for 2010.
With respect to the accuracy-related penalty, the Tax Court found that Jason credibly testified that he believed Jazsmine did not have her own income in 2010 and that it was reasonable for him to believe that a joint filing would be beneficial to the couple. Therefore, the court held that he was not liable for the accuracy-related penalty.
For a discussion of joint filing status, see Parker Tax ¶10,530.
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Tax Court Rejects Charitable Deduction for Easement That Didn't Sufficiently Restrict Use
Because the taxpayers failed to prove their donated easements had any value, they were not entitled to charitable contribution deductions for the donations and were liable for a 40 percent gross valuation misstatement penalty for one of the three years at issue because the rules in effect when they filed their 2006 return did not provide a reasonable cause exception. Chandler v. Comm'r, 142 T.C. No. 16 (5/14/14).
Congress created the Federal Historic Preservation Tax Incentives Program to encourage the preservation of historic structures. The National Park Service (NPS) publicizes the program and assists the IRS in administering it. Logan Chandler learned of the program, and he and his wife decided to grant faeasements to the National Architectural Trust (NAT) on two Boston homes they owned. Under the terms of each easement, the property owner must obtain NAT's approval before beginning any construction that will alter the exterior of the buildings. NAT periodically sends representatives to inspect easement properties for unauthorized changes, for which NAT can order remediation.
The South End Landmark District Commission (SELDC), one of nine Boston municipal government historic district commissions, has jurisdiction over the Chandler's properties to regulate construction. The SELDC's powers closely approximate NAT's powers under the easement agreements, with some exceptions. First, the easement agreements grant NAT authority to regulate construction and order repairs on any exterior surface of the home, but SELDC has no power to regulate construction that is not visible from a public way and may not require property owners to make repairs. Second, NAT has staff members who perform annual site visits, while the SELDC relies on the public to alert it to potential violations. Finally, NAT has absolute authority to enforce the terms of its easements, even when doing so would produce substantial economic hardship for the property owner. Under Massachusetts law, a property owner who faces significant financial hardship may receive an exemption from the SELDC's enforcement.
The Chandlers followed guidance from the NPS and consulted their easement holding organization to find an appraiser to value their easements. The valuations came in at $191,400 and $371,250. The Chandlers consulted with their accountant concerning the appraisals before claiming deductions on their returns. Because of relevant limitations, the Chandlers claimed charitable deduction in 2004, 2005, and 2006. A portion of each of the 2005 and 2006 deductions resulted from a carryforward of the 2004 deduction.
The IRS disallowed the deductions because it determined the easements were valueless since they did not meaningfully restrict the Chandlers' properties more than local law. The IRS also imposed gross valuation misstatement penalties of 40 percent on the underpayments resulting from the alleged easement overvaluations.
At trial, both the Chandlers and the IRS submitted expert reports concerning the values of the Chandlers' easements. The Chandler's expert was Michael Ehrmann and the IRS's expert was John Bowman.
The Tax Court held that the Chandlers failed to prove their easements had any value and consequently were not entitled to the related charitable contribution deductions. The Tax Court found Ehrmann's appraisal report unpersuasive. The court noted that he analyzed sales of seven properties encumbered with easements similar to the Chandler's and compared those sales with sales of comparable unencumbered properties to determine whether the easements diminished property values. Of the seven encumbered properties he chose, four were in Boston and three were in New York City. The court rejected the analyses of the values of easements in other markets, saying it told them little about the easement values in Boston's unique market. With respect to comparable Boston properties, the court concluded that only one analysis was not flawed. The two others were flawed because the "comparable" properties were not really comparable, specifically because one of the "unencumbered" properties was not actually unencumbered by an easement. According to the court, the errors in Ehrmann's appraisal report undermined his credibility, and the court rejected his conclusion that the Chandler's easements diminished their property values by 16 percent.
The court went on to state that Ehrmann's failure to persuasively value the easements did not necessarily mean they had no value. The court looked at several cases cited by the Chandlers in which it had upheld valuations similar to theirs. However, the court noted, each of those cases involved commercial property, and restrictions on construction impair the value of commercial property more tangibly than they impair the value of residential property.
Additionally, the court said that even if the Chandlers had not granted the easements, local law would have prevented them from freely altering their homes. Thus, the court said, the easements had value only to the extent their unique restrictions diminished the Chandlers' property values. In determining whether the value of the Chandler's properties were diminished because of the additional restrictions imposed by NAT, the court noted that it had recently performed this analysis under identical circumstances in Kaufman v. Comm'r, T.C. Memo. 2014-52. In that case, the court determined that the differences in restrictions did not affect property values because buyers do not perceive any difference between the competing sets of restrictions. Thus, the court concluded that the donated easements had no value and no charitable deduction was allowed.
With respect to the 40 percent gross valuation misstatement penalty assessed by the IRS, the court noted that the Pension Protection Act (PPA) of 2006 amended the rules to eliminate the reasonable cause exception for gross valuation misstatements of charitable contribution property. The change applies to returns filed after July 25, 2006. The court concluded that the Chandlers had reasonable cause to avoid the penalty for their 2004 and 2005 tax returns. However, the facts raised a novel issue for the court concerning the Chandlers' right to raise a reasonable cause defense for their 2006 underpayment. The Chandlers noted that a portion of the underpayment resulted from the carryover of charitable contribution deductions they first claimed on their 2004 return, which they filed before the effective date of the change in rules. Accordingly, they argued, denying their right to raise a reasonable cause defense would amount to retroactively applying the PPA. The court disagreed and upheld the 40 percent penalty with respect to the Chandlers' 2006 tax return.
For a discussion of the rules for deducting easement contributions, see Parker Tax ¶84,155.
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Seventh Circuit Affirms 51-Month Sentence for Return Preparer; Rejects Plea to Consider Caregiver Responsibilities
While noting that the taxpayer's teenage children and nephew would suffer emotionally from her incarceration, the court still affirmed a 51-month prison sentence for a return preparer that filed false returns. U.S. v. Williams-Ogletree, 2014 PTC 226 (7th Cir. 5/12/14).
In 2005, Leslie Williams-Ogletree ran Chicago-based LKJ Tax Services, a tax preparation service. Leslie applied for and obtained an Electronic Filers Identification Number (EFIN) from the IRS, which allowed her to file tax returns electronically in other people's names and to obtain electronic refunds. In late 2005, Leslie conspired with Robtrel White and Larryl White to submit false income tax returns to the IRS. Robtrel and Larryl would obtain and provide Leslie with various birth dates and social security numbers for individuals unlikely to file income tax returns, and then Leslie would file the false returns with LKJ's EFIN, using that personal information. The co-conspirators also generated false Form W-2 wage and tax statement data to support the false refund claims.
Between February and October 2006, Leslie used LKJ's EFIN to file 200 fraudulent income tax returns for the tax year 2005 in the names of individuals supplied by Robtrel, Larryl, and others. These tax returns sought refunds in the amount of $834,548 and the actual tax loss to the IRS was $652,730. The proceeds from the fraudulent tax returns were obtained in the form of tax refund anticipation loan (RAL) checks, which Leslie printed at LKJ's offices, pursuant to an agreement with Bank One. Robtrel then deposited many of these checks into his own bank accounts. Leslie also received direct payment from Bank One of a portion of the refund, which represented her purported tax preparation fee. In total, she received $62,203 in tax preparation fees for the 200 fraudulent returns.
When the government eventually detected the scheme, it indicted Leslie, Robtrel, and Larryl, charging them with conspiracy and filing false claims with the IRS. Robtrel and Larryl pleaded guilty, but Leslie pleaded not guilty and proceeded to trial. At trial, the government presented testimony from numerous witnesses, including an IRS agent who testified that a review of tax returns filed in 2006 with the EFIN issued to Leslie's tax preparation business, LKJ, revealed that 200 returns were fraudulent. The jury also heard from five individuals in whose name Leslie had filed tax returns. These individuals testified that they had not worked in 2006; did not live at the addresses listed on the tax returns; had not hired Leslie to file tax returns on their behalf; had never met Leslie; and had not received the tax refunds. Some of the individuals admitted to selling their personal information to Robtrel and/or Larryl, while others claimed that their personal information had been stolen.
Leslie was found her guilty and sentenced to 51 months in prison. She appealed, challenging the substantive reasonableness of her sentence. Leslie's main argument was that the district court failed to give proper weight to her extraordinary familial circumstances, namely her role, before her incarceration, as the primary caregiver to her two teenage sons and her teenage nephew.
The Seventh Circuit affirmed the sentence. The court noted that Leslie's children and nephew would suffer emotionally from her incarceration but said there was nothing in this case outside the normal realm of hardship all children suffer when a caregiving parent is incarcerated. To the extent there was a hardship, the court said, the district court took that into account, allowing Leslie to delay the start of her sentence to allow her to make arrangements for the children. Under these circumstances, the court concluded, there was no abuse of discretion in sentencing her to 51 months' imprisonment.
For a discussion of the penalties for filing false returns, see Parker Tax ¶277,110.
