Couple Can't Deduct Entire Grocery Bill for Household That Includes Foster Individuals; No Home Office Deduction Available for Business Owner's Storage of Records in Garage; Couple Hit with Penalties; Actions Showed a Lack of Reasonable Business Care ...
The Tenth Circuit affirmed a district court's dismissal of a tax refund suit by a medical marijuana business whose business deductions had been denied by the IRS. In so doing, the Tenth Circuit rejected the taxpayer's arguments that (1) the IRS does not have the authority to disallow deductions under Code Sec. 280E without a criminal conviction; (2) Code Sec. 280E violates the Sixteenth Amendment's definition of gross income; and (3) Code Sec. 280E is an excessive fine that violates the Eighth Amendment. Alpenglow Botanicals, LLC v. U.S., 2018 PTC 206 (10th Cir. 2018).
S Corporation Shareholder Not Entitled to Basis Increase as Loan Guarantor and Co-Borrower
The Eighth Circuit held that an S corporation shareholder could not increase his basis in the S corporation by the amount of loans to the S corporation where the shareholder signed loan documents as either a co-borrower or guarantor because the shareholder was never called on to make a payment and was not the primary obligor on any of the loans. The court also held that the shareholder's wife, who was a partner in partnerships that did business with the S corporations, failed to substantiate her basis in the partnerships' liabilities because the evidence did not show whether certain loans to the partnerships were recourse or nonrecourse or how the liabilities were allocated among the partners. Hargis v. Koskinen, 2018 PTC 184 (8th Cir. 2018).
Taxpayer Sues Mortgage Servicer for Not Including Capitalized Interest on Form 1098
A district court found several allegations made by a taxpayer regarding the alleged underreporting of mortgage interest by the entity to which she made her mortgage payments plausible and thus refused to dismiss them. The crux of the taxpayer's allegations were that (1) Code Sec. 6050H's use of the term "interest" includes deferred or capitalized interest, and (2) the amounts of interest stated in her 2011 and 2012 Forms 1098 were false because they did not account for deferred interest. Rovai v. Select Portfolio Servicing, Inc., 2018 PTC 195 (S.D. Calif. 2018).
IRS Supervisor Approval Not Required for Tax Court to Assess Frivolous Arguments' Penalty
The Tax Court held that its authority to impose a penalty under Code Sec. 6673 for making a frivolous argument before the Tax Court is not subject to the IRS supervisor approval requirement in Code Sec. 6751(b)(1). The Tax Court found that (1) Congress's intent in enacting the supervisor approval requirement was to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle, while Code Sec. 6673 is designed to deter bad behavior in the Tax Court and conserve judicial resources, and (2) Code Sec. 6751(b)(1) was clearly not intended as a mechanism to restrain the Tax Court. Williams v. Comm'r, 151 T.C. No. 1 (2018).
A district court granted in part and denied in part an IRS motion for summary judgment in a case involving the nonpayment of taxes by a decedent on a $132 million stock gain and the use by the decedent of an abusive tax shelter to hide the gain. While giving the IRS an opportunity to file a supplemental brief if it so chose, the court ruled that the IRS failed to establish any liability on the part of a trust set up by the decedent but did grant the IRS summary judgment against the decedent's estate for more than $9 million in taxes plus interest. U.S. v. Gonzales, 2018 PTC 200 (N.D. Calif. 2018).
Nuclear Plant Operator's Waste Disposal Fees Did Not Qualify as Specified Liability Losses
The Eleventh Circuit held that a nuclear plant operator was not entitled to a refund for net operating losses resulting from fees it paid for the disposal of radioactive waste. The Eleventh Circuit found that the taxpayer's losses were not specified liability losses under Code Sec. 172(f) because the disposal of radioactive waste did not qualify as deductible power plant decommissioning costs, the disposal fees were not incurred under a federal or state law requiring decommissioning, and the act giving rise to the liability for such costs did not occur more than three years before the claimed loss. NextEra Energy, Inc. v. U.S., 2018 PTC 192 (11th Cir. 2018).
No Innocent Spouse Relief for Widow Who Failed to Report Insurance Proceeds on Form 8857
The Tax Court held that a widow was not entitled to innocent spouse relief from tax liabilities that arose over several years in which she and her husband filed joint returns but did not pay taxes owed. The court cited the fact that, after her husband's death, the widow invested the proceeds of life insurance policies purchased by her husband without her knowledge in several savings accounts opened in her parents' names and did not report the proceeds to the IRS when she requested relief. Hale v. Comm'r, T.C. Memo. 2018-93.
In IR-2018-146, the IRS announced that it plans to streamline Form 1040 into a shorter, simpler form for the 2019 tax season. Along with its announcement, the IRS released a draft of the proposed Form 1040, which is about half the size of the current version. The new form would replace the current Form 1040 as well as Form 1040A and Form 1040EZ. The new Form 1040 uses a "building block" approach in which the tax return is reduced to a simple form that can be supplemented with additional schedules if needed. Taxpayers with straightforward tax situations would only need to file this new 1040 with no additional schedules. The IRS said that it will be working with the tax community to refine the new form to ensure a smooth transition.
Tenth Circuit Affirms That Marijuana Dispensary Can't Deduct Business Expenses
The Tenth Circuit affirmed a district court's dismissal of a tax refund suit by a medical marijuana business whose business deductions had been denied by the IRS. In so doing, the Tenth Circuit rejected the taxpayer's arguments that (1) the IRS does not have the authority to disallow deductions under Code Sec. 280E without a criminal conviction; (2) Code Sec. 280E violates the Sixteenth Amendment's definition of gross income; and (3) Code Sec. 280E is an excessive fine that violates the Eighth Amendment. Alpenglow Botanicals, LLC v. U.S., 2018 PTC 206 (10th Cir. 2018).
Background
Although 28 states and Washington, D.C. have legalized medical or recreational marijuana use, the federal government classifies marijuana as a "controlled substance" under the Controlled Substances Act (CSA). The CSA makes it unlawful to knowingly or intentionally "manufacture, distribute, or dispense . . . a controlled substance." Under former President Obama, the Justice Department had declined to enforce this provision against marijuana businesses acting in accordance with state law, but the IRS has shown no similar inclination to overlook federal marijuana distribution crimes. Instead, the IRS consistently denies business deductions to state-sanctioned marijuana dispensaries under Code Sec. 280E, which prohibits any deduction or credit for any business that consists of trafficking in controlled substances. The disallowance of deductions under Code Sec. 280E does not apply to cost of goods sold.
Alpenglow Botanicals, LLC is a Colorado company doing business in Colorado. Charles Williams and Justin Williams are owner/operators of Alpenglow. Alpenglow is a pass-through entity. It filed federal and state tax returns for the years 2010 through 2012 and its tax liability for those years passed through to Charles and Justin. The IRS audited the Williamses' returns and denied various Alpenglow deductions thus increasing Alpenglow's income. The deductions were denied because the IRS determined that Alpenglow committed the crime of trafficking in a controlled substance in violation of the CSA. Charles and Justin paid the increased tax liability under protest, and filed claims for refunds. Thereafter, the IRS either denied the claims for refunds or did not respond to the claims within 180 days, which acted as a denial.
Alpenglow sued the IRS in district court arguing that the deductions denied were: rent for where the business was conducted; costs of labor; compensation of officers; advertising; taxes and licenses for doing business; depreciation; and other wages and salaries. They alleged that the IRS exceeded its statutory and constitutional authority by denying Alpenglow's business tax deductions under Code Sec. 280E. In 2016, the district court denied Alpenglow's motion for summary judgment and granted the IRS's motion to dismiss the case (2016 PTC 527 (D. Colo. 2016)). Alpenglow then filed a motion to alter or amend that judgment which the district court rejected (2017 PTC 209 (D. Colo. 2017)) after concluding that it was not required to consider arguments not alleged in the prior complaint and Alpenglow's request to amend the prior complaint was untimely. Alpenglow appealed to the Tenth Circuit.
Alpenglow's Arguments
Before the Tenth Circuit, Alpenglow argued it had raised three legal theories that plausibly stated a claim and therefore precluded the district court's dismissal. First, Alpenglow asserted the IRS lacks the general authority to investigate and deny tax deductions under Code Sec. 280E without a criminal conviction, and that, even if it had such authority, the IRS had insufficient evidence of trafficking to apply Code Sec. 280E in Alpenglow's case. Second, Alpenglow claimed the IRS's calculation of Alpenglow's income violated the Sixteenth Amendment because it did not allow deductions for business expenses. Third, Alpenglow contended that Code Sec. 280E violates the Eighth Amendment, which prohibits excessive fines.
Tenth Circuit's Decision
The Tenth Circuit affirmed the district court's decision after finding that none of Alpenglow's arguments supported a conclusion that the district court erred in dismissing Alpenglow's complaint.
With respect to Alpenglow's claims that the IRS could not use Code Sec. 280E to deny its business deductions in the absence of a conviction from a criminal court that its owners had violated federal drug trafficking laws, the court noted that the core of this argument was an assumption that a determination that a person trafficked in controlled substances under the tax law is essentially the same as a determination the person trafficked in controlled substances under criminal law. Because Alpenglow saw the two as inextricably linked, the court said, it was contending that the IRS lacked the authority to apply Code Sec. 280E until after a federal prosecutor had investigated and charged the taxpayer with violating federal criminal law and a judge or jury in a criminal proceeding had issued a verdict of guilty. The Tenth Circuit noted that it had recently rejected this argument in Green Solution v. U.S., 2017 PTC 212 (10th Cir. 2017). In Green Solution, the Tenth Circuit concluded that Code Sec. 280E has no requirement that the Department of Justice conduct a criminal investigation or obtain a conviction before Code Sec. 280E applies. And the court noted that, under Code Sec. 6201(a), the IRS's obligation to determine whether and when to deny deductions under Code Sec. 280E "falls squarely within its authority under the Tax Code." The court also concluded in Green Solution that the Anti-Injunction Act (AIA) prevented it from exercising jurisdiction over Green Solution's "suit for the purpose of restraining the assessment or collection of any tax."
According to the Tenth Circuit, Alpenglow offered no reason why the court should conclude that the IRS has the authority to assess taxes under Code Sec. 280E, but cannot impose excess tax liability under Code Sec. 280E. There is also no evidence, the court observed, that Congress intended to limit the IRS's investigatory power. Indeed, the court said, the Tax Code contains other instances where the applicability of deductions or tax liability turns on whether illegal conduct has occurred and cited Code Sec. 162(c)(2) (denying deductions for illegal bribes, kickbacks, etc.), among other provisions. And, the court continued, other courts have upheld tax deficiencies against state-sanctioned marijuana dispensaries based on application of Code Sec. 280E, without questioning the IRS's authority on this issue.
With respect to Alpenglow's Sixteenth Amendment claim, the court noted that it consisted of two arguments: (1) under the constitutional definition of income, ordinary and necessary business expenses must be excluded from gross income calculations because they are actually exclusions that, like the cost of goods sold, must be subtracted from the calculation of a business's gross income; and (2) the IRS improperly disallowed Alpenglow's "costs of goods sold" exclusions under Code Sec. 263A. Consequently, Alpenglow was claiming that Code Sec. 280E violates the Sixteenth Amendment because it prevents the deduction of expenses that a business could not avoid incurring. The court rejected these arguments, noting that while the Tax Code has statutorily excluded certain expenses from the calculation of gross income, only the cost of goods sold is mandatorily excluded by the very definition of "gross income."
With respect to Alpenglow's Eighth Amendment claim, the court noted that the district court had held that Alpenglow did not raise a plausible Eighth Amendment claim because its complaint was entirely devoid of any allegations pertaining to the effect that Code Sec. 280E has had on a taxpayer's ability to do business. Although Alpenglow argued the district court should have allowed it to amend the complaint to allege sufficient factual allegations to support its Eighth Amendment argument, the Tenth Circuit concluded that Code Sec. 280E is not a penalty and thus does not violate the Eighth Amendment. So any amendment to the complaint, the Tenth Circuit said, would be legally futile and the district court did not abuse its discretion by denying the motion.
For a discussion of the denial of deductions under Code Sec. 280E, see Parker Tax ¶96,512.
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S Corporation Shareholder Not Entitled to Basis Increase as Loan Guarantor and Co-Borrower
The Eighth Circuit held that an S corporation shareholder could not increase his basis in the S corporation by the amount of loans to the S corporation where the shareholder signed loan documents as either a co-borrower or guarantor because the shareholder was never called on to make a payment and was not the primary obligor on any of the loans. The court also held that the shareholder's wife, who was a partner in partnerships that did business with the S corporations, failed to substantiate her basis in the partnerships' liabilities because the evidence did not show whether certain loans to the partnerships were recourse or nonrecourse or how the liabilities were allocated among the partners. Hargis v. Koskinen, 2018 PTC 184 (8th Cir. 2018).
Bobby and Brenda Hargis bought and operated nursing homes. Mr. Hargis was the sole owner of S corporations that operated the homes. Mrs. Hargis owned interests in limited liability companies (LLCs) taxed as partnerships that bought and leased the homes to the S corporations. All of the entities had net operating losses, which the Hargises deducted on their joint returns for 2009 and 2010.
The S corporations had no real assets or working capital, and borrowed to finance operations when revenues were insufficient. They borrowed from commercial lenders, the nursing home LLCs, and each other. All the money was paid directly to the S corporations to operate the homes. Mr. Hargis signed the loans as a co-borrower or guarantor. He admitted that none of the loans were debts of the S corporations to him. The LLCs also took out bank loans in 2005 and 2009.
The IRS issued a notice of deficiency disallowing the Hargis's losses due to insufficient basis in their business etities. As a result, the Hargises owed over $281,000 in taxes for the years at issue. In assessing the deficiency, the IRS estimated Mrs. Hargis's basis in the LLCs based on the Schedules K-1s she received.
The Hargises petitioned the Tax Court, which agreed with the IRS that the loans to the S corporations did not create basis for Mr. Hargis even though he signed the loan documents as a co-borrower or guarantor. The court also found that Mrs. Hargis did not present enough evidence of her basis in the LLCs to shift the burden of proof to the IRS. The Hargises appealed that decision to the Eighth Circuit.
Under Code Sec. 1366, S corporation losses can be deducted only to the extent a shareholder has basis in the corporation. A shareholder's basis in the sum of the basis in the stock and the basis of any debt of the S corporation to the shareholder. To obtain basis in debt, a shareholder must make an actual economic outlay that makes the shareholder poorer in a material sense. The loan must be in substance an investment representing genuine indebtedness. A shareholder's guaranty does not create basis until the shareholder is actually called on to satisfy the S corporation's debt.
Observation: The economic outlay doctrine led to frequent disputes over whether shareholder loans created basis. In response, the IRS issued regulations in 2014 which provide that, in order for an S shareholder to increase basis in indebtedness, the shareholder need only prove that the debt is a bona fide debt under federal tax principles.
A partner's basis in a partnership interest is increased by the partner's share of partnership liabilities under Code Sec. 752. A partner's share of liabilities includes recourse debt if the partner bears the economic risk of loss and includes an allocation of nonrecourse debt.
Mr. Hargis argued that the loans from third parties to the S corporations were in substance loans to the S corporations from him. He reasoned that the loans from the LLCs reduced Mrs. Hargis's capital account balance. As a co-borrower, Mr. Hargis claimed that lenders looked primarily to him for payment and could force him to pay without first seeking payment from the S corporations and that he was therefore directly liable. Mr. Hargis asserted that when he subsequently sold the S corporations in 2014, he received a discounted price due to the S corporations' debt.
Mrs. Hargis also claimed an increased basis in the LLCs as a result of her share of the loans to the LLCs. As proof, she presented agreements showing bank loans to the LLCs. Another member of the LLCs also testified that liabilities were allocated to members based on their percentage ownership.
The Eighth Circuit affirmed the Tax Court's holding that the Hargises did not have the requisite basis in loans to the S corporations or LLCs to deduct losses from those entities. The court rejected the argument that Mr. Hargis's basis was increased because the loans from the LLCs to the S corporations reduced Mrs. Hargis's capital account balance. The court reasoned that indirect lending, even from a closely related entity, does not create basis. The court also found that Mr. Hargis did not have basis as a result of being a co-borrower or guarantor because he was never called on to make good on any debt. The court found that if Mr. Hargis had ever been forced to pay the S corporations' debt, he would have made an actual economic outlay, but because that never happened, he did not have basis in the loans.
The Eighth Circuit also rejected Mr. Hargis's argument that lenders looked primarily to him for repayment. In the court's view, there was no evidence that any lender saw Mr. Hargis as a primary obligor. The fact that the debts reduced the sale price of the S corporations showed to the court only that debt makes a company less valuable, not that Mr. Hargis personally paid any of the debt. The court further noted that the lenders advanced the funds directly to the S corporations, and that no shareholder personally pledged any assets as collateral. The court acknowledged that the S corporations were thinly capitalized but reasoned that the mere presence of risk did not require a finding that the lenders could not expect repayment from the S corporations.
The Eighth Circuit also upheld the Tax Court's holding that Mrs. Hargis failed to substantiate her basis in loans to the LLCs. The Eighth Circuit found that the evidence Mrs. Hargis offered was insufficient because it did not show whether the loans were recourse or nonrecourse or whether any partner bore the economic risk of loss. The court also found no evidence beyond the generalized testimony of the other member (who, the court noted, was not involved in preparing tax returns) of the allocation of the debts to LLC members. Thus, the Eighth Circuit concluded that Mrs. Hargis's share of the loans could not be calculated. The court explained that even if Mrs. Hargis had provided evidence of her share of the loans, it would show only a one time increase in her basis, which would be just one factor in determining her basis for the later years, as the increase could have been offset by a number of other events.
For a discussion of a shareholder's basis in S corporation debt, see Parker Tax ¶32,840. For a discussion of the treatment of partnership's liabilities, see Parker Tax ¶25,100.
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Taxpayer Sues Mortgage Servicer for Not Including Capitalized Interest on Form 1098
A district court found several allegations made by a taxpayer regarding the alleged underreporting of mortgage interest by the entity to which she made her mortgage payments plausible and thus refused to dismiss them. The crux of the taxpayer's allegations were that (1) Code Sec. 6050H's use of the term "interest" includes deferred or capitalized interest, and (2) the amounts of interest stated in her 2011 and 2012 Forms 1098 were false because they did not account for deferred interest. Rovai v. Select Portfolio Servicing, Inc., 2018 PTC 195 (S.D. Calif. 2018).
Background
Under Code Sec. 6050H, any person who is engaged in a trade or business and who receives at least $600 in home mortgage interest payments during a calendar year must report the amount of interest received to the IRS and to the individual who paid the interest.
In 2005, Adriana Rovai obtained an Option ARM home mortgage loan, the terms of which provided an option to make a monthly interest payment less than the full amount due. Under this option, the monthly interest Rovai did not pay was added to the principal amount of her loan and treated as principal for the purposes of the loan. In 2011, Select Portfolio Servicing, Inc. (SPS) became Rovai's loan servicer and received mortgage payments from her, which SPS applied to interest and principal due on the loan. When SPS took over servicing her mortgage loan in December 2011, Rovai's loan balance was $9,013 above her original loan balance, an amount which was charged as interest in the earlier years of her loan, which permitted her to defer mortgage interest for payment at a later date and added that deferred interest to principal. Thereafter, SPS respectively provided the IRS and Rovai with Forms 1098, which reported Rovai's payments on interest and principal for 2011. The amount of interest reported did not reflect deferred interest. When Rovai asked SPS to correct the Forms 1098 to reflect the deferred interest, it refused. Rovai filed a lawsuit in a California district court. The fundamental dispute between the parties was whether Code Sec. 6050H required SPS to report deferred interest payments.
Rovai's Allegations
Rovai alleged that (1) SPS failed to report millions of dollars in mortgage interest that it had actually received from consumers with Option ARM loans, (2) caused taxpayers to unknowingly file erroneous tax returns and permanently lose valuable tax deductions, and (3) caused Rovai to take a smaller tax deduction in 2013 and file an incorrect tax return. She further alleged that the IRS rejected attempts by taxpayers to seek a deduction for an interest amount higher than that reported in a Form 1098 and, because of that, she suffered substantial harm from SPS's conduct.
Specifically, Rovai filed claims for negligence, breach of contract, breach of the implied covenant of good faith and fair dealing, fraud, claims under California's Unfair Compensation Law (UCL), and requested for declaratory judgment.
In her suit, Rovai contended that SPS's reporting on Form 1098 violated Code Sec. 6050H. She alleged that the 2012 Form 1098 she received from SPS failed to report deferred interest payments and that SPS was negligent because it was under a legal duty pursuant to Code Sec. 6050H to report accurately the interest it received during each calendar year and a further duty to correct any mistakes on Forms 1098 as soon as possible after determining that a wrong amount had been reported. Rovai alleged that SPS breached its legal duties to her by failing to accurately report her interest payments on her 2011 and 2012 Forms 1098 and failing to correct the information reported after she complained. Rovai alleged that she had been damaged by SPS's negligence because of the IRS's policy of rejecting a return claiming an amount of interest that does not match the amount stated on a servicer-issued Form 1098.
The crux of Rovai's allegations were that (1) Code Sec. 6050H's use of the term "interest" includes deferred or capitalized interest, and (2) the amounts of interest stated in her 2011 and 2012 Forms 1098 were false because they did not account for deferred interest. Rovai cited the Supreme Court's decision in Old Colony Railroad Company v. Comm'r, 284 U.S. 552 (1931) to support her argument that interest is the price charged for the use of money and thus includes capitalized interest.
Challenges in Code Sec. 6050H Reporting
The district court noted that federal courts have proceeded with caution in addressing challenges to Code Sec. 6050H reporting by mortgage lenders and servicers, like the challenge Rovai raised, even when those challenges present familiar state law claims. This is because, the court said, neither Code Sec. 6050H nor its implementing regulations provide explicit directions on how, whether, and when to report capitalized interest. According to the district court, state law claims incorporating Code Sec. 6050H-based challenges raise novel issues that have given federal courts pause, particularly because of the IRS's role in the federal tax scheme. The court noted that, despite the filing of five class actions in federal courts concerning Code Sec. 6050H reporting, with the earliest filed some six years ago, the IRS has not weighed in on Code Sec. 6050H's scope.
District Court's Analysis
With respect to Rovai's reliance on the Old Colony Railroad Company decision, the court found Rovai's reliance flawed. While Rovai would characterize the question as a simple undertaking of statutory construction, the court said, that is "quite frankly not the case." According to the court, it cannot be said, based on a plain reading of Code Sec. 6050H, whether or not the statute's use of the term "interest" encompasses capitalized interest. The court noted that multiple courts have expressly acknowledged, "[n]either Sec. 6050H nor its implementing regulations provide explicit direction to recipients on how, whether and when to report capitalized interest." And, the court noted, the IRS has not made any pronouncement regarding what Code Sec. 6050H requires with respect to reporting of deferred interest. Nor, the court observed, has any federal court adopted the statutory construction Rovai advanced. The court said that if it were to do adopt the statutory construction advanced by Rovai, prior case law counseled that it could not be used to show that SPS's reporting in 2011 and 2012 was false when made because the law did not unambiguously set forth clear requirements for reporting deferred interest payments
According to the court, although the IRS may very well adopt Rovai's position on Code Sec. 6050H reporting at a later point and even if it were to consider Rovai's position to be reasonable, this could not show SPS's knowledge of falsity at the time it issued the 2011 and 2012 Forms 1098. Rovai's allegations regarding SPS's intent to defraud fared no better. Mere conclusory allegations that representations or omissions were intentional and for the purpose of defrauding and deceiving, the court said, are insufficient to establish fraud.
While rejecting most of Rovai's claims, the court concluded that some had merit. The court dismissed (1) the claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and claims of fraud, (2) one prong of the claim relating to California's UCL, and (3) the declaratory judgment claim. The court also dismissed Rovai's claim for a preliminary and permanent injunction. However, the court allowed a second prong of the UCL claim, as well as the negligence claim, to go forward.
For a discussion of the Code Sec. 6050H reporting requirement, see Parker Tax ¶252,505.
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IRS Supervisor Approval Not Required for Tax Court to Assess Frivolous Arguments' Penalty
The Tax Court held that its authority to impose a penalty under Code Sec. 6673 for making a frivolous argument before the Tax Court is not subject to the IRS supervisor approval requirement in Code Sec. 6751(b)(1). The Tax Court found that (1) Congress's intent in enacting the supervisor approval requirement was to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle, while Code Sec. 6673 is designed to deter bad behavior in the Tax Court and conserve judicial resources, and (2) Code Sec. 6751(b)(1) was clearly not intended as a mechanism to restrain the Tax Court. Williams v. Comm'r, 151 T.C. No. 1 (2018).
In 2012, Benton Williams received wages, unemployment compensation, and an early distribution from a qualified retirement plan, but did not file a tax return. The IRS prepared a substitute for return (SFR) that consisted of a Form 13496, Code Sec. 6020(b) Certification; a Form 4549, Income Tax Examination Changes; and a Form 886-A, Explanation of Items. In 2015, the IRS sent Williams a notice of deficiency, and Williams petitioned the Tax Court.
Williams filed a motion for summary judgment asserting that the income he received in 2012 was not taxable under the Code. He made what the Tax Court described as shopworn tax protester arguments that have been universally rejected. Before trial, counsel for the IRS sent Williams two letters informing him that the arguments in his motion were frivolous and that the IRS would move for the Tax Court to impose a penalty under Code Sec. 6673(a)(1) if he persisted. Code Sec. 6673(a)(1) authorizes the court to impose a penalty of up to $25,000 if the taxpayer initiated or maintained Tax Court proceedings primarily for delay, or if the taxpayer's position is frivolous or groundless.
At trial, Williams acknowledged that his motion had been denied and that the Tax Court would not recognize his arguments. The Tax Court later warned Williams that the type of arguments he was pursuing was the sort that have generated Code Sec. 6673(a)(1) penalties. However, Williams continued raising frivolous arguments. The IRS filed a motion asking the Tax Court to impose a Code Sec. 6673(a)(1) penalty.
When the IRS assesses a penalty, Code Sec. 6751(b)(1) requires that the initial penalty determination be personally approved in writing by the immediate supervisor of the IRS employee making the determination, or a designated higher level official. In Graev v. Comm'r, 149 T.C. No. 23 (2017), the Tax Court agreed with the holding in Chai v. Comm'r, 2017 PTC 124 (2d Cir. 2017) that the IRS must offer evidence of its compliance with Code Sec. 6751(b)(1) in order to meet its burden of production. Graev did not address whether Code Sec. 6751(b)(1) applies to a Code Sec. 6673(a)(1) penalty.
The Tax Court considered that question in this case and held that its authority to impose a Code Sec. 6673(a)(1) penalty is not subject to the approval requirement in Code Sec. 6751(b)(1). The Tax Court analyzed the statutory construction of the two provisions and found that they were not in conflict; in enacting the supervisor approval requirement, Congress did not intend to repeal Code Sec. 6673(a)(1) or to modify longstanding Tax Court procedural rules, the court found.
The Tax Court explained that when Congress enacted Code Sec. 6751, it intended that penalties be imposed only where appropriate and not as a bargaining chip. The court observed that this intent was key to the holding in Chai, where the Second Circuit concluded that the statute was meant to prevent IRS agents from threatening unjustified penalties to encourage taxpayers to settle.
The Tax Court found that Code Sec. 6673, on the other hand, was enacted to give the Tax Court a tool to combat frivolous litigation and reduce its congested docket. The court noted that in 1989, Congress amended Code Sec. 6673 to increase the award amount from $5,000 to $25,000 and to designate the award a "penalty" rather than "damages." The purpose of the change in term was to make it clear that damages incurred by the U.S. need not be proven before the court can impose a penalty. The Tax Court concluded that Code Sec. 6751(b)(1) was intended to apply only to IRS determinations, while Code Sec. 6673 has an entirely different purpose, and there was no conflict between the two.
The Tax Court noted that Congress's objective in preventing coercive settlements is expressed in Code Sec. 6751(b)(1) where it provides that an IRS manager approve penalties that the IRS has the authority to determine. The "individual" described in the statute is an IRS employee, and the Tax Court is not mentioned in Code Sec. 6751 or its legislative history. The Tax Court concluded that Code Sec. 6751(b)(1) was clearly not intended as a mechanism to restrain the Tax Court.
The Tax Court found further support for its holding in analogous Code provisions that give federal district and appellate courts the power to impose penalties on taxpayers who make frivolous arguments. The Tax Court concluded that Code Sec. 6751(b)(1) was not intended as a broad restraint mechanism on the federal judiciary. In the court's view, Congress did not intend for the statute to cover the imposition of penalties that could be imposed by courts because of misbehavior by a litigant during the course of a judicial proceeding.
For a discussion of penalties for frivolous tax submissions, see Parker Tax ¶262,145. For a discussion of procedural requirements in computing penalties, see Parker Tax ¶262,195.
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IRS Wins Judgment Against Estate Where Decedent Used Tax Shelter to Avoid Taxes
A district court granted in part and denied in part an IRS motion for summary judgment in a case involving the nonpayment of taxes by a decedent on a $132 million stock gain and the use by the decedent of an abusive tax shelter to hide the gain. While giving the IRS an opportunity to file a supplemental brief if it so chose, the court ruled that the IRS failed to establish any liability on the part of a trust set up by the decedent but did grant the IRS summary judgment against the decedent's estate for more than $9 million in taxes plus interest. U.S. v. Gonzales, 2018 PTC 200 (N.D. Calif. 2018).
In 2000, Thomas J. Gonzales II (Gonzales II) sold shares of stock resulting in a capital gain of over $132 million. To avoid income taxes on the gain, Gonzales II participated in a tax shelter and, in April 2001, he filed a tax return for 2000 on which he reported capital losses from the tax shelter. Gonzales II died in December 2001. Upon his death, his father, Tom Gonzales (Gonzales), became the personal representative of his son's estate, the Estate of Thomas J Gonzales II (the Estate), and the successor trustee of a trust his son had established, The Thomas J. Gonzales II 2001 Trust (the Trust). Thereafter, Gonzales signed a series of consent forms (i.e., the Consents) that purported to extend, through December 31, 2006, the deadline for the IRS to assess taxes against Gonzales II for the 2000 tax year.
On December 6, 2006, the IRS issued a statutory notice of deficiency (SNOD) to Gonzales, in his capacity as the representative of the Estate, for underpayment of income taxes in the amount of $26.2 million and an accuracy-related penalty in the amount of $5.2 million. On April 12, 2007, the IRS assessed these sums on Form 4340, Certificate of Assessments and Payments, as well as $13.3 million in interest. The Estate paid the tax and penalty under protest on August 17, 2007, and then Gonzales, as the personal representative of the Estate filed an administrative claim for refund. The IRS abated the penalty in full because the Estate had complied with an IRS disclosure initiative regarding abusive tax shelters, but otherwise disallowed the claim. The IRS did not refund the penalty, however, but retained the funds as a setoff against a portion of the interest owed on the additional tax liability for 2000. On behalf of the Estate, Gonzales filed a refund suit in district court. Among the issues raised was whether the IRS had properly credited the refund of the accuracy-related penalty against the Estate's unpaid statutory interest. The refund suit was resolved in the government's favor on summary judgment and was affirmed by the Ninth Circuit. The Supreme Court denied a petition for writ of certiorari.
Although Gonzales paid the underpayment of income tax and the penalty prior to filing the refund suit, he failed to pay the interest assessed against Gonzales II for 2000 and Gonzales II remained indebted to the U.S. for approximately $8.7 million, plus such additional amounts, including interest and penalties, which accrued and continued to accrue. The government filed suit against Gonzales - in his capacity as the personal representative of the Estate and as successor trustee of the Trust - to collect unpaid interest assessed against Gonzales II. Subsequently, the government filed a motion requesting summary judgment against Gonzales, as personal representative of the Estate and successor trustee of the Trust, in the amount of $9.2 million for unpaid interest associated with the tax liability of Gonzales II for 2000, less any additional credits and plus interest and other statutory additions.
Parties Arguments
Gonzales argued that the government was not entitled to summary judgment for the following reasons: (1) the government failed to establish the liability of either the Trust or the Estate; (2) the government's claim was barred by the three-year statute of limitations in Code Sec. 6501(a); (3) the government did not give the requisite notice of the assessment of interest; (4) the government's claim was barred by estoppel; and (5) the government cannot rely on the Form 4340 to carry its burden of proving the amount owed.
As evidence of the purported failure to provide notice of the interest assessment, Gonzales noted that he had previously requested all notices and assessments sent by the IRS but received nothing regarding the interest assessment. With respect to the statute of limitations claim, Gonzales argued that either the consents were invalid against the Estate, and thus, failed to extend the statute of limitations or, even if the consents were valid, the time to assess any tax or interest was extended only through December 31, 2006. Gonzales noted that the statute of limitations was initially set to expire in 2004 and although the consents purported to extend the statute of limitations to December 31, 2006, Gonzales claimed that the forms were "ambiguous." The government asserted that the refund suit conclusively determined Gonzales II's liability for the 2000 tax year and, thus, the accrual of interest on that tax was automatic. The government further argued that the Form 4340 established that the assessment of interest was proper.
District Court's Decision
The district court agreed that the Estate and Trust were separate entities and that the government failed to establish that the Trust was liable for any outstanding debt of Gonzales II. As a result, the court held that the government failed to demonstrate that the Trust was a proper party to the government's action and denied summary judgment as to the Trust.
With respect to the argument that the time period for assessing the tax and interest was extended only through December 31, 2006, and thus was time barred, the court found two material errors in this argument. First, by operation of Code Sec. 6503(a)(1) and Code Sec. 6213(a), the statute of limitations was suspended for 150 days after the SNOD was issued on December 6, 2006. Consequently, the limitation period to assess a tax deficiency did not expire on December 31, 2006, but rather, on May 30, 2007. The assessment on April 12, 2007, the court found, was therefore timely. Second, although a tax deficiency must be assessed within three years after a return is filed, under Code Sec. 6601(g), interest may be assessed and collected at any time during the period within which the tax to which such interest relates may be collected. Under Code Sec. 6502(a), the collection period for the underlying tax at issue extended ten years after the assessment of the tax. Thus, the court said, given that the assessment of interest coincided with the beginning of the collection period, the assessment of interest was timely.
With respect to the argument that the IRS did not give the requisite notice for the assessment of interest, the court noted that the SNOD issued in December 2006 did not include interest and this was standard procedure. However, the court said that the government's assertion that notice separate and apart from the SNOD was not required was tantamount to an argument that no notice is required at all. The court disagreed, noting that the government provided no authority to support its assertion, which was contradicted by Code Sec. 6601(e)(1). Generally, the notice and demand requirement is satisfied when the IRS informs a taxpayer of the amount owed and requests payment thereof, the court said. While the court concluded that Gonzales was thus entitled to notice of the assessment of interest, it also found that Gonzales did, in fact, receive notice of the assessment of interest because documents filed in the refund suit indicated that the IRS had credited the accuracy-related penalty against asserted interest allegedly due of more than $13 million.
The court also concluded that Gonzales failed to establish the elements of estoppel and found without merit his argument that the government was not entitled to rely on the Form 4340's presumption of correctness to prove the amount of interest owed. According to the court, the IRS does not have to "prove" the amount of interest because, while establishing the amount of tax liability is a matter of evidence, the amount of interest accrued on such liability is a matter of law. The court concluded that the government could rely on Form 4340 to establish the amount of interest owed. Consequently, the court found that the Estate remained indebted to the government in the sum of $9.2 million plus interest provided by Code Sec. 6601 and Code Sec. 6621.
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Nuclear Plant Operator's Waste Disposal Fees Did Not Qualify as Specified Liability Losses
The Eleventh Circuit held that a nuclear plant operator was not entitled to a refund for net operating losses resulting from fees it paid for the disposal of radioactive waste. The Eleventh Circuit found that the taxpayer's losses were not specified liability losses under Code Sec. 172(f) because the disposal of radioactive waste did not qualify as deductible power plant decommissioning costs, the disposal fees were not incurred under a federal or state law requiring decommissioning, and the act giving rise to the liability for such costs did not occur more than three years before the claimed loss. NextEra Energy, Inc. v. U.S., 2018 PTC 192 (11th Cir. 2018).
Background
Nuclear reactors are powered by hundreds of fuel assemblies that contain rods of enriched uranium. The fuel assemblies become less efficient over time and eventually need to be replaced. Used fuel assemblies continue to emit dangerous radiation for thousands of years. Spent nuclear fuel can be stored for years at the nuclear facility, but it ultimately needs to be transferred to a permanent storage site.
The Nuclear Regulatory Commission (NRC) issues licenses for the operation of nuclear power plants, and strict guidelines apply to such operators. For example, the NRC will not terminate a license until a nuclear facility is free of radioactive contamination. In 1982, Congress enacted the Nuclear Waste Policy Act (NWPA) to provide for permanent disposal of spent nuclear fuel. Under the NWPA, the Department of Energy (DOE) is responsible for depositing spent fuel in a permanent disposal site.
Nuclear facilities are required under contracts with the DOE to pay a disposal fee based on the amount of electricity generated by the plant. The fees are paid to the Treasury and placed in the Nuclear Waste Fund. The DOE is authorized to pay from the fund for the disposal of radioactive waste. By paying the fee, the nuclear facility has no further financial obligation to the government for the long-term storage and permanent disposal of spent fuel.
NextEra Energy, Inc. operated two nuclear plants in Florida and one each in Iowa, New Hampshire, and Wisconsin. NextEra entered into NWPA contracts with the DOE and paid approximately $200 million in contract fees to the Nuclear Waste Fund during 2003-2005 and 2008-2010. In 2012, NextEra filed a claim for a refund of approximately $97 million which was based on net operating losses incurred as a result of paying the NWPA fees. In 2015, when the IRS had still made no decision on the refund, NextEra sued for a refund in a district court. The district court granted summary judgment in favor of the IRS because it found that the NWPA contract fees did not qualify as deductible specified liability losses under Code Sec. 172(f).
Analysis
A net operating loss exists when a taxpayer has more deductions in a given year than the taxpayer has income. For the years at issue, net operating losses could be carried forward to future years or back to a previous year, with the carryback generally being limited to the previous two years (although some losses were allowed a longer carryback period).
At all relevant times, Code Sec. 172(f) provided an extended carryback period for certain specified liability losses for decommissioning a nuclear power plant. A ten year carryback applied to liabilities incurred to satisfy a federal or state law requiring the decommissioning of a nuclear power plant if the act giving rise to the liability occurred at least three years before the claimed loss. An even longer carryback applied to a specified liability loss attributable to amounts incurred in decommissioning a nuclear power plant. In that case, the loss could be carried back to the year the plant was placed in service. Thus, to qualify for a refund, NextEra had to show that (1) its payment of NWPA fees was for an act that qualified as nuclear decommissioning, (2) the payments were made pursuant to a law requiring decommissioning, and (3) the act occurred more than three years before the claimed loss. Decommissioning is not a defined term in Code Sec. 172.
The district court granted summary judgment for the government because it found that spent nuclear fuel was not decommissioned under the plain meaning of the term. The district court also found that, even if disposal of spent nuclear fuel qualified as decommissioning, NextEra was still not entitled to a refund because the DOE, not NextEra, was the body with the actual liability under federal law to dispose of the radioactive material. The NWPA contract fees did not go directly to the task of disposing of radioactive material, but instead went to the Nuclear Waste Fund, the district court observed. NextEra appealed to the Eleventh Circuit.
NextEra argued on appeal that disposing of spent nuclear fuel was essential to commissioning and decommissioning a nuclear power plant. It asserted that because its plants could not be fully decommissioned until all radioactive material was removed, decommissioning must encompass the removal of spent nuclear fuel. NextEra claimed that federal regulations supported its argument that decommissioning a nuclear power plant involved ridding the site of radioactive waste and spent nuclear fuel so the license could be terminated. NextEra further contended that the cost of permanent disposal should be treated as costs incurred to temporarily store spent fuel pending its delivery to the DOE for permanent disposal, and that such temporary storage costs are considered nuclear decommissioning costs under Reg. Sec. 1.468A-1(b)(6). NextEra argued that its losses were incurred under a law requiring decommissioning because decommissioning could not take place until all spent nuclear fuel was removed and because NextEra paid the costs of permanent disposal of spent fuel. According to NextEra, the act giving rise to the liability for decommissioning was either the initial startup of the plant or the insertion of fuel assemblies into the reactor core.
The Eleventh Circuit rejected NextEra's arguments and affirmed the summary judgment. The Eleventh Circuit found that although removal of radioactive material is required for decommissioning a nuclear power plant, the removal of spent fuel during the life of a facility is not itself an act of decommissioning. A nuclear plant could operate in perpetuity and never be decommissioned, the court explained, and spent fuel would still need to be removed. In the court's view, disposing of spent fuel was best thought of as a periodic operational expense and did not qualify as decommissioning all or part of a nuclear plant.
The Eleventh Circuit also distinguished the NWPA contract fees from temporary storage costs. In the court's view, the contract fees were akin to a tax on the production of nuclear energy to fund the DOE's cost of permanently storing spent fuel. In contrast, temporary storage costs are borne by individual power plants and incurred not when energy is produced but when spent fuel is removed from the reactor and stored in preparation for eventual removal. The court reasoned that a decommissioned plant would still bear the costs of temporary onsite storage. Given these differences, the court was not convinced that permanent storage costs should be treated the same as temporary storage costs under Code Sec. 172(f).
The Eleventh Circuit found that even if NextEra could prevail on the first prong of its argument, it would not qualify for a refund because no law required NextEra or any nuclear facility to engage in decommissioning. The court found that while every nuclear plant must submit a decommissioning plan to the NRC and maintain funds sufficient for decommissioning, nuclear plants may lawfully remain operational in perpetuity, and any operational plant needs to dispose of spent nuclear fuel on an ongoing basis. The court therefore found that NextEra's NWPA contract fees were not made pursuant to a law requiring decommissioning.
The court also rejected NexEra's argument that NextEra was ultimately responsible for decommissioning because it paid the costs of permanent spent fuel disposal. The court reasoned that funding is only part of the responsibility for decommissioning and that the DOE was required to actually dispose of the radioactive waste. In the court's view, the DOE's disposal obligation and the plant's obligation to pay into the Nuclear Waste Fund were two separate legal obligations.
The Eleventh Circuit further found that the NWPA fees were tied not to the cost of waste disposal, but to the production of electricity. The Eleventh Circuit observed that the NWPA contracts determined the fee based on the amount of electricity generated in the preceding quarter and reasoned that if NextEra built nuclear plants but never produced electricity, it would have incurred no NWPA fees. The NWPA fees were therefore not a law requiring decommissioning, in the court's view.
Finally, the court found that the acts giving rise to the liability happened in the quarters immediately preceding the months in which NextEra paid the fees. Therefore, the acts did not occur more than three years before the claimed loss as required under Code Sec. 172(f).
Observation: The Tax Cuts and Jobs Act eliminated the special 10-year carryback provision for specified liability losses arising in tax years ending after 2017.
For a discussion of determining a carryback or carryforward period for net operating losses, see Parker Tax ¶99,110.
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No Innocent Spouse Relief for Widow Who Failed to Report Insurance Proceeds on Form 8857
The Tax Court held that a widow was not entitled to innocent spouse relief from tax liabilities that arose over several years in which she and her husband filed joint returns but did not pay taxes owed. The court cited the fact that, after her husband's death, the widow invested the proceeds of life insurance policies purchased by her husband without her knowledge in several savings accounts opened in her parents' names and did not report the proceeds to the IRS when she requested relief. Hale v. Comm'r, T.C. Memo. 2018-93.
Background
Kimberly and Stephen Hale were married in 2003. That year, Mr. Hale bought real estate in Memphis, Tennessee needing extensive renovations. The renovations created three apartments, one of which the Hales occupied while they rented out the other two. Sometime before 2004, the Hales also acquired a timeshare in Cancun, Mexico which they used for annual one week vacations.
Mrs. Hale maintained the household and cared for the couple's three children. After her third child, Mrs. Hale received medication for postpartum depression. Mr. Hale was an attorney who was a name partner of a general practice firm. The firm experienced difficulties as a result of adverse market conditions beginning in 2007. Mr. Hale's friend and accountant, J. Anthony Marston, described him as a very controlling person who was reluctant to turn over the accounting to the professionals. Mrs. Hale was not involved in household finances; Mr. Hale kept the checkbook at his office, had all bills sent to his office, and paid the bills from there.
The Hales filed tax returns for 2004 through 2009 but did not pay the taxes owed. Mr. Hale prepared the returns and Mrs. Hale signed them. In 2010, the IRS filed a notice of tax lien, which was sent to Mr. Hale at his law firm.
In 2011, a bank filed suit to collect unpaid interest on a mortgage on the Hales' property. On the day of a scheduled hearing, Mr. Hale did not appear. It was later discovered that he had taken his own life. After Mr. Hale's death, Marston found in Mr. Hale's office evidence of many personal and business debts, including household bills, unopened IRS correspondence, default notices and creditor lawsuits. Marston notified Mrs. Hale of the unpaid taxes.
Mrs. Hale's father, Steven Reid, served as the executor of Mr. Hale's estate. Mr. Hale's gross estate was valued at approximately $17 million, including over $15.7 million in insurance on Mr. Hale's life and the Memphis property valued at around $1.2 million. The estate was not a beneficiary of any of the insurance policies. The estate's Tennessee inheritance tax return showed a deduction for bequests to Mrs. Hale of $8.1 million, which included life insurance proceeds of almost $8 million that Mr. Hale had purchased and funded with his own income. It also reported expenses and debts totaling almost $10 million.
Mrs. Hale did not know about the life insurance policies. Although there was sufficient insurance at Mr. Hale's death to provide Mrs. Hale, their children, and his law firm with over $15 million in benefits, other policies had lapsed because the premiums were not paid. After Mr. Hale's death, the Memphis property went into foreclosure and the estate received no proceeds from it.
A few weeks after Mr. Hale's death, IRS agent Kimberly Huston contacted Marston's office because she believed that one of the mortgages on the Memphis property was paid off with insurance proceeds. Around one week after Huston's inquiry, Mrs. Hale signed three checks totaling approximately $4.7 million, which were deposited in cash deposit (CD) accounts at three different banks. Each deposit exceeded $200,000, and all of the accounts were opened in the names of Mrs. Hale's parents. Mrs. Hale relied on her father and professional advisors to help with her finances. Reid had been advised regarding the implications, including in terms of Federal Deposit Insurance Co. (FDIC) protection, of dispersing assets in different accounts at different banks.
In May 2012, Mrs. Hale submitted two Forms 8857, Request for Innocent Spouse Relief. An attached statement explained that Mrs. Hale owned only some personal property and a retirement account. She reported monthly income of $6,400 and expenses of $7,900.
In July 2012, a payment of $1.5 million, on behalf of Mr. Hale's estate, was made to the IRS for the taxes owed. An additional $350,000 was paid to the IRS on behalf of Mrs. Hale for taxes, penalties and interest. These payments satisfied the Hales' tax liabilities in full. Mrs. Hale then petitioned the Tax Court for a refund, asserting innocent spouse relief under Code Sec. 6015(f).
Analysis
Spouses filing joint tax returns are generally jointly and severally liable for any taxes owed. However, Code Sec. 6015(f) allows a spouse to be relived from liability if it would be inequitable to hold the spouse liable.
Rev. Proc. 2013-34 lists seven factors to consider if certain threshold conditions do not apply. The factors are: (1) whether the couple is still married, (2) whether economic hardship would arise if relief is not granted, (3) whether the requesting spouse had reason to know that the taxes would not be paid, (4) whether either spouse had a legal obligation to pay the taxes, (5) whether the requesting spouse significantly benefitted from the unpaid taxes, (6) whether the requesting spouse made a good faith effort to comply with the income tax laws in subsequent years, and (7) whether the requesting spouse was in poor health at the time the returns were filed.
Mrs. Hale argued that she had no reason to know about the unpaid taxes because she was not involved in the couple's financial decisions. She pointed out that she complied with the tax laws in subsequent years because she filed returns and had no balance owing, and that her failure to list the insurance proceeds on her Forms 8857 was due to a miscommunication among her advisors. She claimed that the transfers of her insurance proceeds into nominee CD accounts was not concealment from the IRS but rather a way to obtain greater FDIC coverage and avoid harassment from creditors. She also asserted that she suffered postpartum depression required medication and severe mental struggles after Mr. Hale's death.
The IRS argued that Mrs. Hale would experience no economic hardship because she received almost $8 million in insurance proceeds and that, contrary to her Forms 8857, her monthly income exceeded her expenses by over $6,000. The IRS argued that Mrs. Hale structured her assets in nominee accounts to avoid collection by the IRS and that Mr. Hale's accumulation of significant assets during the years at issue, including the Cancun timeshare, should have given her reason to suspect that the taxes were not being paid. According to the IRS, Mrs. Hale significantly benefitted from the unpaid taxes because Mr. Hale's life insurance policies were funded by income that could have been used to pay the taxes. The IRS also argued that Mrs. Hale did not comply with the tax laws in subsequent years because she failed to fully disclose her assets on her Forms 8857.
The Tax Court held that it would not be inequitable to deny relief to Mrs. Hale. The court explained that a simple toting up of the seven factors would support granting relief, because Mrs. Hale's lack of knowledge and mental health weighed in her favor and strictly applied, no factor weighed against relief. However, the court noted that the factors are nonexclusive, the degree of importance of each factor varies depending on the facts and circumstances, and that the court was not bound by the IRS's published guidelines.
The Tax Court found that there would be no inequity in requiring Mrs. Hale to bear the burden of the unpaid taxes because, by her own admission, the payments did not cause her economic hardship. The court explained that Rev. Proc. 2013-34 amended earlier guidance by providing that the lack of economic hardship is a neutral factor rather than one weighing against relief. Nevertheless, the court found that under the circumstances, Mrs. Hale's ability to pay the taxes out of the insurance proceeds weighed against her.
The court also reasoned that the tax payments were funded with proceeds from insurance policies for which Mr. Hale paid premiums out of his income. In the court's view, Mr. Hale might have had to allow the policies to lapse if he had paid the couple's taxes. The court further reasoned that the IRS would likely be unable to collect the tax from any source other than the insurance proceeds if the refunds were allowed.
The Tax Court viewed with suspicion the transfers of insurance proceeds and failure by Mrs. Hale to mention them on her Forms 8857. The court noted the timing of the transfers, which occurred one week after the IRS's inquiry about Mrs. Hale's receipt of insurance money. The court also found that the Form 8857 omission could not be attributed entirely to Mrs. Hale's advisors. Rather, the court reasoned that even in her situation, the omission should have been obvious. In the court's view, the Forms 8857 misleadingly suggested that Mrs. Hale lacked the resources to pay the taxes from which she sought relief.
The Tax Court also found that Mrs. Hale's mental condition weighed only slightly in her favor. The court found that she was not involved in the couple's financial decisions, so the failure to pay taxes could not be attributed to her postpartum depression. The court also found no evidence of the severity or duration of Mrs. Hale's condition after her husband's death other than the fact that she attending counseling with her children, and viewed the counseling as being for the children at least as much as it was as for Mrs. Hale.
For a discussion of innocent spouse relief, see Parker Tax ¶260,560.
