Whose Job Is It Anyway?

One of our accountants asked me recently:

R:      Do you think [so and so] qualifies as a real estate professional?

CTG: I do not know [so and so]. Tell me a little.

R:      Husband pulls a W-2.

CTG: How much and how many hours?

R:      Blah blah dollars.

CTG: Works in real estate?

R:      Nah.

CTG: Hours?

R:      Maybe 2,000.

CTG: Is the wife in real estate?

R:      No.

I have told you (almost) everything you need to answer the question.

Let’s look at the Warren case.

James Warren organized Warren Assisted Living, LLC in 2015.

He purchased a group home in 2016.

He started repairing the home almost immediately.

In 2017 he worked at Lockheed Martin for 1,913 hours as an engineer.

On his 2017 tax return he claimed a $41 thousand-plus loss from the group home. He claimed he was a real estate professional.

Warren did not keep time logs.

What sets this up are the passive activity rules under Section 469. As initially passed, that Section considered rental activities (with minimal exceptions) to be “per se” passive.

The passive activity rules would then stifle your ability to claim losses. You – for the most part – had to wait until you had income from the activity. You could then use the losses against the income. 

Well, that caught real estate landlords and others around the country by surprise. When you do one thing, it is difficult to have a Congressional staffer decide that your thing is not a regular thing like the next thing across the street.

Congress made a change.

(c)(7)  Special rules for taxpayers in real property business.

 

(A)  In general. If this paragraph applies to any taxpayer for a taxable year-

 

(i)  paragraph (2) shall not apply to any rental real estate activity of such taxpayer for such taxable year, and

(ii)  this section shall be applied as if each interest of the taxpayer in rental real estate were a separate activity.

 

Notwithstanding clause (ii) , a taxpayer may elect to treat all interests in rental real estate as one activity. Nothing in the preceding provisions of this subparagraph shall be construed as affecting the determination of whether the taxpayer materially participates with respect to any interest in a limited partnership as a limited partner.

 

(B)   Taxpayers to whom paragraph applies. This paragraph shall apply to a taxpayer for a taxable year if-

 

(i)  more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

(ii)  such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.

 

In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements. For purposes of the preceding sentence, activities in which a spouse materially participates shall be determined under subsection (h) .

The above is called the real estate professional exception. It is a mercy release from the per se rule that would otherwise inaccurately (and unfairly) consider people who work in real estate all day to not be working at all.

It has two main parts:

(1) You have to spend at least 750 hours working in real estate, and

(2)  You have to spend more than 50% of your “working at something” total hours actually “working in real estate.”

If you are a real estate professional, you avoid the “per se” label. You have not yet escaped the passive activity rules – you still have to show that you worked - but at least you have the opportunity to present your case.

The Court looked at Warren’s 1,913 hours at Lockheed. That means he would need 3,827 total hours for real estate to be more than ½ of his total work hours. (1,913 times 2 plus 1).

First of all, 3,827 total hours means he was working at least 74 hours a week, every week, without fail, for the entire year.

Maybe. Doubt it.

Warren is going to need really good records to prove it.

Here is the Court:

Mr Warren did not keep contemporaneous logs of his time renovating the group home.”

Not good, but not necessarily fatal. I represented a client who kept Outlook and other records. She created her log after the fact but from records which themselves were contemporaneous. Mind you, we had to go to Appeals, but she won.

In preparation for trial, Mr Warren created – and presented – two time logs.”

Good grief.

The first log maintained that he worked 1,421 hours at the group home; it was created one week before trial.”

End it. That is less than his 1,913 hours at Lockheed.

The second log maintained that Mr. Warren worked 1,628 at the group home; it was created the night before trial.”

Why bother?

This was a slam dunk for the Court. They did not have to dwell on contemporaneous or competing logs or believability or whether the Bengals will turn their season around. Whether 1,421 or 1,628, he could not get to more-than-50%.

Warren lost.

As a rule of thumb, if you have a full-time W-2, it will be almost impossible to qualify as a real estate professional. The exception is when your full-time W-2 is in real estate, maybe with an employer such as CBRE or Cushman & Wakefield.  At 1,900-plus Lockheed hours, I have no idea what Warren was thinking, although I see that it was a per se case. That means he represented himself, and it shows.

I suppose one could have a W-2 and work crazy hours and meet the more-than-50% requirement, but your records should be much tighter. And skip the night before thing.

BTW another way to meet this test is by being married.

Look at (B)(ii) again:

In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements. For purposes of the preceding sentence, activities in which a spouse materially participates shall be determined under subsection (h) .

If your spouse can meet the test (both parts), then you will qualify by riding on the shoulders of your spouse.

Our case this time was Warren v Commissioner, T.C. Summary Opinion 2024-20.

Qualifying As A Real Estate Professional

 

The first thing I thought when I read the opinion was: this must have been a pro se case.

“Pro se”” has a specific meaning in Tax Court: it means that a taxpayer is not represented by a professional. Technically, this is not accurate, as I could accompany someone to Tax Court and they be considered pro se, but the definition works well enough for our discussion.

There is a couple (the Sezonovs) who lived in Ohio. The husband (Christian) owned an HVAC company and ran it as a one-man gang for the tax years under discussion.

In April 2013 they bought rental property in Florida. In November 2013 they bought a second. They were busy managing the properties:

·      They advertised and communicated with prospective renters.

·      They would clean between renters or arrange for someone to do so.

·      They hired contractors for repairs to the second property.

·      They filed a lawsuit against the second condo association over a boat slip that should have been transferred with the property.

One thing they did not do was to keep a contemporaneous log of what they did and when they did it. Mind you, tax law does not require you to write it down immediately, but it does want you to make a record within a reasonable period. The Court tends to be cynical when someone creates the log years after the fact.

The case involves the Sezonovs trying to deduct rental losses. There are two general ways you can coax a deductible real estate rental loss onto your return:

(1) Your income is between a certain range, and you actively participate in the property. The band is between $1 and $150,000 for marrieds, and the Code will allow one to deduct up to $25 grand. The $25 grand evaporates as income climbs from $100 grand to $150 grand.

(2)  One is a real estate professional.

Now, one does not need to be a full-time broker or agent to qualify as a real estate professional for tax purposes. In fact, one can have another job and get there, but it probably won’t be easy.

Here is what the Code wants:

·      More than one-half of a person’s working hours for the year occur in real estate trades or businesses; and

·      That person must rack-up at least 750 hours of work in all real estate trades or businesses.

Generally speaking, much of the litigation in this area has to do with the first requirement. It is difficult (but not impossible) to get to more-than-half if one is working outside the real estate industry itself. It would be near impossible for me to get there as a practicing tax CPA, for example.

One more thing: one person in the marriage must meet both of the above tests. There is no sharing.

The Sezonovs were litigating their 2013 and 2014 tax years.

First order of business: the logs.

Which Francine created in 2019 and 2020.

Here is what Francine produced:

                                     Christian              Francine

2013 hours                        405                      476                

2014 hours                         26                        80                 

Wow.

They never should have gone to Court.

They could not meet one of the first two rules: at least 750 hours.

From everything they did, however, it appears to me that they would have been actively participating in the Florida activities. This is a step down from “materially participating” as a real estate pro, but it is something. Active participation would have qualified them for that $25-grand-but-phases-out tax break if their income was less than $150 grand. The fact that they went to Court tells me that their income was higher than that.

So, they tried to qualify through the second door: as a real estate professional.

They could not do it.

And I have an opinion derived from over three decades in the profession: the Court would not have allowed real estate pro status even if the Sezonovs had cleared the 750-hour requirement.

Why?

Because the Court would have been cynical about a contemporaneous log for 2013 and 2014 created in 2019 and 2020. The Court did not pursue the point because the Sezonovs never got past the first hurdle.

Our case this time was Sezonov v Commissioner. T.C. Memo 2022-40.

Reorganizing A Passive Activity

 

I am looking at a case that stacks a couple of different tax rules atop another and then asks: are we there yet?

Let’s talk about it.

The first is something called the continuity of business doctrine. Here we wade into the waters of corporate taxation and - more specifically - corporate reorganizations. Let’s take an easy example:

Corporation A wants to split into two corporations: corporation B and corporation C.

Why? It can be any number of things. Maybe management has decided that one of the business activities is not keeping up with the other, bringing down the stock price as a result. Maybe two families own corporation A, and the two families now have very strong and differing feelings about where to go and how to get there. Corporate reorganizations are relatively common.

The IRS wants to see an active trade or business in corporations A, B and C before allowing the reorganization. Why? Because reorganizations can be (and generally are) tax-free, and the IRS wants to be sure that there is a business reason for the reorganization – and avoiding tax does not count as a business reason.

Let me give you an example.

Corporation A is an exterminating company. Years ago it bought Tesla stock for pennies on the dollar, and those shares are now worth big bucks. It wants to reorganize into corporation B – which will continue the exterminating activity – and corporation C – which will hold Tesla stock.

Will this fly?

Probably not.

The continuity of business doctrine wants to see five years of a trade or business in all parties involved. Corporation A and B will not have a problem with this, but corporation C probably will. Why? Well, C is going to have to argue that holding Tesla stock rises to the level of a trade or business. But does it? I point out that Yahoo had a similar fact pattern when it wanted to unload $32 billion of Alibaba stock a few years ago. The IRS refused to go along, and the Yahoo attorneys had to redesign the deal.

Now let’s stack tax rules.

You have a business.

To make the stack work, the business will be a passthrough: a partnership or an S corporation. The magic to the passthrough is that the entity itself does not pay tax. Rather its tax numbers are sliced and diced and allocated among its owners, each of whom includes his/her slice on his/her individual return.

Let’s say that the passthrough has a loss.

Can you show that loss on your individual return?

We have shifted (smooth, eh?) to the tax issue of “materially participating” and “passively nonparticipating” in a business.

Yep, we are talking passive loss rules.

The concept here is that one should not be allowed to use “passively nonparticipating” losses to offset “materially participating” income. Those passive losses instead accumulate until there is passive income to sponge them up or until one finally disposes of the passive activity altogether. Think tax shelters and you go a long way as to what Congress was trying to do here.

Back to our continuity of business doctrine.

Corporation A has two activities. One is a winner and the other is a loser. Historically A has netted the two, reporting the net number as “materially participating” on the shareholder K-1 and carried on.

Corporation A reorganizes into B and C.

B takes the winner.

C takes the loser.

The shareholder has passive losses elsewhere on his/her return. He/she REALLY wants to treat B as “passively nonparticipating.” Why? Because it would give him/her passive income to offset those passive losses loitering on his/her return.

But can you do this?

Enter another rule:

A taxpayer is considered to material participate in an activity if the taxpayer materially participated in the activity for any five years during the immediately preceding ten taxable years.

On first blush, the rule is confusing, but there is a reason why it exists.

Say that someone has a profitable “materially participating” activity. Meanwhile he/she is accumulating substantial “passively nonparticipating” losses. He/she approaches me as a tax advisor and says: help.

Can I do anything?

Maybe.

What would that something be?

I would have him/her pull back (if possible) his/her involvement in the profitable activity. In fact, I would have him/her pull back so dramatically that the activity is no longer “materially participating.” We have transmuted the activity to “passively nonparticipating.”

I just created passive income. Tax advisors gotta advise.

Can’t do this, though. Congress thought of this loophole and shut it down with that five-of-the-last-ten-years rule.

This gets us to the Rogerson case.

Rogerson owned and was very involved with an aerospace company for 40 years. Somewhere in there he decided to reorganize the company along product lines.

He now had three companies where he previously had one.

He reported two as materially participating. The third he treated as passively nonparticipating.

Nickels to dollars that third one was profitable. He wanted the rush of passive income. He wanted that passive like one wants Hawaiian ice on a scorching hot day.

And the IRS said: No.

Off to Tax Court they went.

Rogerson’s argument was straightforward: the winner was a new activity. It was fresh-born, all a-gleaming under an ascendent morning sun.

The Court pointed out the continuity of business doctrine: five years before and five after. The activity might be a-gleaming, but it was not fresh-born.

Rogerson tried a long shot: he had not materially participated in that winner prior to the reorganization. The winner had just been caught up in the tide by his tax preparers. How they shrouded their inscrutable dark arts from prying eyes! Oh, if he could do it over again ….

The Court made short work of that argument: by your hand, sir, not mine. If Rogerson wanted a different result, he should have done - and reported - things differently.

Our case this time was Rogerson v Commissioner, TC Memo 2022-49.

Can You Really Be Working If You Work Remotely?

Have you ever thought of working remotely?

Whether it is possible of course depends on what one does. It is unlikely a nurse could pull it off, but could an experienced tax CPA…?  I admit there have been moments over the years when I would have appreciated the flexibility, especially with out-of-state family.

I am looking at a case where someone pulled it off.

Fred lived in Chicago. He sold his company for tens of millions of dollars.

COMMENT: I probably would pull the (at least semi-) retirement trigger right there.

He used some of the proceeds to start a money-lending business. He was capitalizing on all the contacts he had made during the years he owned the previous company. He kept an office downtown at Archer Avenue and Canal Street, and he kept two employees on payroll.

Fred called all the shots: when to make loans, how to handle defaulted loans. He kept over 40 loans outstanding for the years under discussion.

Chicago has winters. Fred and his wife spent 60% of the year in Florida. Fred was no one’s fool.

But Fred racked up some big losses. The IRS came a-looking, and they wanted the following:

                   Year                          Tax

                   2009                     $336,666

                   2011                     $  90,699

                   2012                     $109,355

The IRS said that Fred was not materially participating in the business.

What sets this up are the passive activity rules that entered the Code in 1986. The IRS had been chasing tax-shelter and related activities for years. The effort introduced levels of incoherence into the tax Code (Section 465 at risk rules, Section 704(b) economic substance rules), but in 1986 Congress changed the playing field. One was to analyze an owner’s involvement in the business. If involvement was substantial, then one set of rules would apply. If involvement was not substantial, the another set of rules would.

The term for substantial was “material participation.”

And the key to the dichotomy was the handling of losses. After all, if the business was profitable, then the IRS was getting its vig whether there was material participation or not.

But if there were losses….

And the overall concept is that non-material participation losses would only be allowed to the extent one had non-material participation income. If one went net negative, then the net negative would be suspended and carryover to next year, to again await non-material participation income.

In truth, it has worked relatively well in addressing tax-shelter and related activities. It might in fact one argued that it has worked too well, sometimes pulling non-shelter activities into its wake.

The IRS argued that Fred was not materially participating in 2009, 2011 and 2012. I presume he made money in 2010.

Well, that would keep Fred from using the net losses in those respective years. The losses would suspend and carryover to the next year, and then the next.

Problem: Sounds to me like Fred is a one-man gang. He kept two employees in Chicago, but one was an accountant and the other the secretary.

The Tax Court observed that Fred worked at the office a little less than 6 hours per day while in Chicago. When in Florida he would call, fax, e-mail or whatever was required. The Court estimated he worked 460 hours in Chicago and 240 hours in Florida. I tally 700 hours between the two.

The IRS said that wasn’t enough.

Initially I presumed that Barney Fife was working this case for the IRS, as the answer seemed self-evident to me. Then I noticed that the IRS was using a relatively-unused Regulation in its challenge:

          Reg § 1.469-5T. Material participation (temporary).

(a)  (7)  Based on all of the facts and circumstances (taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year.

The common rules under this Regulation are the 500 hours test of (a)(1), the substantially-all-the-activity test of (a)(2) and 100-hours-and-not-less-than-anyone-else test of (a)(3). There are only so many cases under (a)(7).

Still, it was a bad call, IRS. There was never any question that Fred was the business, and the business was Fred. If Fred was not materially participating, then no one was. The business ran itself without human intervention. When looked at in such light, the absurdity of the IRS position becomes evident.

Our case this time was Barbara, TC Memo 2019-50.

The IRS Updates a Real Estate Professional Tax Rule

I am glad to see that the IRS has reversed course on an issue concerning real estate professionals.

You may remember that “passive losses” entered the tax Code in 1986 as retaliation against tax shelters. The IRS had previously battled tax shelters using challenges such as “at-risk,” but 1986 brought a new and updated weapon to the IRS armory.

The idea is simple: separate business activities into two buckets: one bucket for material participation and a second for passive. The classic material participation is an activity where one works more than 500 hours. Activities in the material participation bucket can offset each other; that is, losses can offset income.

Move on to the second bucket. Losses can offset income – but not beyond zero. The best one can do (with exceptions, of course) is get to zero. One cannot create a net loss to offset against net income from bucket one.

Consider that tax shelters were placed into bucket two and you understand how Congress changed the tax Code to pull the rug out from under the classic tax shelter.

It was quickly realized that the basic passive activity rules were unfair to people who made their living in real estate. For example, take a real estate developer who keeps a few self-constructed office condominiums as rentals. If one went granular separating the activities, then the real estate development would be a material participation activity but the condominium rentals would be a passive activity. This result does not make sense, as all the income in our example originated from the same “activity.”

So Congress came in with Section 469(c)(7):

   469(c)(7) SPECIAL RULES FOR TAXPAYERS IN REAL PROPERTY BUSINESS.—

469(c)(7)(A) IN GENERAL.— If this paragraph applies to any taxpayer for a taxable year—

469(c)(7)(A)(i)   paragraph (2) shall not apply to any rental real estate activity of such taxpayer for such taxable year, and

469(c)(7)(A)(ii)   this section shall be applied as if each interest of the taxpayer in rental real estate were a separate activity.

Notwithstanding clause (ii), a taxpayer may elect to treat all interests in rental real estate as one activity. Nothing in the preceding provisions of this subparagraph shall be construed as affecting the determination of whether the taxpayer materially participates with respect to any interest in a limited partnership as a limited partner.

469(c)(7)(B) TAXPAYERS TO WHOM PARAGRAPH APPLIES.— This paragraph shall apply to a taxpayer for a taxable year if—

469(c)(7)(B)(i)   more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

469(c)(7)(B)(ii)   such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.

Look at Section 469(c)(7)(B)(ii) and the reference to 750 hours. There was confusion on what happened to the plain-vanilla 500-hour rule. Was a real estate pro to be held to a higher standard?

Here for example is the Court in Bahas:

Mrs. Bahas misconstrues section 469. Because petitioners did not elect to aggregate their real estate rental activities, pursuant to Section 469(c)(7)(A) petitioners must treat each of these interests in the real estate as if it were a  separate activity. Thus, Mrs. Bahas is required to establish that she worked for more than 750 hours each year with respect to each of the three rental properties.”

How in the world did we get from 500 hours to 750 hours for each of Mrs. Bahas’ activities?  This is not what Section 469(c)(7) appears to say. There was a torrent of professional and academic criticism on Bahas and related decisions, but in the interim practitioners (me included) elected to aggregate all the real estate activities into one activity. Why? To make sure that one got to the 750 hours, that is why.

Academicians could argue the sequence of phrases and the intent of the law. Practitioners had to prepare annual tax returns, protect their clients and wait their time.

And now it is time.

The IRS released ILM 201427016 to discuss how the “750-hour test” works when one has multiple real estate activities. It includes the following obscuration:

However, some court opinions, while reaching the correct result, contain language which may be read to suggest that the election under Treas. Reg. 1.469-9(g) affects the determination of whether a taxpayer is a qualified taxpayer.”

The IRS finally acknowledged that the 750-hour rule is not a substitute or override for the generic 500-hours-to-materially-participate rule. A real estate taxpayer goes activity-by-activity to determine if he/she is materially participating in each activity. If it is advantageous, the taxpayer can also make an election to aggregate all real estate activities before determining material participation status.

Then, once all that is done, the IRS will look at whether the taxpayer meets the more-than-half and more-than-750-hours tests to determine whether the taxpayer is a real estate pro.

There are two separate tests. One is to determine material participation and a second to determine real estate pro status. 

A bit late for Mrs. Bahas, though.

Can A Trust Carryback A Loss for A Tax Refund?

I am remembering a tax issue from 2004. The firm I was with had a sizeable business client. The business owner had two daughters and wanted them to participate in the business. One daughter did; the other daughter went on to other pursuits. The father transferred shares to his daughters using special trusts: first a QSST (Qualified Subchapter S Trust), followed by an ESBT (Electing Small Business Trust). Trusts are normally disallowed as eligible S corporation shareholders, but the tax Code makes an exception for a QSST or an ESBT. Dad settled the trusts and acted as their trustee. He was of course also the majority shareholder and CEO of the underlying company.

The company was impressively profitable, but in 2004 it had a loss. It happens.

The company had been profitable. Its shareholders, including the trusts, had previously paid taxes on that profit. Now there was a business loss. Could the shareholders – more specifically, the trusts – use that loss to any tax advantage?

And we walked right into IRS Regulation 1.469-8. As a heads up, there is no Regulation 1.469-8. The IRS reserved that slot to provide its position on material participation by a trust. However the IRS never wrote the Regulation. Practitioners were required to divine whether their client trusts would be “materially participating” in an activity or whether the trust would be “passive” in an activity.

You may remember the “passive activity” rules in the Code. These were passed in 1986 as another effort to limit tax shelters, a task which they accomplished to an admirable degree. It did so by dividing business activities into material participation and passive activities. Generally speaking, losses from passive activities could not offset income from material participation activities.  There were problems, of course, one of which was Congress’ decision to label most real estate activities as “passive.” That may be the case for many, but there are people out there who make their living in real estate. For them real estate is about as passive as my involvement with my CPA firm.

Seven years later Congress corrected this error by enacting Section 469(c)(7), which said that the passive loss rules did not apply to someone who worked at least 750 hours a year in real estate, provided that his/her real estate activities were more than one-half of his/her hours worked for the year.

Now, our client company had nothing to do with real estate but had a lot to do with plastics. Section 469(c)(7) did not apply to them. I was aware that the IRS had informally intimated that a trust could not materially participate because a trust was not a person, and only a person could materially participate. I guess their reasoning made sense if material participation was like breaking a sweat.

The law was relatively new, and no one had yet challenged the IRS. The IRS was in no hurry to publish a Regulation. Why? I thought both then and now that the IRS suspected they had a losing hand, but they were not going to back off until they were forced. The IRS could ride roughshod until someone brought suit.

And I am looking at that someone. The case is Aragona v Commissioner, and it was a Tax Court case decided March 27.

Frank Aragona settled the trust in 1979. He died in 1981, at which time the trust went irrevocable. The trust had several trustees, the majority of which were family members. The trust owned a real estate LLC, which employed several people: family, leasing agents, maintenance workers, clerks, a controller and so on. Three of the trustees worked there and received a paycheck from the LLC. It was clear the LLC was materially participating in a business activity.

During 2005 and 2006 the LLC incurred losses. The trust treated the losses as “material participation” and carried the losses back to the 2003 and 2004 tax years for tax refunds.

The IRS said these were passive losses. No passive losses were allowed, much less operating losses that the trust could carryback for tax refunds. The IRS wanted back almost $600,000 of taxes. In addition, they asserted penalties.

Here was the IRS argument before the Court: a trust is incapable of performing “personal services” because Regulations define “personal services” to mean “any work performed by an individual in connection with a trade or business.” Obviously a trust is not an individual.

The Court immediately spotted the obvious: a trust is a fiduciary vehicle whereby a trustee agrees to act in the best interest of a beneficiary. The trustee may be a “person.” If that “person” in turn performs personal services in his/her role as trustee, then why cannot those personal services be attributed back to the trust?  How else could a trust possibly do anything? The trust would have performed personal services in the only way it can: through its trustees. The same concept applies for example to a corporation. As an artificial entity, a corporation can only act through its officers. It does not have arms and legs and cannot join a softball league. Its officers can, however.

The IRS continued that a trust cannot perform personal services because of words that Congress used in committee reports and selected Code sections. Funny, said the Court. When Congress intended that a Code section disallow trusts, it used the term “natural person.” A trust, not being a natural person, cannot take advantage of that Code section. Congress did not use that term in the Code section addressing material participation. Why-oh-why would that be, asked the Court.

The IRS lost and the Aragona trust won.

Let us say a word about the penalties the IRS wanted. Obviously they became moot when the Aragona trust won, but how could the IRS possibly defend asserting penalties in the first place? It refused to publish Regulations for 28 years, and when someone had the audacity to challenge them it responded by asserting penalties?

Here is an observation from a tax pro: the IRS is all but automatically asserting penalties these days. If there is an adjustment, the IRS clicks through its quiver of available penalties and lobs a few your way. It does not care whether you had authority for your position or whether you were just being zany. The government is going broke and the IRS is chasing money under every seat cushion. However, is this good tax policy? Shouldn’t penalties be reserved for those claiming unsubstantiated deductions, masking transactions or just making up their own tax law?

Here is an idea: if the IRS asserts a penalty and loses the issue, the IRS has to pay you the penalty amount. Force them to risk a losing hand. Maybe that will prompt them to back-off a bit.

Congratulations to the Aragona trust for taking this on.