Getting Married And ObamaCare Subsidies

I am reading a case that reminds me of a return from last year’s filing season. I had an accountant who became upset, arguing that the result was unfair.

I agree, but this is tax.

I started practice in the eighties, and a significant portion of my tax education was at a law school.  Tax accounting classes tended to be staccato-like:  issue-driven, procedural and reliably arithmetic. Tax law classes were case and doctrine-focused: what is income, for example, and we would study the concept of income as it evolved over the decades.

It seemed to me that tax law early in my career followed – as a generalization - more of that law school feel: corporate liquidations and the General Utilities doctrine; the claim of right doctrine and North American Oil; business purpose and Helvering v Gregory. There were strong Ways and Means and Finance Committee chairs with some understanding of the issues (and precedent) their committees were addressing.  

But those were different politicians. Both they and taxes have gotten progressively weirder.

Congress went on to introduce something called uniform capitalization, arguing that accountants did not know how to absorb costs into inventory; tax items – personal exemptions or itemized deductions, for example – that would evaporate like a Thanos movie moment; an alternative minimum tax that would tax something that ultimately went down in value; the increasing refundability of tax credits, meaning that those at the low end of the income scale had as much if not more opportunity to game the system than any big-baddy McMoneybags did.

Let’s look at the Fisher case.

Christina Fisher began the year as a single mom. She married Timothy in November. Christina was struggling, and she received Obamacare subsidies.

You may recall that there are two relevant aspects to Obamacare that will come into play in this case:

(1)  If you are below a certain income level, you might be entitled to some – or even full – subsidy of your health insurance premiums.

(2)  You can use that subsidy to pay your premiums immediately rather than wait to the end of the year and receive the subsidy via a tax refund.

There was no question that Christina was entitled to a subsidy for more than 10 months. Her circumstances changed when she married; she no longer qualified.

Time to prepare her taxes.

One is supposed to attach a reconciliation of projected income when receiving the subsidy to actual income ultimately reported on the tax return. The Fishers did not.

The IRS did it for them. They also wanted approximately $4,500, saying she was not entitled to the subsidy.

A rational mind would expect that the tax law would go to a month-by-month calculation. There was no doubt that she qualified for 10 months. Let’s allow for some doubt in the month of marriage. Let’s also disqualify the last month of the year because of Timothy’s income.

At worst she would have to pay back 2 months, right?

Nah.

She has to use her household income for the year – including Timothy’s income.

Then she takes half of that amount for her monthly testing.

Not her OWN income, mind you, but one-half of combined income for the year.

Who came up with this?

Not the best and brightest exercising due deliberation, clearly.

Well, using even one-half of the combined household income, Christina failed all 10 months one would have expected her to pass. She owed almost $4,500 to the IRS.

And that is why my accountant lost his mind last year. He could not believe that what he was reading is really what was meant. It made no sense! Surely there is an alternative calculation? Does the tax Code allow a facts and circumstances …?

Ahh, he is still young. He will learn.

I Filed A Petition With The Tax Court

This week I put in a petition to the Tax Court.

It used to be that I could go for years without this step. Granted, I have become more specialized, but unfortunately this filing is becoming almost routine in practice. A tax CPA unwillingly to push back on the new IRS will have a frustrating career.

Heck, it is already frustrating enough.

The IRS caused this one.

We have a client. They received an audit notice near the end of 2018. They were traveling overseas. We requested and received an extension of time to reply.

Then happened the government shutdown.

We submitted our paperwork.

The client received a proposed assessment.

We contacted the IRS and were told that the assessment had been postdated and should not have gone out. Aww shucks, it was that IRS-computers-keep-churning-thing even though there were no people in the building. The examining agent had received our pack-o’-stuff and we should expect a revised assessment.

Sure. And I was drafted by the NFL in Nashville recently.

We received a 90-day notice, also known as a statutory notice of deficiency. The tax nerds refer to it as a “NOD” or “SNOD.” Believe it or not, it was dated April 15.

Let’s talk this through for a moment, shall we?

The IRS returned from the government shutdown on January 28^th.  We had an audit that had not started. Worst case scenario there should have been at least one exchange between the IRS and us if there were questions. There was no communication, but let’s continue. I am supposed to believe that an IRS agent (1) returned from the shutdown; (2) picked-up my client file immediately; (3) wanted additional paperwork and sent out a notice that never arrived requesting the same; (4) allowed time for said notice’s non-delivery, non-review and non-reply; (5) forgot to contact taxpayer’s representative, despite having my name, address, CAFR number, telephone number, fax number, waist size and favorite ice cream; (6) and yet manage to churn a SNOD by April 15^th?

I call BS.

I tell you what happened. Someone returned from the shutdown and cleared off his/her desk, consequences be damned. Forget about IRS procedure. Kick that can down the road. What are they going to do – fire a government employee? Hah! Tell me another funny story.

If you google, you will learn that there are two conventional ways to respond to a SNOD. One is to contact the IRS. The other is to file a petition with the Tax Court.

Thirty-plus years in the profession tells me that the first option is bogus. Go 91 days and the Tax Court will reject your petition. The 90 days is absolute; forget about so-and-so at the IRS told me….

What happens next? The case will return to Appeals and – if it proceeds as I expect – it will return to Examination. Yes, we would have wasted all that time to get back to where the initial examining agent failed to do his/her job.

I wish there were a way to rate IRS employees. Let’s provide tax professionals - attorneys, CPAs and enrolled agents - a website to rate an IRS employee on their performance, providing reasons why. Allow for employee challenge and an impartial hearing, if requested. After enough negative ratings, perhaps these employees could be - at a minimum - removed from taxpayer contact. With the union, it probably is too much to expect them to be fired.

You can probably guess how I would rate this one.

Keeping A Corporation Alive

Recently I received a call from a client requesting that certain records be sent to an attorney as soon as possible, hopefully before noon.

It was not a big request, just the QuickBooks files for two companies (those who know me will understand the inside joke in that sentence). Activity in recent years has been minimal, and the companies have been kept alive primarily because of a lawsuit. The companies previously experienced one of the most astounding thefts of intellectual property I have encountered. It sounds like the attorneys have now stopped playing flag and are now playing tackle, as legal discovery is turning up some rather unflattering information. We are talking retirement-level money here.

Notice what I said: the companies have been kept alive.

Why?

Because it is the companies that are suing.

Keeping the companies alive means filing tax returns, renewing annual reports with the secretary of state and whatever else one’s particular state of organization may require. It may also require the owners kicking-in money to pay those taxes, registrations and fees.

What if you do not do this? To use a rather memorable phrase: what difference does it make?

Let’s talk about the recent Timbron case.

There are two Timbrons: the parent (Timbron Holdings) and the operating company (Timbron Internation). For ease, we will call them both Timbron.

Timbron was organized in California.

Timbron did not pay state taxes.

By 2013 California has suspended corporate rights for both Timbrons.

In 2016 the IRS showed up and issued Notices of Deficiency for 2010 and 2011.

In October, 2016 Timbron filed a petition with the Tax Court.

In November, 2016 the IRS filed its response.

A couple of months later the IRS realized Timbron was no longer a corporation under California law. This is a problem, as corporations are legal entities, meaning they are created and sustained under force of law.

An attorney at the IRS earned one of the easiest paychecks he/she will ever receive.

The IRS moved to dismiss.

Timbron fought back. Someone must have invested in a legal dictionary, as we are introduced to “certificates of reviver.” Timbron continued on, arguing “vitality” and “mere irregularities.”

I am not an attorney, although I did a substantial portion of my Masters at the University of Missouri Law School. When I come across gloss and floss like “vitality” and so forth, I discern that an attorney is hard-pressed.

Here is the Court:

With respect to corporate taxpayers like petitioners, a proper filing requires taxpayers tendering petitions to the Court to have the capacity to engage in litigation before this Court.”

To no one’s surprise:

… we find that petitioners lacked capacity to timely file proper petitions.”

Timbron lost.

On the most basic of facts: it failed to maintain its corporate status under California law.

Converting A Residence To A Rental

I have a client who owns a very nice house. Too nice, in fact, at least for its neighborhood. My client used to have a contracting business, and he used his business talents and resources to improve his residence. He is now thinking of moving to another city, and it is almost assured he will lose money when he sells his house.

He is quite creative in thinking of ways to make that loss tax deductible.

The first thought is to convert it to a rental. One can deduct losses on the sale of a rental, right?

There are two significant issues with this plan. One has to do with the amount of loss one can deduct when the rental is underwater – that is, when it costs more than it is worth. The second has to do with whether there actually is rental activity.

We have previously talked about the second point, especially when one rents to family. Doing so is not fatal, but doing so on the cheap (not charging rent or enough rent) is.

Consider the following:

The Langstons purchased a residence (75^th Place) in 1997.

They lived there until 2005, when they moved to an apartment. They kept some of their possessions at 75^th Place until they could move them to storage.

Renovations to 75^th Place were completed in 2010.

In 2011 they received an unwanted telephone call from their insurance agent. Someone had to live at 75^th Place or the insurance would be terminated.

In July, 2011 Mr. Langston rented the property to a fraternity brother for $500 a month.

COMMENT: The market rent was between $2,500 and $2,800 a month, but the fraternity brother would be home about five days per month. Mr. Langston prorated the rent accordingly.

In 2013 they finally sold 75^th Place. They deducted a loss of over $400 grand.

QUESTION: Do you think they successfully converted the property to a rental?

Let’s consider a few factors.

·      What was their intent when they moved to an apartment?

If the intent was to renovate and sell, this would indicate an income-producing purpose. The problem is that the renovations went on forever.

·      They tried to rent the property

No, actually they did not. In fact, the Court thought that they rented the property only after the insurance company threatened to cut-off their insurance.

·      They actually rented the property

For much less than market value rent. The Court was not impressed by that.

·      They tried to sell the property

Eventually, after nearly a decade and after never marketing the property. They did not even seek an appraisal until a refinancing required them to do so.

The Court decided that they never converted the property to a rental. There was no deductible loss.

Zero surprise. I get the feeling that the taxpayers did whatever they wanted for however long, and near the end they wanted some tax leverage from the deal. It was a bit unfair to the tax practitioner, as some planning – any planning – might have helped.

Let’s go crazy with their planning. What can we do….? Let me think, let  me… I got it! How about actually renting the place before the insurance company is about to drop you? How about charging market rent – or at least close?  How about listing the house with a realtor? Shheeesssh.

I suspect my client is shrewder than the Langstons. He however cannot get past the second tax issue.

You see, when you have a personal asset (say your residence) which you convert to income-producing status (say a rental), you have to look at its basis and its fair market value when you convert.

Basis is a fancy word for what you paid to acquire or improve the asset. Say that my client has $1.5 million in his house.

Say he converts May 1^st, when the house is worth $1 million.

He now has a “dual basis” situation.

His basis for calculating gain is $1.5 million.

But his basis for calculating loss is $1 million.

You see what happened? He was hoping to use that $1.5 million to calculate any loss on sale. Folks, the IRS figured out this gimmick ages ago. That is how we wound up with the dual basis rule.

I suspect the Langstons had a similar situation, but they never got to first base. You see, their activity had to qualify first as a rental before the Court would have to consider the dual basis rule. The activity didn’t, so the Court didn’t.

Our case this time was Carlos and Pamela Langston, TC Memo 2019-19.

You Inherit. Can You Owe Estate Tax?

I came across an estate tax lien case the other day.

It has become unlikely that one will owe estate tax, as the lifetime exclusion has now gone over $11 million. Still, it can and does happen.

The federal estate tax is an odd beast. It is a combination of assets owned or controlled at death, increased by an addback for reportable lifetime gifts. This system is called a “unified” tax, and the intent is to not avoid the estate tax by giving property away to family over the course of a lifetime. In truth, the addback is necessary, as tax planners (including me) would drive an 18-wheeler through the estate tax if the lifetime-gift addback did not exist.

There is a potential trap if the estate tax kicks-in.

Let me give you a scenario, very loosely based on the case.  

Mr Arshem was successful. He created and funded a family limited partnership with real estate, stock and securities. He began a multi-year gifting sequence to his children, each time claiming a generous discount for lack of control and marketability. He had cumulatively gifted away $5 million in this manner.

He passed away early in 2019. He died with an estate of $6 million.

On first pass, $6 million plus $5 million equals $11 million. He is just under the threshold, so he should not have an estate tax issue – right?

Not so fast.

The IRS audits one or more of those gift tax returns. They argue that the discounts were too generous, and the reportable gifts were actually $8 million. The estate disagrees; they go to Court; the estate loses.

Now we have $8 million plus $5 million for $13 million.

There is an estate tax filing requirement.

And estate tax due.

Let’s say that the estate had been probated and closed. There no estate assets remaining.

Who pays the tax?

Look over this little beauty:

§ 6324 Special liens for estate and gift taxes.

(a)  Liens for estate tax.

Except as otherwise provided in subsection (c) -

(1)  Upon gross estate.

Unless the estate tax imposed by chapter 11 is sooner paid in full, or becomes unenforceable by reason of lapse of time, it shall be a lien upon the gross estate of the decedent for 10 years from the date of death, except that such part of the gross estate as is used for the payment of charges against the estate and expenses of its administration, allowed by any court having jurisdiction thereof, shall be divested of such lien.

(2)  Liability of transferees and others.

If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees' trust which meets the requirements of section 401(a) ), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent's death, property included in the gross estate under sections 2034 to 2042 , inclusive, to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax.

It is not the easiest of reading.

What (a)(2) means is that the IRS can after the transferees – the children of Mr Arshem in our example. There is also a sneaky twist. Income tax liens have to be recorded; estate tax liens do not. They are referred to as “silent” liens and can create unexpected – and unpleasant – surprises.  You cannot go to the courthouse and research if one exists.

What if Arshem’s children received his assets and thereafter sold them? What happens to the lien?

The children are “transferees.” They are personally liable for the estate tax.

COMMENT: There are procedures to possibly mitigate this consequence, but we will pass on their discussion in this post.

The case is U.S. v Ringling. The moral of the story is – if the estate is large enough to draw the wrath of the federal estate tax – please consult an experienced professional. Think of it as insurance.

Captain Eddie’s Firefly

The case starts with:

Edward G Kurdziel is the only man in America licensed to fly a Fairey Firefly. He is also the only man in America who has a Firefly to fly.”

I was immediately hooked.

What is a Fairey Firefly?

The Firefly entered service as a carrier-based fighter for the Royal Navy toward the end of the war (WW II - CTG), and became a specialist in antishipping and antisubmarine warfare.”

Mr Kurdziel – also known as Captain Eddie – explained that the Firefly “was the first British airplane to fly over Japan and Tokyo in 1945 during the [occupation] of Japan.”

In the fall of 1993 Captain Eddie learned that a Firefly was for sale in Australia. He travelled; he consulted with mechanics. The plane had not flown in years, possibly decades.

He borrowed against his house and bought the plane for $200,000. It cost another $60,000 to have it shipped.

The plane is a near-museum piece. What was he going to do with it?

His early plan was to sell rides on the plane. He looked into insurance (can you imagine?). He collaborated with the Royal Australian Navy on a plan to restore the plane.

That took eight years, 45,000 man-hours and as many as 10 full-time workers.

Captain Eddie was a bit of an Anakin Skywalker, designing and crafting many replacement parts himself.

In 2002 he received an “air worthiness certificate” from the FAA. He also got the FAA to license him to fly it. To this day, he is the only person in the country with such a license.

He showed the plane. It won prizes. It landed on 20 or 30 magazine covers.

This being a tax blog, there has to be a tax angle. What you think it was?

Yep, Captain Eddie deducted everything.

Problem: to pull this off, Captain Eddie had to persuade the IRS – and then the Court – that he actually had a business. As opposed to … say … a hobby. A really cool hobby, but a hobby nonetheless. A business has to have the intent – perhaps misplaced but nonetheless sincere – that it will show a profit.

How was this old warbird going to show a profit after the near-herculean effort and cost of restoring it?

Rides? Nah, that was nixed immediately by the authorities. No surprise that the FAA was not too keen with public rides on an antique, near-unflyable-by-today’s-standards airplane.

There were airshow appearances and prizes.

Yes, but the winnings were a pittance against what he spent. No chance of a profit there.

The Firefly crashed in 2012. Captain Eddie is still working on its repair.

The IRS brought out its hobby loss hammer and said “no deduction here.”

Off to Court they went.

Captain Eddie had to show that a sane businessperson would keep putting money into a money pit. Granted, one may do it for love, for respect for history or other reasons, but those reasons are not business reasons.

But it can happen. Take thoroughbred horses, for example. The odds of winning the Derby are miniscule, but the payoff is so great – especially if one can win the Triple Crown – that the activity can still make business sense.

Captain Eddie had an ace in his hand: he could sell the plane for a profit.

Mind you, there are a number of factors the Court could consider, such as:

·      Manner in which the activity is conducted

·      Expertise of taxpayer or advisors

·    Time and effort expended by taxpayer

·      Success on carrying on other similar activities

·      History of income or loss

·      Amount of occasional profits, if any

·      Taxpayer’s financial status 

·      Elements of personal pleasure or recreation 

·      Expectation that assets used in activity will increase in value

Captain Eddie won and lost some of these. For example, he received retirement pay pushing $180K from the Navy and Delta. He could afford an expensive hobby. There was no question about the pleasure he derived from the Firefly. He had a real estate business, but that it was a stretch to argue that it was “similar” to the Firefly.

At trial, Captain Eddie brought in experts who testified the plane was worth between $3.5 and $8 million. That would cover the approximately $1.9 million Captain Eddie had put into it.

The IRS quickly pointed out the plane crashed and had not flown since.

But planes can be repaired….

The Court acknowledged that Captain Eddie could have made money by selling the plane, but then it wondered why he did not sell it years before, when it was winning all those awards. That would likely have been its peak price.

The Court considered all the pieces.

• Initially Captain Eddie had thought of selling rides. The Court was unimpressed. A moment’s research would have told him there was no chance the FAA would allow this.
• A businessperson would respond by revising the business plan. The Court was looking at things titled “Original Plan 1999-2000?,” which did not increase its confidence that Captain Eddie had landed on his feet. 
• He had listed the activity on his personal tax return as “airplane leasing,” The Court was not humored, as nothing had ever been leased. 
• He filed a local property tax exemption for the Firefly, stating that he was not using it for commercial purposes or holding it for sale. 
•  Oh oh
• If he had thought of selling the plane, he waited a long time – 2014 – before obtaining an appraisal. The Firefly was rocking it in the early aughts – many years before 2014. 

It didn’t add up. The Court was bothered by the rides, as that would have taken minimal effort to discover. Why didn’t Captain Eddie entertain offers for the plane? Why would he sign property tax paperwork saying the plane was personal and not commercial-use or held for sale?

The Court said hobby. No loss for Captain Eddie.

A taxpayer can win a hobby loss challenge. It happens quite a bit, actually. The key is that the taxpayer should respond as a businessperson would. If one door shuts the taxpayer must show that he/she went after another open door, always with the objective of making a profit. Maybe it played out, maybe it did not – but the taxpayer tried.

And it helps to be consistent, the one thing Captain Eddie failed to do.

Our case this time is Edward G. Kurdziel, Jr v Commissioner.

No Harm No Foul? Fuhgeddaboudit!

I am looking at a case involving whether a penalty requires a supervisor’s approval before being imposed.

It is dry stuff.

The rest of the case is what caught my eye.

Mr and Mrs Allen extended their individual tax return. They also owned 100% of an S corporation.

COMMENT: An S corporation’s income is reportable on its shareholder’s personal return. Since M/M Allen owned 100% of their S, all of the S corporation’s income would be reported on their return.

Somebody somewhere forgot to extend the S corporation return. It was due March 15, and it was filed on September 13.

COMMENT: Meaning it was filed 6 months late. The penalty is $195 per month per owner. The math is ($195 times 2) times 6 = $2,340. Not filing that extension got expensive.

The Allens thought that this was outrageous. After all, all of the corporation’s income went on their return, and their return was properly extended. There was no harm to the Treasury. Surely that lack of harm was reasonable cause for abatement.

The IRS told them to pound salt.

Off to Tax Court they went.

Let’s slide to the side a bit. If this had been a partnership, they would have requested abatement under Rev Proc 84-35. A partnership comes under 84-35 scope if:

·        There are 10 or fewer partners

·        Who are individuals (except nonresidents) or an estate

·        The partners each have the same income/loss allocation percentage

·        Each partner has reported his/her share of the income/loss on a timely filed return

·        There is one more requirement concerning audit procedures, which need not concern us here

Rev Proc 84-35 says that – if you meet the above – you have “reasonable cause.” Consider that reasonable cause is grounds to abate a penalty and 84-35 is a way out of a penalty.

Guess what: S corporations have no equivalent to Rev Proc 84-35. Why? Who knows? Is it fair? What does fair have to do with anything?

So the Allens have no 84-35 pass. They instead based everything on their correctly extended underlying personal return.

Here is the Court:

[] evidently conceives that the sole purpose of the Form 1120S is to give the shareholder the information that he or she needs in order to file a Form 1040 tax return; and since Mr. and Mrs. Allen knew the affairs of [], did eventually file their Form 1040 timely …, and did not fail to report any income, the intended purpose of the S corporation’s filing requirement was accomplished and the penalty was moot.”

Lots of shade here, Tax Court. The Allens were instead arguing no loss to the Treasury, so the Treasury could afford to be magnanimous and not impose an otherwise burdensome penalty just because. Save us from the French court of Louis XVI, why don’t you?

Back to the Court:

[] cites no authority in support of its claim that the penalty should be waived on the grounds that its two shareholders were aware of the information to be shown on the return. Section 6699 does not include a condition of harm before the penalty is imposed; it simply imposes a penalty when the filing is late (without reasonable cause).”

I am at a loss why the Court is looking for “authority” when all the Allens are requesting is reasonable cause. Reasonable cause is an equity and not statutory argument. It does not need to be based on chapter and verse from the dustiest tome in the most unvisited tax library in the land. Statutory says you stop and wait at a red light. Equity says you stop and then run the light because you are transporting someone experiencing a heart attack to the hospital.

Ahh, you know how this case turned out.

And I continue to point out that the IRS long ago stopped using penalties to disincentive bad tax behavior and abatement to incentivize good tax behavior. The IRS is now using penalties to pad its budget. In that world, abatement is tantamount to the IRS taking money from its own wallet, something it will not do willingly.

I was saddened to see the Tax Court drink the same Kool-Aid. To be fair, I suppose the Court did not want to go where the IRS has been reluctant to proceed regulatorily. I nonetheless argue that the Court whiffed on a chance to force the IRS to be reasonable when determining reasonable cause.

Our case this time was ATL & Sons Holding Inc v Commissioner.