Tax Representation: The Impact of Recent Tax Cases

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1 Tax Representation: The Impact of Recent Tax Cases Get new slides at Thomas S. Groth Phone: E mail: Groth@grgllp.com Glouzgal Ramos Groth LLP Attorneys at Law 304 Federal Rd, Ste 112 Brookfield, CT 06804

2 Tax Cases: Who should care? Clients with current audits /other pending assessments Clients making claims for refund Anyone who would benefit from the ambiguity Clients who owe money to the IRS or State 2

3 Federal Tax and State Tax Cases Deficiency, Collections, and Liability Cases Different Types of Forums: Types of Controversies: Tax Court US District Court US Court of Appeals Supreme Court State Court Deficiency Cases Collections Cases Joint Liability Cases 3

4 Common Types of Tax Court Decisions Tax Court: think of it as a court of limited jurisdiction* it can hear the following kinds of cases (among others): 1. Following an Audit: The IRS has Deficiency Jurisdiction for tax liabilities that are the result of a proposed or jeopardy assessment by the IRS. These cases are generally referred to as deficiency cases. (Letter: Final Notice of Deficiency) 2. Collection Due Process Hearings: These cases are generally Referred to as CDP cases. (Letter: Final Notice of Determination) 3. Denial of Innocent Spouse: A timely filed Innocent Spouse claim (filed any time before the CSED date) can be appealed to tax court. Innocent Spouse issues can also be raised in Deficiency and CDP cases. (Letter: Notice of Final Determination) *Technically an administrative court 4

5 Tax Court Decisions: Deficiency Cases The IRS can sometimes act like certain tax court decisions don t exist Gov t doesn t always need to follow tax court decisions Bad Tax Court decisions are inconvenient for the IRS even if the decision is not completely binding on the IRS Bad Tax Court decisions give the taxpayer and his representatives ammunition. 5

6 Tax Representation: Audits Advocating for a position the client has already taken on a return Examples: Character of items: Loan or Income? Ordinary Income or Capital Gain? Mortgage or sale? Advertising or Donation? Meals and Entertainment or Owner Draw? Substantiation of items: Do you have the documentation you need to prove your case to satisfaction of the IRS, can your client establish enough facts in court? Another consideration: Influence of hazards of litigation on IRS Appeals 6

7 Deficiency Case: Ordinary Income or LTCG? Long v. Comm r (2014) 11 th Circuit Taxpayer reported sale of interest in civil litigation to a buyer Reported sale (for $5.75M) as Ordinary Income on Schedule C. Reported Taxable Income of $0 IRS Audited and disallowed deductions for Cost of Goods and Attorneys fees Long argued at trial that the income was actually a Long Term Capital Gain and not ordinary income. TC found for IRS, District Court reversed and found the sale was a LTCG 7

8 Long v. Comm r (2014) 11 th Circuit (Continued) Litigation was about contract to purchase Real Estate 11 th Circuit held that the vital question was the nature of the litigation right at the time of the sale and not what Long intended to do with the property (develop and sell condos) when he entered into the Real Estate Purchase Contract. The litigation right was essentially an option to purchase real estate a capital asset and not the land itself which might have been seen as inventory instead. 8

9 Long v. Comm r (2014) 11 th Circuit Observations Long actually argued this entire case both the Tax Court case and the Appeal on his own Actually took the opposite position in his actual Tax Court trial than he took on the return The taxpayer s story was full of contradictions, but he still won. 9

10 Long v. Comm r (2014):Audit Representation Making similar arguments at the audit stage If a taxpayer sells a litigation right (or another similar right) which is essentially 1) a contractual right, and 2) does so outside of the ordinary course of business then the arguments which ultimately won the day in Long may be successful at the audit stage, avoiding expense time stress uncertainty 10

11 Long v. Comm r (2014) 11 th Circuit Arguing Hazards of Litigation in Appeals The IRS does not have to accept the decision in Long v. Comm r in every case because of the way precedent for tax cases works. The Tax Court is only required to follow Long if a case would be appealed to the 11 th Circuit Court of Appeals (Alabama, Florida and Georgia). The IRS does not do itself any favors by taking the chance that a betterrepresented taxpayer with similar facts to Long might win in Tax Court, creating bad case law for the IRS in every jurisdiction without controlling precedent. 11

12 Deficiency Case: Rental or Vacation Home? Redisch v. Comm r (2015) US Tax Court Taxpayers moved out of vacation home in 2006, placed it with a real estate agency in 2008 with the hope of renting it. Property was never rented (only two offers to rent from ineligible tenants) and was eventually sold in If the property was actually a rental property, the Redisches would be able to take any losses from the time the home was converted to a Rental Property until the time it sold as ordinary losses. Tax Court held that property was not a rental property because the Redisches did not try hard enough to rent it. 12

13 Redisch v. Comm r (2015) US Tax Court Key takeaways: Facts and Circumstances (1) the length of time the house was occupied by the individual as his residence before placing it on the market for sale; (2) whether the individual permanently abandoned all further personal use of the house; (3) the character of the property (recreational or otherwise); (4) offers to rent; and (5) offers to sell Saunders v. Commissioner T.C. Memo

14 Redisch v. Comm r (2015) US Tax Court Arguing Hazards of Litigation in Appeals When a taxpayer loses a case, it does not necessarily make bad law for taxpayers. The IRS has a interest in having cases with weak facts (but similar to Redisch) decided in Tax Court because it gives the IRS ammunition when dealing with similar cases during an audit. But if you can convince the IRS that your client tried harder than the Redisches, there is a chance they won t want to push the issue. Having a case with marginally better facts than Redisch could add nuance to case law in a way that hurts the IRS. 14

15 Tax Court Decisions: Collections The IRS can sometimes act like certain tax court decisions don t exist Gov t doesn t always need to follow tax court decisions Bad Tax Court decisions are inconvenient for the IRS even if the decision is not completely binding on the IRS Bad Tax Court decisions give the taxpayer and his representatives ammunition. 15

16 Tax Representation: Collections Advocating for a clients who already have a valid tax liability Examples: Audit reconsideration Penalty abatements Offers in Compromise, Installment Agreements, and Currently Not Collectible hardship status Levy releases, partial levy releases 16

17 CDP Case Success Rates (not very good) Annual Report/downloads/Collection Due Process Hearings Under IRC 6320 and 6330.pdf 17

18 CDP Jurisdiction Case: What Circuit Court controls? Byers v. Comm'r (2014), 740 F.3d 668 Tax Court is generally allowed to follow its own decisions unless there is controlling precedent from a higher court. When a Circuit Court of Appeals reverses a Tax Court decision, the Tax Court only has to follow rules established by that Court when the case can be appealed to that court. In Byers V. Comm r, the DC Circuit Court of Appeals ruled that it had sole jurisdiction (unless both parties agreed otherwise) to take appeals on collections only CDP cases. The Tax Court seemed to agree 18

19 Tax Court Decisions: Byers v. Comm'r (2014), 740 F.3d 668 Where do you appeal a CDP case? What Circuit s Precedents control? Court of Appeals for the District of Columbia Circuit ruled that it was actually the proper appellate venue for CDP cases appealed from Tax Court and the Tax Court Tax Court called out the case in some footnotes. Seems to agree: Scott Labor, LLC v. Comm'r, T.C. Memo (footnote 4) Boulware v. Comm'r, T.C. Memo (footnote 4) 19

20 Follow an IRS Revenue Procedure? No thanks. Varela v. Comm r TC Memo Tax Court judge declined to follow an IRS Revenue Procedure when determining whether or not to grant Innocent Spouse relief to a taxpayer under Section 6015(b). Generally the Tax Court will consider the factors laid out in the relevant Revenue Procedure (Currently Rev. Proc ) This specific Tax Court judge simply made the determination on whether or not holding the requesting spouse liable would be inequitable by citing previous Tax Court decisions. 20

21 Varela v. Comm r TC Memo (Continued) Applicability to other Innocent Spouse Cases: Can refer to this decision (and others like it) for the proposition that the Tax Court does not need to refer to an IRS Revenue Procedure to determine whether or not imposing a tax on an innocent spouse would be inequitable. This basic understanding is actually referred to in both the Revenue Procedure and the code section itself by directing judges and appeals to consider whether it is inequitable to stick one spouse with the bill by taking into account all of the facts and circumstances See 6015(b)(1)(D) and 6015(f) 21

22 State Tax Decisions: Generally Meaningful decisions often occur in Federal Court Some states do not have much case law available on a particular topic Looking at cases from other jurisdictions can be useful in determining whether similar arguments can be made in our state Often, tax cases from other states are more meaningful when they are appealed to the Federal level, because Federal law (usually based on the constitution) takes precedence over State law. 22

23 State Tax Controversies in Federal Court Berjikian v Franchise Tax Bd (2015)93 F. Supp. 3d 1151 Constitutional Challenge to California law that (because of tax due) revoked taxpayers Driver s Licenses and deprived one plaintiff of her Pharmacy License without adequate due process At the time the Plaintiffs had opportunity for a hearing regarding their tax liabilities, they did not have notice that they could lose their licenses. This changes the stakes. Imposition of new law revoking licenses on the grounds of previously closed tax years was too tenuous and therefore impermissibly retroactive. 23

24 Berjikian v Franchise Tax Bd (2015)93 F. Supp. 3d 1151 Key Takeaways: A state cannot take away a license that allows a person to make a living without affording that individual with meaningful Due Process rights. Case was easier for the court to decide because the law resulted in the licenses being revoked instead of the state refusing to renew or issue a license. Argument is a tougher one to make if a state simply requires someone to be in tax compliance to renew a license as is the case in CT with Sales and Use Tax Permits and Cigarette Licenses But the argument can still be made 24

25 Berjikian v Franchise Tax Bd (2015)93 F. Supp. 3d 1151 Application to CT Clients: DRS Failure to renew license or permits CT has a new law stating that DRS shall not issue a license to, or renew the license of anyone who owes taxes to the State of Connecticut if the taxes are finally due and payable and with respect to which any administrative or judicial remedies, or both, have been exhausted C.G.S o DRS can apply pressure on convenience stores and other businesses who have outstanding tax liabilities by refusing to renew their permits under this section and then threatening with criminal prosecution for operating without a license or permit. 25

26 CT Tax Appeals Results: Why CT Doesn t Have Many State Tax Cases 26

27 Is that State Tax Unconstitutional? Comptroller v. Wynne (2015) 135 S. Ct State of Maryland imposed a tax on residents for income earned outside of the state. The state gave a credit against income taxes paid to other states but only for the Maryland state tax and not the Maryland county tax. SCOTUS ruled that the state must allow a credit for taxes paid on out of state sourced income for all state taxes (the county tax was considered a state tax here because it was collected by the MD treasury). The basic rule is that if a tax is essentially an tariff on interstate commerce, it is unconstitutional 27

28 Comptroller v. Wynne (2015) 135 S. Ct (Continued) Applicability to other states: Possible application to states or municipalities that treat nonresidents as residents for tax purposes if this would result in those residents being taxed twice on the same (world wide) income Application to any tax law that is similar to the law in Wynne ask the question: If every state adopted this tax scheme, would interstate commerce be taxed more than intrastate commerce? 28

29 States must recognize same sex marriages Obergefell v. Hodges 135 S. Ct SCOTUS held that same sex couples have a right to marry. As a result, states must recognize same sex marriages for all purposes. This means no more preparing fake federal tax returns to prepare returns for same sex married couples living in states that previously did not recognize same sex marriages Refund claims in states with same sex marriage bans should be made for couples that were actually married but forced to file as single. 29

30 Dealer or Investor? Allen v. United States(2014)113 A.F.T.R.2d (RIA) 2262 Taxpayer brought refund claim in US District Court for the Northern District of California Government won motion for Summary Judgment. Court decided (citing among other authorities the Tax Court decision in Long, which the taxpayer lost in Tax Court) that the fact that Allen originally held the property intending to develop it made the real estate property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. 30

31 Allen v. United States(2014)113 A.F.T.R.2d (RIA) 2262 Key Takeaways: Allen was decided before the appeal in Long was decided, and it was apparently not appealed. Forum was US District Court for Northern District of CA Appeals go to 9 th Circuit. If Allen was appealed, then the appeal likely would not have been heard until Long was decided. Not clear that decision in Allen would have been different if Long had been decided prior to the decision, because 11 th Circuit precedent would not be binding on the Allen court. Fact intensive test might have led to a different result even if the Court decided to follow the 11 th Circuit logic in Long Long probably would not impacted the outcome here even if it was binding because the court made a (somewhat meaningless) distinction between actual real property and exclusive right to purchase real property. 31

32 Considering Allen and Long Two similar situations with different results. Allen Taxpayer sought to develop one specific plot of land, and ended up abandoning his development plans and selling the land to another party. Taxpayer took the position on his return that the $ he received was a LTCG. Result: treated as ordinary income not LTCG Long: Taxpayer ordinarily and regularly developed land and sold off the developed land to buyers. In one case, the taxpayer had a contact to purchase real estate that was not honored by the seller. On his return, taxpayer treated the income as Sch C income. Result: treated as LTCG. 32

33 Can Colorado require e tailers to report transactions? Direct Mktg. Ass'n v. Brohl, 135 S. Ct Trade association of online retailers sued an injunction to stop the State of Colorado from requiring sellers of more than $100k in Colorado To inform Colorado buyers of their obligation to pay use tax, and Report tax related information to the CO and customers District Court granted injunction 10 th Circuit Court of Appeals reversed (saying the order violated the Tax Injunction Act 28 US 1341 SCOTUS reversed and found that the TIA did not bar a lawsuit for injunction Required notification during each transaction or $5 penalty. Required retailers to send 1099 style report for cumulative purchases over $500. $10 penalty for failure to send each report. 33

34 Direct Mktg. Ass'n v. Brohl, 135 S. Ct (Continued) Supreme Court found that the Tax Injunction Act did not bar the District Court from issuing the injunction, but did not decide the case on the merits. On the District Court level, the e tailers won. Court relied on Quill and other earlier decisions. Found the requirements unconstitutional via the Dormant Commerce Clause (the winning argument in Wynne). Requirement only imposed on out of state companies The requirement the District Court said interferes with Interstate Commerce. Bottom line: Merits in the case are up in the air. 34

35 Federal Govt: Smart enough to call penalty a tax! Fla. Bankers Ass'n v. U.S. Dep't of Treas. (Aug 2015), 799 F.3d 1065 Penalty imposed on U.S. Banks that failed to report information to I.R.S. Under IRC 6671(a), Congress wisely stated that certain penalties shall be assessed and collected in the same manner as taxes. Lucky IRS. FL Bankers Ass n sued in D.C. District Court to stop the IRS from imposing reporting requirements. District Court found in favor of the I.R.S. and the FL Bankers appealed. Ten Circuit Appeals Court found that the Federal version of the TIA, the AIA* meant that federal courts lacked jurisdiction for the lawsuit. *Anti Injunction Act 35

36 Comparing Direct Mktg. and Fla. Bankers Ass'n In Direct, the lower court found for the Taxpayer, the Appeals Court reversed on procedural grounds (the TIA) and the US Supreme Court reversed the reversal on procedural grounds, sending it back to the Appeals Court to give them another crack. The taxpayer wins. (For now.) 36

37 Comparing Direct Mktg. and Fla. Bankers Ass'n In Fla. Bankers Ass n, the lower court found against the taxpayer, The Appeals Court found that the federal courts could not hear this type of case because of the AIA, and the case was returned to the lower court to dismiss it based on the procedural grounds instead of the merits. The IRS wins. (For now.) 37

38 Thank you. Any Questions? Thomas S. Groth Phone: E mail: Groth@grgllp.com Glouzgal Ramos Groth LLP Attorneys at Law 304 Federal Rd, Ste 112 Brookfield, CT 06804