Tax Controversy CPA/U.S. Tax Court Litigator

IRS Collection and Tax Litigation-Tax Controversy CPA/U.S. Tax Court Litigator: Raleigh and Wilmington, NC/North Myrtle Beach and Myrtle Beach, SC

TRADE OR BUSINESS, BUT FAILED TO SUBSTANTIATE EXPENSES-J. FRANK BEST, TAX CONTROVERSY CPA/U.S. TAX COURT LITIGATOR

Entertainment Company Was a Trade or Business, but Failed to Substantiate Expenses

The Tax Court held that an entertainment company that signed artists and produced, promoted and distributed their work was engaged in a trade or business for profit because, although the company never earned a profit during the years at issue, the owner had prior business successes in the music industry, ran the company in a businesslike manner, and devoted significant capital to make it a profitable business. However, the owner’s losses from the business were denied because the court found that the company’s bank statements, which were the only evidence of the expenses produced by the owner, were insufficient to establish the amounts and business purpose of the expenses. Barker v. Comm’r, T.C. Memo 2018-67.

Cecile Barker is an experienced aerospace engineer with a background in music. In the mid-1960s he formed the group Peaches & Herb, which achieved considerable commercial success, and in 1973 he co-produced a song by Gladys Knight & the Pips. Barker left the music business and formed an aerospace engineering company in the 1970s. In 2001, he sold that company and decided to reenter the music business.

Barker formed SoBe Entertainment International LLC in 2002. He contributed all of SoBe’s capital and owned 95 percent of its profits and losses. His son, Yannique, and daughter, Angelique, split the other five percent. SoBe is an independent entertainment company that signs artists and celebrities, produces music and videos, and promotes its artists and distributes their work. As SoBe’s chief executive officer (CEO) and managing member, Barker devoted 40 to 60 hours per week to the business. He consulted music industry professionals before forming SoBe, and hired several high profile producers to bolster SoBe’s chances of success. SoBe employed a marketing professional and, at one time, chief financial officer (CFO). In total, SoBe had eight employees and regularly hired independent contractors.

Yannique Barker was one of SoBe’s signed artists. SoBe had several artist contracts and renewed at least one. SoBe also contracted with producers and writers to work with its artists. SoBe also entered into a distribution agreement with Universal Music to distribute music digitally. SoBe advertised online and through its websites in addition to placing ads in print magazines. SoBe was also a member of the trade organization Record Industry Association of America.

Barker saw stars like Adele and Taylor Swift as examples of how one artist could make his company profitable. Although none of his artists had achieved such a level of success, they had each contributed to the catalog of songs that SoBe owned. SoBe’s catalog had value in March 2016 and it placed a song in a TV show on ABC.

SoBe was founded at a time of major change to the music industry, as online platforms made it possible to buy or sell music at low cost or share it for free. SoBe cut costs as a result of the effects of these platforms, reducing its employees from 17 to 8, and moving its recording studio to a less expensive location. SoBe had never earned a profit and its cumulative losses increased from year to year.

SoBe employed John McQuagge as its CFO and controller from 2006 through 2010. McQuagge used Quickbooks software to produce SoBe’s general ledger and journals. SoBe had two separate bank accounts, one used as a primary operating account and the other used for payroll. McQuagge balanced the accounts against monthly bank statements. While SoBe kept records of the checks it used to pay its expenses from 2006-2010, other expenses recorded in SoBe’s general ledger were paid by credit card or cash, for which no documentation existed other than bank statements.

SoBe had two outside accounting firms prepare its tax returns for 2003-2011. SoBe provided its accountants with all of its Quickbooks records. Accountant Stanley Foodman prepared SoBe’s returns for 2006-2009. Foodman also prepared Barker’s personal income tax returns for 2005-2011. Foodman calculated Barker’s net operating losses (NOLs) and total capital contributions to SoBe for 2002-2011 and listed each of his individual capital contributions to SoBe in 2006-2009. Foodman determined that Barker made over $45 million in capital contributions to SoBe from 2002-2011. This calculation was based on the Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc. from SoBe, supplemented by SoBe’s general ledger and bank statements.

Barker reported income from sources other than SoBe, mostly capital gains, interest and dividends. His 2011 income came mostly from Mistral, a defense contractor Barker helped found. Foodman calculated Barker’s income or loss after taking into account Barker’s interest and dividend income, net capital gains and losses, and share of gain or loss reported on the Schedules K-1 from SoBe and other businesses in which he held an interest.

Barker was the victim of identity theft when someone filed a tax return for 2011 using his social security number. Barker eventually filed his 2011 Form 1040 in August 2016. His return showed a loss from SoBe of over $800,000 and an NOL carryover of $19.6 million for 2011. The IRS issued a notice of deficiency in June 2014, determining various adjustments to Barker’s income and deductions. The notice showed that Barker owed approximately $1.2 million in tax for 2011 and that a 25 percent addition to tax applied for Barker’s failure to file his return on time. Barker challenged the notice in the Tax Court.

The IRS asserted that SoBe did not incur any operating losses (and thus, no losses flowed through to Barker) because SoBe was a hobby rather than a trade or business. In the IRS’s view, Barker lacked the actual and honest objective of making a profit. The IRS also argued that Barker could not substantiate the expenses giving rise to SoBe’s operating losses. Barkley contended that SoBe was run as a business from its formation and that making a profit was always its primary objective. He also challenged the addition to tax by arguing that his late filing was due to the identity theft.

The Tax Court held that, under the facts and circumstances, Barker operated SoBe as a trade or business with the actual and honest objective of making a profit. The Tax Court found that Barker had prior business successes in the music industry and had run successful defense contracting businesses, having helped to turn one of them around after several years without a profit. In the court’s view, Barker leveraged his experience and contacts in the music industry as he prepared for SoBe’s formation. He also ran SoBe in a businesslike manner, working there full time and devoting significant capital to it.

Although SoBe had never been profitable, the court found that it had positioned itself to make a profit by amassing a catalog of songs that it had been able to monetize. The court also took into account the turmoil in the music industry and the difficulties faced by artists and producers during the years at issue. The fact that Barker’s son, Yannique, was a SoBe artist did not mean that SoBe was merely a vehicle to fund Yannique’s musical aspirations, according to the Tax Court, because SoBe had other artists and did not devote most of its resources to Yannique. Nor did the fact that Barker enjoyed the creative aspects of the music industry, and had income from other sources. prevent SoBe from being engaged in a trade or business, given the other factors indicating a profit motive.

Although SoBe was engaged in a trade or business for profit, the Tax Court found that Barker failed to provide evidence on which the Tax Court could determine or even estimate the amount of SoBe’s business expenses for all prior years of its operation. The court found that the only documentation to support SoBe’s business expense deductions for previous years were SoBe’s bank statements. Those statements, in the court’s view, did not document the amounts of SoBe’s expenses paid by cash or credit card, nor did they describe the business purpose of the expenditures. The court found that Barker had produced SoBe’s general ledger only for 2005-2009 and that his testimony was insufficient to fill in the gaps. The Tax Court reasoned that Barker had access to additional documentation, including SoBe’s general ledger for all years of its existence, but failed to produce it; therefore the court presumed that such documentation would be unfavorable to Barker.

The Tax Court also held that Barker failed to provide enough evidence for it to determine his NOL deduction for 2011. Barker failed to substantiate SoBe’s income and business expenses for all prior years and, in turn, the amount of losses for which he claimed a deduction for 2011. If the court could not estimate the amount of SoBe’s operating losses, it could not know how much flowed through to Barker. Moreover, even if Barker had substantiated SoBe’s expenses, the court could not determine how much of those losses were absorbed by Barker’s other income in the years before 2011, because Barker did not produce his returns for 2002-2004 and those that he produced for later years were missing crucial information.

The Tax Court also upheld the penalty assessment after rejecting Barker’s argument that his identity theft issue excused his failure to file his 2011 return on time. The court reasoned that Barker was a sophisticated businessman who should have known that he was required to file his return, and that his accountants and return preparers could have made inquiries.

United States Tax Court Decision for the Week and Filing Status

A recent Tax Court decision was reported potentially dealing with tax litigation and filing status of Joint v. Separate returns. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Taxpayer Can File Joint Return After Original Return Erroneously Reported Single Status

The Tax Court held that a return that a taxpayer originally filed, erroneously claiming single status, did not constitute a “separate return” within the meaning of Code Sec. 6013(b) and, thus, the taxpayer and his wife were entitled to file a joint return and pay joint return tax rates for the year at issue. The Tax Court concluded that the term “separate return” means a return on which a married taxpayer has claimed the permissible status of married filing separately, rather than a return on which a married taxpayer has claimed a filing status not properly available to him or her. Camara v. Comm’r, 149 T.C. No. 13 (2017).

Facts

Fansu Camara was married to Aminata Jatta. Nevertheless, on his 2012 Form 1040, which he filed on April 15, 2013, Mr. Camara erroneously checked the box for single filing status. In a notice of deficiency issued to Mr. Camara for his 2012 tax year, the IRS changed his filing status from single to married filing separately. On May 8, 2015, Mr. Camara and Ms. Jatta timely petitioned the Tax Court with respect to that notice of deficiency as well as a notice of deficiency that the IRS issued to them for their 2013 tax year. On May 27, 2016, Mr. Camara and Ms. Jatta filed with the IRS a joint 2012 return, which they had both signed. Ms. Jatta had not previously filed a 2012 return.

The couple and the IRS agreed that if Mr. Camara and Ms. Jatta were entitled to elect joint filing status for 2012, the joint return that they filed on May 27, 2016 – after receiving the notice of deficiency and petitioning the Tax Court – correctly reflected their 2012 tax liability with certain agreed-upon changes. And the IRS conceded that Mr. Camara and Ms. Jatta met the substantive requirements for joint filing status and rates for 2012. However, the IRS contended that Code Sec. 6013(b)(2) barred Mr. Camara and Ms. Jatta from filing a joint return, and consequently, they were procedurally barred from claiming the benefits generally available to married taxpayers who file a joint return.

Code Sec. 6013 governs whether a married couple may file a joint return. Under Code Sec. 6013(a), a married couple can “make a single return jointly of income taxes” subject to three restrictions, which are not applicable in this case. Code Sec. 6013(b) permits married taxpayers to elect in certain circumstances to switch from a separate return to a joint return. Code Sec. 6013(b)(1) provides that if an individual has filed a “separate return” for a tax year for which that individual and his or her spouse could have filed a joint return, that individual and his or her spouse may nevertheless “make a joint return” for that year. Because the Code Sec. 6013(b) election applies only where an individual has filed a separate return, limitation under Code Sec. 6013(b)(2) likewise apply only if the individual has filed a separate return. The term “separate return” in Code Sec. 6013(b)(1) is not defined in the Code or the regulations.

IRS Arguments

The IRS argued that Mr. Camara’s original 2012 return, on which he erroneously claimed single filing status, constituted a “separate return” within the meaning of Code Sec. 6013(b)(1) and, consequently, two limitations under Code Sec. 6013(b)(2) applied to prevent Mr. Camara from making the Code Sec. 6013(b) election to switch to a joint return. The two limitations that the IRS invoked were in Code Sec. 6013(b)(2)(A) and Code Sec. 6013(b)(2)(B). The first limitation bars the Code Sec. 6013(b) election after three years from the filing deadline (without extensions) for filing the return for that year. The second limitation bars the Code Sec. 6013(b) election after there has been mailed to either spouse, with respect to such tax year, a notice of deficiency, if the spouse, as to such notice, files a petition with the Tax Court within 90 days.

According to the IRS, the two limitations were satisfied because: (1) the date on which Mr. Camara and Ms. Jatta filed a joint return – May 27, 2016 – was more than three years after Mr. Camara filed a separate return; and (2) Mr. Camara received a notice of deficiency, and filed a petition with the Tax Court before filing a joint return.

The IRS also cited the Sixth Circuit’s decision in Morgan v. Comm’r, 807 F.2d 81 (6th Cir. 1986), aff’g T.C. Memo. 1984-384, as compelling a decision in its favor. Morgan involved married taxpayers who filed “protest returns” claiming married filing jointly status for some years and married filing separately status for other years. Affirming the Tax Court, the Sixth Circuit in Morgan held that Code Sec. 6013(b)(2) precluded the husband from claiming the benefits of joint return filing status after the IRS issued a notice of deficiency calculating his tax on the basis of married filing separately.

Tax Court Holding

The Tax Court held that the 2012 return that Mr. Camera originally filed, erroneously claiming single status, did not constitute a “separate return” within the meaning of Code Sec. 6013(b). Thus, Mr. Camera and his wife were entitled to file a joint return and pay joint return tax rates for that year.

The Tax Court began its analysis by noting that the issue raised by the IRS has not been formally addressed by the Tax Court in a reported or reviewed opinion. The court also noted that no Court of Appeals has held that a single return or a head of household return is a separate return for the purposes of Code Sec. 6013(b) and the two Appeals Court cases that have considered this issue, Ibrahim v. Comm’r, 788 F.3d 834 (8th Cir. 2015) and Glaze v. Comm’r, 641 F.2d 339 (5th Cir. 1981), have held the opposite. The court also observed that some Memorandum Opinions had interpreted “separate return” to include a single return or a head of household return for this purpose. For the most part, however, those Memorandum Opinions merely accepted the rationale of earlier cases, and the ultimate authority for those Memorandum Opinions appeared to be traceable to earlier cases where the effect of an erroneous claim of filing status was neither addressed nor even presented as an issue.

The Tax Court noted that its decision in the instant case would be appealable to the Sixth Circuit. However, the court rejected the IRS’s argument that the Sixth Circuit’s holding in Morgan compelled it to rule in the IRS’s favor. Morgan, the court said, did not squarely address the issue presented in the instant case because Morgan did not explain the effect under Code Sec. 6013(b) of a married taxpayer’s initial filings of a return erroneously claiming single status.

The court did find, however, that the Fifth Circuit, in Glaze, squarely addressed the issue. In Glaze, the Fifth Circuit held that filing a return with an erroneous claim to an impermissible filing status (i.e., a filing status of single when the taxpayer was married) did not constitute an “election” to file a separate return. The Fifth Circuit in Morgan, the court observed, distinguished Glaze on the grounds that Glaze involved no protest return and the taxpayer had not attempted to file a return as a married taxpayer originally. The Tax Court found that Mr. Camara’s case was distinguishable from Morgan on the same grounds on which Glaze was distinguished in Morgan. Mr. Camara neither filed a protest return nor attempted to file a return as a married taxpayer originally.

Considering the context of Code Sec. 6013(b) as a whole and giving due regard to the Fifth Circuit’s opinion in Glaze, as well as an Eight Circuit’s opinion in Ibrahim, the Tax Court concluded that the term “separate return” means a return on which a married taxpayer has claimed the permissible status of married filing separately, rather than a return on which a married taxpayer has claimed a filing status not properly available to him or her.

Finally, the court also noted that the legislative history showed that Code Sec. 6013(b)(1) was intended only to provide taxpayers flexibility in switching from a proper initial election to file a separate return to an election to file a joint return; it was not intended to foreclose correction of an erroneous initial retur

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J. Frank Best is rated in the Top 5 Tax Controversy CPA Profiles/Linkedin and is a United States Tax Court Litigator licensed in NC & SC and works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

 

 

United States Tax Court Decision for the Week and Gambling Winnings

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation and gambling winnings and standard deduction v. itemized deductions. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Taxpayers Who Elected Standard Deduction Can’t Deduct Gambling Losses

The Tax Court held that a couple was taxable on gambling winnings shown on their Form W-2G and, because the couple could not substantiate how much was spent in producing the winnings, no reduction was allowed. The court also found that the couple’s election to take the standard deduction precluded them from taking an itemized deduction for their gambling losses. Viso v. Comm’r, T.C. Memo. 2017-154.

During 2013, William Viso engaged in a variety of recreational gambling activities: he bet on college and professional sports, played slot machines, and bought lottery tickets. That year, he won $5,060 on slot machines at three different casinos. The gambling winnings were reported on Forms W-2G, Certain Gambling Winnings. That same year, Viso and his wife sustained approximately $7,000 in gambling losses.

On their joint Form 1040, the Visos did not report any gambling winnings or losses for the 2013 tax year. They claimed a standard deduction of $12,200. The IRS assessed a tax deficiency after including the $5,060 of gambling winnings in the couple’s 2013 income.

The Visos did not challenge the accuracy of the gross gambling winnings included in their income; instead they argued that those amounts should be reduced by the amounts of bets they placed to produce their winnings. Although the couple introduced evidence of losses at another casino (in addition to lottery tickets and sporting bets), they produced no evidence as to how much William bet to produce the winnings reflected on the Forms W-2G.

For tax purposes, gambling losses are treated in one of two ways. Taxpayers engaged in the trade or business of gambling may deduct their gambling losses against their gambling winnings “above the line” as a trade or business expense in arriving at adjusted gross income. In the case of taxpayers not engaged in the trade or business of gambling, gambling losses are allowable as an itemized deduction, but only to the extent of gambling winnings.

The Tax Court held that the couple’s election to take the standard deduction precluded them from taking an itemized deduction for their gambling losses. In addition, because they could not substantiate how much was spent in producing the winnings reflected on Forms W-2G, no reduction was allowed. In reaching its conclusion, the court cited Torpie v. Comm’r, T.C. Memo. 2000-168 which held that, in order to claim any Schedule A itemized deductions, a taxpayer must forgo the standard deduction.

The Tax Court noted that the couple’s standard deduction of $12,200 exceeded their potential itemized deduction for gambling losses of $5,060. Thus, the court said, the couple’s election to take the standard deduction resulted in a larger deduction than if they had taken an itemized deduction for their gambling losses. Since the couple elected to take the standard deduction, the court held they could not take an itemized deduction for their gambling losses to offset their gambling winnings.

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Former IRS Agent and Wife Liable for $73,000 in Fraud Penalties:In Langer v. Comm’r, T.C. Memo. 2017-92, the Tax Court held that a couple’s repeated concealment of income by overstating deductions on their 2011-2013 tax returns exemplified a pattern of fraudulent behavior and the couple was thus liable for fraud penalties of approximately $73,000. The court noted that the husband had been an IRS agent for more than 29 years and that the couple’s explanations regarding the deductions taken on their returns were implausible and unpersuasive.

UNITED STATES TAX COURT

T.C. Memo. 2017-92-CIVIL FRAUD

May 30, 2017.

HENRY LANGER AND PATRICIA LANGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22719-15.

Thomas Edward Brever , for petitioners.

Christina L. Cook and John Schmittdiel , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NEGA, Judge : Respondent issued a notice of deficiency to petitioners determining deficiencies in income tax and fraud penalties as follows:1

[*2]

                           Penalty

Year     Deficiency1     sec. 6663(a)

2011       $36,595        $27,446.25

2012        27,386         20,539.50

2013        33,689         25,266.75

__________

1The amounts referred to herein reflect an agreement by the parties to
revised deficiencies in Federal income tax as reflected on Form 5278,
Statement–Income Tax Changes, and are less than respondent’s initial
determinations in the notice of deficiency.

Petitioners conceded in full the deficiencies for tax years 2011-13. The only issue for decision is whether petitioners are liable for fraud penalties under section 6663 for tax years 2011-13.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Minnesota when the petition was timely filed.

Henry Langer was an Internal Revenue Service revenue agent for over 29 years and received training in determining allowable business expense deductions; he was also a certified forensic examiner. Petitioners have a history of claiming [*3] business expense deductions for obvious personal expenses and expenses they could not substantiate. See, e.g. , Langer v. Commissioner (Langer I ), T.C. Memo. 2008-255, 96 T.C.M. (CCH) 334, 339 (2008) (“[P]etitioners claimed as business expense deductions many obviously personal items . A former Internal Revenue Service agent should have known better .” (Emphasis added.)), aff’d without published opinion , 378 F. App’x 598 (8th Cir. 2010); Langer v. Commissioner (Langer II ), T.C. Memo. 1992-46, 63 T.C.M. (CCH) 1900 (1992), aff’d , 989 F.2d 294 (8th Cir. 1993); Langer v. Commissioner (Langer III ), T.C. Memo. 1990-268, 59 T.C.M. (CCH) 740, 746 (1990) (holding petitioners liable for an addition to tax under section 6653(a) for negligence because petitioners’ conduct suggested a “pattern of carelessness” and because petitioners used methods for determining deductions that had “no basis in the law”), aff’d , 980 F.2d 1198 (8th Cir. 1992).

Respondent disallowed $113,194, $67,186, and $84,087 of petitioners’ claimed deductions on Schedules C, Profit or Loss From Business, for 2011-13, respectively, as personal expenses; many of petitioners’ claimed and disallowed expense deductions were identical to those disallowed as personal expenses in Langer I and Langer II , including expenses for parties, gifts, flowers, vases, and holiday decorations, to name a few.

[*4] OPINION

The Commissioner must establish by clear and convincing evidence that, for each year at issue, an underpayment of tax exists and that some portion of the underpayment is due to fraud. Secs. 6663(a), 7454(a); Rule 142(b). The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner , 90 T.C. 1130, 1143 (1988). The taxpayer’s entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971).

Petitioners conceded in full the deficiencies for 2011-13, and therefore respondent satisfied his burden of proving an underpayment of tax for each year at issue. Respondent established that, for each year at issue, petitioners’ underpayment of tax was fraudulent and that they intended to conceal taxable income and prevent the collection of tax by overstating deductions and claiming nondeductible and obvious personal expenditures as business expenses. See Rahall v. Commissioner , T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486, 1492 (2011) (“An additional badge of fraud includes a taxpayer disguising nondeductible personal expenditures as business expenses.”). Mr. Langer’s nearly 30 years of experience as a revenue agent and petitioners’ history before this Court for identical issues are relevant considerations in determining whether they had [*5] fraudulent intent. See Beaver v. Commissioner , 55 T.C. 85, 93-94 (1970) (stating that petitioner’s business experience is a relevant consideration in determining whether he had fraudulent intent). Petitioners’ repeated concealment of income by overstating deductions exemplifies a pattern of fraudulent behavior, and their explanations are implausible and unpersuasive. See McGraw v. Commissioner , 384 F.3d 965, 971 (8th Cir. 2004) (“[A] consistent pattern of sizeable underreporting of income * * * and unsatisfactory explanations for such underreporting also can establish fraud.”), aff’g Butler v. Commissioner , T.C. Memo. 2002-314; Sanchez v. Commissioner , T.C. Memo. 2014-174, at *17 (stating that “a pattern of conduct that evidences an intent to mislead” is one of the “badges of fraud” from which fraudulent intent can be inferred), aff’d , ___ F. App’x ___, 2016 WL 7336626 (9th Cir. Dec. 19, 2016); Bruce Goldberg, Inc. v. Commissioner , T.C. Memo. 1989-582, 58 T.C.M. (CCH) 519, 529 (1989) (“[F]raud may sometimes be inferred from a pattern of overstating deductions.”). Accordingly, petitioners are liable for the fraud penalties under section 6663 for all years at issue.

[*6] To reflect the foregoing,

Decision will be entered under Rule 155 .

Footnotes

1Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

[End of Document]

 

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Litigator works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Court Calls Taxpayer’s Arguments “Heavy on Chutzpah”; Duty of Consistency Prevents Additional Deductions-CIVIL FRAUD

The Tax Court held that a restaurant owner who underreported his employees’ wages for years that were outside of the three-year assessment period could not later amend his returns to increase the amount of wages he paid in order to claim additional deductions. The duty of consistency prevented him from taking a contradictory position after the statute of limitations had run in order to change a previous representation to the detriment of the IRS. Musa v. Comm’r, 2017 PTC 200 (7th Cir. 2017).

Background

Alaa Musa owns and operates a restaurant in Milwaukee, Wisconsin. For the years 2006 to 2010, the IRS determined that Musa underreported his income taxes by more than $500,000 and made numerous other misrepresentations on his tax returns. Musa employed his family members and did not report their wages to the company he hired to assist with payroll. The payroll company’s services included withholding the required taxes from employees’ paychecks, issuing Forms W-2 to the employees and the IRS, and filing Musa’s quarterly employment tax returns. Between 2006 and 2008, Musa did not include any of his family members’ earnings when he reported his employees’ information to the payroll company. For 2009 and 2010, he included only two family members’ wages. He also underreported the restaurant’s revenues on his individual tax returns by giving inaccurate information to his accountant.

In 2009, the IRS audited Musa starting with his 2007 return, then expanded the audit to include his returns from 2006 to 2008. The IRS reviewed the bank statements for Musa and the restaurant and found that the amount of credit card deposits in the restaurant’s account exceeded what Musa had reported on his returns. The IRS decided to pursue Musa for civil tax fraud. While under audit, Musa hired a new accountant to prepare his 2009 and 2010 returns and to file amended employment tax returns for 2006 to 2008. He made these corrections, however, only after the statute of limitations had run on the IRS’s ability to collect the correct amounts of employment taxes that Musa’s amended returns admitted were due.

In 2012, the IRS sent Musa a notice of income tax deficiency for 2006 to 2010. Musa challenged the notice in the Tax Court. In 2013, Musa responded to a discovery request by providing a list of employees who he claimed had been paid additional wages. Musa claimed he was entitled to additional deductions for these wages in calculating his income tax liabilities.

The IRS argued that Musa’s duty of consistency prevented him from claiming new expense deductions on his income tax returns for wages paid between 2006 and 2009 because the IRS had relied on representations made by Musa in his original reports of employee wages in the restaurant’s quarterly tax returns and because the three-year period under Code Sec. 6501 for assessing employment taxes on those wages had expired. The Tax Court ruled in the IRS’s favor and determined that Musa had understated his income, failed to keep adequate records, concealed income, failed to file Forms W-2 and 1099-MISC for all employees, filed false documents, and failed to make estimated tax payments. The Tax Court found him liable for over $500,000 in income tax for 2006 to 2010, and over $380,000 in fraud penalties.

Analysis

The duty of consistency is an equitable tax doctrine which prevents a party from prevailing in a court proceeding by taking one position and then taking a contradictory position in a later case. It applies when there has been a representation by the taxpayer on which the IRS has relied followed by an attempt after the statute of limitations has run to change the previous representation or to recharacterize the situation in a way that harms the IRS.

Musa appealed to the Seventh Circuit. On appeal, Musa conceded that he had filed fraudulent income and employment tax returns but said the Tax Court had erred in its ruling on the duty of consistency. Calling Musa’s arguments “heavy on chutzpah but light on reasoning or any sense of basic fairness,” the Seventh Circuit affirmed the Tax Court.

The Seventh Circuit agreed with the IRS that Musa violated the duty of consistency. First, Musa made representations on his employment tax filings for 2006 to 2009 that the restaurant paid its employees certain sums in non-tip wages. Then, in 2013, Musa amended his filings to add wages that he had paid to his employees but failed to report for those same years. The court found that the IRS had relied on Musa’s original representations because it assessed employment taxes based on the original filings.

Musa argued that the IRS did not rely on the employment returns because it should have known that the returns were inaccurate. Musa claimed that the IRS either had all the facts available to it or had the opportunity to gain such knowledge before the limitations period expired, so the IRS did not “rely” on Musa’s false representations. In other words, Musa argued, after the IRS discovered his income tax fraud and he submitted amended income tax returns, the IRS should have induced from the amended income tax returns that the restaurant’s quarterly employment tax returns had also been incorrect.

The Seventh Circuit found there was no merit to Musa’s claim that the IRS lost its ability to rely on Musa’s employment tax returns because Musa amended his income tax returns. The court reasoned that the tax system is based on self-reporting and the IRS must be able to rely on truthful reporting for the system to function. In the court’s view, the IRS was permitted to take at face value the representations on Musa’s original employment tax returns and the duty of consistency prevented Musa from claiming the additional deductions which Musa tried to use to offset the consequences of his own fraud.