CCH's Annual List of Wacky Tax Court Cases
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Fourth Annual List of Wacky Tax Court Cases
VENTRILOQUIST, BEGGAR, SPY, BROTHEL VISITOR: IRS THREW THE BOOK AT THESE CHARACTERS, BUT A FEW FOUND A HAPPY ENDING IN COURT
(RIVERWOODS, ILL., January 17, 2000) – The expression “truth is stranger than fiction” can usually be proved in court, according to CCH INCORPORATED (CCH), a leading provider of tax law information. The company today released its fourth annual picks for the year’s wackiest – and more creative -- tax court cases, which included a ventriloquist’s dummy, beggars, spies, a CPA and an aspiring novelist’s brothel visits.
“When it comes to the real-life application of federal tax laws, taxpayers should be advised to temper their creativity,” cautioned Kay Harris, an editor who monitors court opinions for CCH Tax Day. “Year in and year out, however, it’s interesting to watch new scenarios play out in court.”
Here’s CCH pick for the “Wackiest Tax Court Cases of 1999.”
Ill Repute Dispute
Although the IRS disallowed certain business expenses incurred by an aspiring writer in the course of his research for a book, which involved visiting brothels and acting as a customer for prostitutes, the Tax Court was a little more understanding. The court held that the former Treasury Department budget analyst's activity of writing novels was pursued with an intent to make a profit, so certain expenses were, in fact, deductible under section 162 of the Internal Revenue Code.
The court acknowledged that the would-be author’s failure to seek expert advice on how to start or maintain a business as a fiction writer did weigh against his argument that he carried on his activity in a businesslike manner.
However, it maintained that his prior budget analysis writing experience at the Treasury Department was not unrelated to his anticipated performance as a writer in another field. Overall, the court held that he managed some aspects of the activity in a businesslike fashion, he expended substantial time and effort on writing and research and his other income was not so great as to suggest that he pursued the activity for tax advantages.
Disagreeing with the IRS, the court said it was irrelevant that the writing activity had not shown a profit because it qualified as a start-up business during the years at issue, and the personal pleasure the writer derived from the activity did not prevent it from qualifying as a business.
The court allowed the budgeter-turned-scribe to deduct a percentage of his travel expenses under section 274(d), but disallowed certain deductions relating to advertising, supplies, utilities and commissions and fees that were unsubstantiated, as well as some substantiated expenditures to visit prostitutes. According to the court, the payments he made to prostitutes and brothels while he was researching his subject were so inherently personal that they could not be deducted as business expenses.
R.L. Vitale, Jr. v. Commissioner of Internal Revenue
Failed Jail Tax Break
A prisoner who listed his occupation as “beggar” on his 1996 and 1997 federal income tax returns was not entitled to the earned income tax credit, based on the $2,150 he received from family and friends. The U.S. Tax Court concluded that the money he received from begging did not meet the definition of earned income under section 32. Rather, the prisoner received the money as gifts given out of generosity or charity, and that family and friends who provided the money had no expectation of repayment.
M. A. Bauta v. Commissioner of Internal Revenue
The Tax Court’s No Dummy
A San Francisco police officer who patrolled his beat with Officer O’Smarty – a ventriloquist's dummy complete with uniform, badge and water pistol – to make himself less forbidding to the public could not deduct amounts that he spent to influence a public referendum to save the puppet.
When the officer was ordered by the police department to stop taking the puppet on patrol, he tried and failed to reverse the decision through administrative means. The officer then took the puppet issue to local voters, where Officer O’Smarty won the hearts of voters and once again was allowed to patrol the streets of San Francisco.
Business opportunities arose from the high-profile ballot campaign, and at tax time, the officer reported earnings from various commercial enterprises, while claiming an $11,465 advertising expense deduction on Schedule C representing his ballot expenditures.
The Tax Court, however, held that the costs that he incurred to establish a committee, gather signatures to qualify for the election ballot and secure voting-slate approval from local political organizations were nondeductible lobbying and political expenditures, which are disallowed under section 162(e), rather than advertising expenses. The officer was also found liable for an accuracy-related penalty.
R. J. Geary v. Commissioner of Internal Revenue
You Would Have Thought He Could Do These Things in His Sleep
There was no relief for a seasoned tax accountant who was convicted of willfully failing to file his tax returns over a 13-year period, although he maintained his failure was innocently inadvertent. The accountant, who made his living computing and filing income tax returns for others, was not as industrious when it came to his own tax filings.
Although he suffered from a neurological disorder that caused him to sleep for all but four hours each day, he was able to rise to the level of senior accountant at an accounting firm and, later, as a sole practitioner, prepared timely returns and reports for clients. He also held a state accounting license, which required him to complete 40 hours of continuing education each year.
He also maintained a sound personal life – he was married, had raised three children, reached the level of second-degree blackbelt in one of the martial arts and paid his mortgage and other bills on time.
For years, he filed his tax returns on time, but failed to file returns for himself and his wife from 1980 through 1992. In 1994, when a client (who was also a relative) told him that the IRS had recently visited him and revealed that the accountant was under investigation, the accountant managed to file the 13 delinquent tax returns for those years within eight days.
The Seventh Circuit Court of Appeals found there was sufficient proof that his disorder had not prevented him from achieving other professional and personal accomplishments. Since he was aware of his duty to file returns and two doctors testified that his condition did not keep him from filing returns, his failure to do so was deliberate and criminally willful, not innocently inadvertent, the Court said, upholding a conviction, six months’ imprisonment, a fine and an assessment.
U.S. v. M.T. McCaffrey
‘Charitable’ Court Rules on Deduction
Individuals who purchased hospital equipment owned by a bankrupt hospital for $40,000 and later donated it to a re-established hospital were allowed to claim a charitable contributions deduction under section 170 for $1 million, which was approximately 25 times what they paid for the equipment.
Despite the IRS’s objections, a federal district court in Tennessee concluded that the appraisal of the equipment that was done following its donation reflected its true value and the valuation done by the hospital’s bankruptcy trustee was done in haste and grossly undervalued the equipment to the detriment of the hospital’s creditors. The court’s decision resulted in a significant tax windfall to the individuals, but there was no fault on their part.
The court concluded that the individuals did not act with intent to defraud. The taxpayers recovered federal income taxes, penalties and related interest, which the court found were erroneously assessed and collected in connection with the charitable deductions taken, totaling over $500,000.
D.L. Herman and B. J. Herman v. United States of America and Paul Brown v. United States of America
Traitor Takes Several Tax Hits on Spy Compensation
After being exposed as a spy for the Soviet Union, former CIA employee Aldrich Ames, who collected over $1 million for selling Top Secret information to the KGB, got tripped up again in Tax Court.
In 1985, Ames received word from a Soviet agent that $2 million had been set aside for him in an account he would be able to draw upon. From 1989 through 1992, Ames received payments from the Soviets, which he did not report on his federal income tax return, nor did he report the money that had been set aside for him.
Ames was indicted for, and pled guilty to, charges of conspiracy to commit espionage and defraud the IRS. He challenged the IRS in Tax Court, however, as to when he should have reported the income from his illegal activities.
Ames contended that he constructively received most of the unlawful espionage income in 1985, and was not required to report the income received in 1989-1992. The spy may have been able to avoid paying the taxes if the court had agreed with him that he received the money when it was set aside for him, since that earlier year was not before the court in this lawsuit. The court held, however, that even if an account had been created by the Soviets in the earlier year, Ames did not have ready access to it, in part because of complex arrangements that had to be followed to determine if a “withdrawal” could be made.
In addition, to avoid being held liable for the negligence penalty, the spy also argued that his failure to report the income was fraudulent. The court observed that his admission of fraud may have put Ames at a disadvantage since the presence of fraud would allow for a longer statute of limitations period and keep the earlier year open for assessment of additional taxes.
The court also held that the government’s pursuit of both taxes and penalties on the espionage income did not subject the spy to Double Jeopardy, even though he was already in jail serving a life sentence for his espionage activities. The taxes and penalties were not considered to be a criminal punishment within the meaning of the Double Jeopardy clause of the U.S. Constitution.
A. H. Ames v. Commissioner of Internal Revenue
Though They Tried, the IRS Can’t Tax Something that Doesn’t Exist
The Tax Court refused to allow the IRS to assess and collect an accuracy-related penalty with regard to the filing of a couple’s federal income tax return, after finding that no filing existed in the first place. The taxpayers filed a document that purported to be their 1995 federal income tax return – it was a handwritten document on six plain sheets of paper that the taxpayers created – but they did not file a return on Form 1040. The IRS did not process the document as a return because it did not include sufficient information.
The IRS sent the petitioners a notice of deficiency in 1998, and also determined that they were liable for the accuracy-related penalty under code section 6662(a) in the amount of $2,225.
The court said not so fast and found that the so-called tax form submitted by the petitioners did not constitute a return for the purposes of code section 6011(a), which requires taxpayers to file a return or statement according to the forms and regulations prescribed by the Secretary of the Treasury. In addition, the court held that, regardless of all other defects, the document was rendered useless by the petitioners’ statement on the first page that said the document was not intended in any way as a self-assessment of tax. Since the petitioners did not file a return for their 1995 tax year, the court concluded the IRS was prevented from imposing an accuracy-related penalty.
R. Andrews and L. Scott-Andrews, Petitioners v. Commissioner of Internal Revenue
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CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, legal, securities, human resources, health care and small business markets. CCH is a unit of Wolters Kluwer U.S.