CCH’s Annual Picks For The Most Quirky Tax Court Cases

The nation’s tax code hardly reads like a novel, yet interesting stories come out of it every year, according to CCH INCORPORATED (CCH), a leading provider of tax law information and software. Once again as gleaned from court cases decided in 2002, taxpayers put their own distinctive spin on the complex rules of federal tax law, and then had to explain themselves to the judge.

Kay Harris, an analyst who monitors court opinions for CCH Tax Day, a daily compilation of tax developments, noted that a wide variety of factors can set a case aside from the routine run of tax litigation – a prickly defendant, an outrageous IRS position, a historical sidelight or a deal just a little too good to be true.

"What’s truly odd is that some people never seem to learn. They lose to the IRS but keep coming back for more."

Here’s a look at some of the more interesting tax cases that passed through the nation’s courts during 2002.

This Transaction Didn’t Smell Right

A farmer who pays a farm laborer with a bushel of tomatoes in addition to cash doesn’t have to count the tomatoes as "wages" paid and doesn’t have to pay FICA withholding tax on their value.

A large Iowa hog operation tried to take that principle to extremes by paying "bonuses" in the form of hogs. Applying the payment-in-kind rule, the farm corporation excluded the value of the hogs from its FICA computations.

The farm claimed that the hog transfers were intended to motivate its employees, but two officers – brothers who ran the family corporation – were the only employees to actually receive the hog payments.

Also, the "bonuses" were put into the brothers’ names within days of when the hogs would have been sold in the ordinary course of business. The "bonus" hogs and other market-ready hogs "were loaded into the same truck and sold to the same hog buyer on the same terms," the U.S. District Court for the Southern District of Iowa noted.

The court concluded that the hog bonuses were actually disguised cash transfers "whose sole purpose was tax avoidance."

(Highway Farms, Inc., DC Iowa, 2002-1 USTC ¶50,281)

Why Can’t He Just Take Up Golf?

A former Air Force major is leading an active retirement – entirely too active for the taste of some judges. He spends much of it in Tax Court arguing that his wages, Social Security benefits and military pension aren’t subject to tax.

He claims that attempts to tax his military retirement pay constitute a "fraudulent claim for federal pension benefits," that the pay is "governed and disciplined under Title 10 of the Uniform Code of Military Justice" and that "the IRS can’t tax the Armed Forces."

Similarly, he maintains that Social Security benefits "can’t be the subject of a legal process" and, therefore, aren’t taxable.

In the latest incident, he sent in a "protest" tax return, showing no liability, even though he claimed it was not legally necessary. "I was being nice and submitting one anyway, even though I didn’t have to."

The protest return was sent back to him. "I may have thrown it in the wastebasket," he testified at his trial. When asked whether he kept a copy, he answered "Maybe, maybe not."

The Tax Court has heard this all before, several times. After making it clear that the positions he was putting forward were frivolous and discredited, the court held him liable for over $600 in penalties for his failure to timely pay his taxes and $5,000 in damages for maintaining a frivolous position in his case. The tax liability he was trying to avoid paying was $2,500.

Since 1986, the major has taken five other trips to Tax Court, all of which were dismissed, and this is the third time he has been held liable for a $5,000 damage award for making frivolous claims.

(J.E. Simanonok, Dec. 54,676(M))

A Kinder, Gentler IRS?

Sometimes you wonder whether if everyone at the IRS has gotten the message.

IRS lawyers argued to the Tax Court that a 68-year-old woman should be required to pay income taxes on almost $400,000 that her husband had embezzled 20 years ago.

The court analyzed several factors in reaching its decision. One deciding factor was the question of economic hardship. The IRS argued that the woman would suffer no economic hardship if forced to pay a huge tax bill, even though her current income was $430 per month in Social Security benefits.

Why not?

The IRS implied that she would suffer no hardship because her children would step in to pay the taxes.

The court saw things a bit differently.

It concluded that she would suffer one hardship if she were to be held liable for the taxes, and then she’d suffer a second hardship if she had to ask her children to bail her out of the mess, especially since there was no evidence that they could or would do it.

(R. Ferrarese, Dec. 54,894(M))

The Real Enron Didn’t Fare So Well, Either

A former stockbroker who claimed he conducted a "health, wealth and healing ministry" was not considered by the court to have conducted that activity for profit.

That meant he was not entitled to deduct losses in excess of the income generated by the activity – losses that had offset a healthy stream of income from investments and reduced his tax liability to less than $1,000 a year.

The minister – a "bishop" according to his mail-order ordination – described the activity of his ministry to the Tax Court by saying, "people need to be understood in terms of the fact that they have a body…" and that his approach centered on "helping people learn how to make money" through his own participation in a broad range of marketing schemes.

He described one of them to the court:

And the first business I got into, in multi-level marketing, was marketing electricity. I paid $1,250 for the worldwide rights for the Los Angeles – well, the United States rights. And … it all went down the drain. They could never deliver electricity.

A wondering court asked: "You were going to be kind of like your own Enron Corporation?" To which he replied, "Well, something like that."

Not only did this ministry never make a profit or seem likely to, but its business records left much to be desired. The former broker never maintained a separate checking account for the ministry, and categorized almost all his checks – including all of the ones written to grocery stores – as "unreimbursed business expenses."

On his tax return, the broker-turned-minister deducted "business storage/rental" fees of $1,000 a month that he paid to his mother for space to keep various products, including "wigglers…heat-type things" and "ozone machines."

In the end, the court was not convinced that the ministry was much more than a strategy designed generally to lower, if not virtually eliminate, the would-be minister's federal income tax liability by converting personal living expenses into deductible business expenses. It also disallowed a large portion of his claimed charitable contributions and imposed a negligence penalty.

(H.D. Singer, T.C. Summary Opinion 2002-48)

This Nurse Needed More Education – About Taxes

As she described it to the Tax Court, the taxpayer, in 1998, a registered nurse in Roseville, California, heard something on a television show about early withdrawals from retirement plans not being subject to the normal 10-percent penalty when the money is used to pay for educational expenses.

She proceeded to withdraw over $41,000 from her retirement plan. She enrolled for two nursing courses – which meant she did not meet the law’s requirement that she be enrolled as at least a half-time student in order to avoid the penalty.

During 1998, she paid $261 toward the courses. She paid an additional $2,076 for her 1998 courses in 1999.

Then, the IRS imposed a penalty on her withdrawal, based on the fact that only a tiny fraction had gone to pay for education in 1998 and even that amount didn’t qualify because of her light academic schedule.

The nurse asked the court to rule in her favor, since it was "unrealistic" of the IRS to expect anyone to complete all their education in a single year.

Her argument was "misguided," the court patiently explained. No one was demanding that students cram an entire degree program into 12 months. A taxpayer-student could avoid the penalty "simply by withdrawing during the year an amount less than or equal to the amount the taxpayer pays for higher education expenses."

And, by the way, what happened to the rest of the money?

The court noted that the nurse said she made the withdrawal "because she needed funds to buy a car and pay off bills" in addition to paying for her courses. So the bulk of the funds went to pay purely personal expenses and the court concluded that the penalty was in order.

(C.J. Dunn, T.C. Summary Opinion 2002-108)

Taxpayer and Court Were Safe with this Late Petition

A Syracuse New York taxpayer received a notice of deficiency from the IRS dated September 4, 2001. The notice said that the taxpayer would have to petition the Tax Court in Washington, D.C., within 90 days to contest the deficiency. In practical terms, this meant that the petition had to be postmarked no later than December 3, 2001.

The taxpayer claimed he met the deadline, sending in his petition in late November.

But his petition arrived at the Tax Court on January 2, 2002. There was no legible postmark on the envelope. Counsel for the IRS argued that the petition should be thrown out because it wasn’t timely filed.

The court chose instead to believe the "forthright" and "candid" testimony of the taxpayer and accepted the petition, despite the obvious fact that it did not arrive on time and there was no evidence on the envelope as to the date it was mailed.

Why such an exception to the usual rules? Because it was an unusual time.

Following the discovery of anthrax in Washington mail facilities, the post office serving the Tax Court was closed. Vast quantities of mail were set aside and irradiated to kill any possible biological agents. The court noted that, in January 2002, it was still receiving mail from November and December 2001. It was this irradiation that obliterated the postmark on the petition’s envelope.

(L. Gibson, Dec. 54,858(M))

Tax Court Gives Musician the Homesick Blues

From 1990 to 1995, a musician would ride a bus nearly every Thursday or Friday from his parents’ home in Stoughton, Wisconsin, where he lived, to Chicago. There, he would perform over the weekend as part of a band known as Dr. Bop and the Headliners. He earned anywhere between $11,000 and $18,000 a year doing this, although he never bothered to file a tax return during those performing years. Eventually, though, he gave up the band. He stopped riding the bus and started driving one, for the city of Madison.

A few years later, the IRS came calling, asking about all the unreported income from his Dr. Bop years. Then, the former Headliner had to apply his artistry in a new form – Form 1040.

In giving a financial account of his musical career and trying to lessen his potential obligation to the U.S. Treasury, the musician deducted all the bus fares on his old Stoughton-to-Chicago run as business travel expenses.

Not so fast, the Tax Court said. When it comes to taxes, home is where you earn your bread, not necessarily where you lay your head. Most of Dr. Bop’s gigs were in the Windy City, so as far as taxes were concerned, the band members’ tax home was Sweet Home Chicago. Only travel away from Chicago to perform at other venues counted as business travel for any of the musicians – and, like the rest of the Dr. Bop organization, this one was reimbursed for those trips.

But why had a member of a Chicago-based band been living with his parents in Wisconsin the first place? He had been trying to save money so he could pay off a debt to the IRS.

(L.A. Bjornsted, Dec. 54,657(M)

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