I recently blogged about credibility. Litigation is About Persuasion Which Requires Credibility (Federal Tax Procedure Blog 4/12/24; 4/23/24), here. The Tax Court yesterday issued an opinion, Schwarz v. Commissioner, T.C. Memo. 2024-55, TC Dkt 12347-20 at Doc 190, here and GS here, in which Senior Judge Goeke offers lessons on the same subject. Those lessons appear in about 17 pages of the 117 page opinion. I’ll discuss the pages, but first offer an introduction to the case via the Court summary or syllabus at the beginning. See Supreme Court Opinion Syllabus as Persuasive Authority? (Federal Tax Procedure Blog 2/8/21), here):
Ps have a history of conducting real estate activities in South Texas, mostly involving ranch land. Through entities they controlled, Ps bought 15,070 acres of land in Zapata County in 2005 with the intent to improve and sell it. Ps later decided to conduct ecotourism operations consisting of hunting, fishing, and events on a portion of the land.
In the years at issue, 2015–17, ecotourism in Zapata County was conducted by TI, a partnership owned by Ps. TI leased the Zapata County land from entities controlled by Ps. TI also conducted farming and construction operations on the Zapata County land and other properties owned by Ps, related entities, and third parties.
TI filed Schedule F, Profit or Loss From Farming, with its return for each year 2005–20. TI reported income and expenses for both ecotourism and farming/construction operations on Schedule F. TI reported Schedule F gross income totaling over $14 million for years 2005–20. However, large expenses resulted in TI’s reporting a Schedule F net loss for each year. These net losses total over $15 million for years 2005–20. TI’s Schedule F losses flowed through to Ps, who used them to offset significant taxable income.
R issued Ps a notice of deficiency for years 2015–17. R determined that TI’s Schedule F activity was not engaged in for profit pursuant to I.R.C. § 183. Multiple adjustments flowed from this determination, including the disallowance of deductions for TI’s Schedule F losses. R also determined that a 20% accuracy-related penalty applies for each year at issue.
Ps filed a Petition challenging R’s determinations. Ps contend that TI’s Schedule F activity was engaged in for profit and that it and the real estate activities that Ps and related entities conducted are a single activity. Ps also contend they have a reasonable cause defense to penalties.
Held: TI’s Schedule F activity and the real estate activities are separate activities.
Held, further, TI’s Schedule F activity was not engaged in with the intent to make a profit.
Held, further, accuracy-related penalties are not applicable.
Let me say that, on the basis of the credibility issues
Judge Goeke discusses (which I recount below), I am a bit surprised that
Schwarz ducked the accuracy-related penalty for his reporting of the activity so
handily rejected on the merits. But Judge Goeke is the judge (and a good judge
too), and he has spoken.
Apparently, because the opinion is so long, Judge Goeke offered an outline at the beginning with each element in the outline linking to the part of the opinion relating to the outline (nice feature!). (I could find no discussion in the Tax Court’s Citation and Style Manual, here, as to when to include an outline, but I suppose is the judgment call of the deciding judge.) The relevant portions of the Opinion part of the outline relating to the credibility issues are:
The Court’s direct comments on credibility begin at IV. The Parties’ Work, Petitioners’ Credibility, and Years After 2020, on p. 65 and go through 83, for a total of 18 pages.
The Court starts by noting the confusion, to say the least, of the parties’ respective counsel in the case (pp. 65-66). I won’t discuss those. Certainly, though, confusion can generate a lack of credibility.
The Court then moves (beginning on p. 66-67) to the section (pp. 66-on Petitioners’ Credibility. The Court identifies Schwarz’ lack of credibility at several points and concludes (p. 67):
Most of the evidence in this case was presented or created by petitioners (and/or affiliated persons/entities). However, petitioners put forth an incomplete and often inaccurate set of facts. This was ultimately to their detriment, as many of their arguments rest on inaccurate claims.
Then, in the balance of the discussion from p. 67 through p. 83, there are numerous expressions of lack of credibility or similar issues with the expert’s reports.
The lesson is that counsel must give an honest assessment to the client of his or her credibility and that of the experts that will be proffered for the client. I have no way of knowing whether Schwarz’s counsel made that type of assessment.
JAT DOJ Tax Trial War Story:
One type of animal mentioned in the Schwarz case was “exotics.” I knew from a client who used to own and manage an exotic game ranch that these were non-native animals of a type prized by some hunters. (I am not a hunter; although I visited my client’s ranch, I never did any type of shooting there except for nonlive target practice.)
My earlier encounter with exotics was with DOJ Tax Trial Section (then affectionately and creatively known as Refund Section 2 (covering roughly the South). I was assigned a refund case titled Joe Peach v. United States (M.D. Ga. Civil No. 74-4-ALB), where the taxpayer resided and ran his night club business. The ultimate opinion is Peach v. United States, 1975 U.S. Dist. LEXIS 14560 * | 75-1 U.S. Tax Cas. (CCH) P16,186 | 36 A.F.T.R.2d (RIA) 6543 (M.D. Ga. 1975), but I could not find any free link to the case. In part, the opinion describes the business as :
B. Facts on the Merits
1. Before, during, and after the period in issue, the plaintiff operated a night club in Albany, Georgia. [*2] (Hereinafter, unless otherwise specifically stated, all references are to the period in issue - the second quarter of 1963 through the second quarter of 1965.) The night club, known as Joe's Cellar Lounge, served liquor by the drink, beer, and related refreshments. The nightclub provided live entertainment from 9:00 p.m. until 3:00 a.m.
When I first was assigned the case after transferring from the Appellate Section to the trial section (Refund 2), reading through the file I found several references to "exotics" in Peach's place of business. I did not know what that meant at the time, so I went to my boss, John Murray, for that part of my education. Peach’s “exotics” were not game animals except in the broadest usage of the term. Persons such as Peach engaging such “exotics” had other tax issues later as to whether they were employees or independent contractors. See Exotic Dancers—Employees or Independent Contractors? (National Legal Research Group, Inc. 5/12/21), here.
The tax involved in Peach was the now repealed federal cabaret excise tax liability described in the opinion as follows:
During the quarters in issue, an excise tax - known as a cabaret tax - was [*16] imposed at ten percent of the receipts for admission and refreshment while a night club had live entertainment. Section 4231(6), Internal Revenue Code of 1954 (repealed effective December 31, 1965, by the Excise Tax Reduction Act of 1965, P.L. 89-44, 79 Stat. 136). The parties agree that the plaintiff's receipts for admission and refreshments during the period the plaintiff's night club had live entertainment - 9:00 p.m. to 3:00 a.m. daily - are subject to tax. The only dispute between the parties is the amount of receipts during that period.
Needless to say, in order to reconstruct the taxable receipts, during the audit, the agents had to visit during operational hours (or, at least, they did so, whether or not they had to). They made several undercover visits to the premises to observe the indicia that sales might have exceeded the sales Peach was reporting for tax purposes. That meant, of course, that, while doing their duty, they observed the exotic dancers (without prurient interest, at least according to their notes).
At any rate, I found that all cases I handled before and after DOJ Tax became part of my continuing education and experience. However, I never actually myself attended such an exotic bar until I went to one with a group hosting a partner in advance of his marriage. That was long after leaving DOJ Tax. I learned from that experience as well; I never attended another one.
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