Further Lesson on Importance of Credibility for Clients and Expert Witnesses (5/14/24)

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. 

Litigation is About Persuasion Which Requires Credibility (4/12/24; 4/23/24)

I write on the tax saga of Burt Kroner. The underlying saga goes back many years and has played out in three tax cases.

• Kroner v. Commissioner (Kroner I), T.C. Memo.  2020-73, here, sustaining the substantial penalty but denying the substantial penalty because of failure to obtain written supervisor approval required by § 6751(b)(1).
• Kroner v. Commissioner (Kroner II), 48 F.4th 1272 (11th Cir. 2022), here, reversing Kroner I on the § 6751(b) penalty issue (the Tax Court’s sustaining of the deficiency was not appealed); I previously wrote on Kroner II. Eleventh Circuit Makes Clarity from Confusion as to the Written Supervisor Approval in § 6751(b) (Federal Tax Procedure Blog 9/20/22), here. 
• Kroner v. Commissioner (Kroner III), T.C. Memo. 2024-41, TA here and GS here, applying the penalty on the merits on remand and rejecting Kroner’s reasonable cause defense. 

The holding in these cases that will likely be cited most in the future is the holding in Kroner II regarding the proper timing of the written supervisor approval requirement as courts further calibrate precisely what the requirement is (perhaps based in part on the Treasury proposed regulations when finalized).

I write today on the merits of the tax deficiency which the recitation of facts in the recent opinion in Kroner III suggested I should take a further look.

The deficiency issue was whether a series of transfers into Kroner’s accounts were gifts from a business associate (also an alleged friend), a David Haring, or taxable income. Kroner claimed the transfers were gifts which IRC § 102 excludes from taxable income; the IRS claimed that they were not gifts (or at least that Kroner had not shown on audit or at trial that they were gifts). The concept is that the Code taxes all income (generally all accretions to wealth presently subject to a realization requirement) unless the income is excluded by some Code section, in this case § 102. The taxpayer bears the burden of persuading the trier of fact that the transfers were gifts.

As an aside, the gift v. income issue can arise in many settings. See e.g., my trial and appellate war stories in Justice Thomas and Tax -- The Plot Sickens (Federal Tax Procedure Blog 10/29/23; 10/31/23), here.

Judge Marvel explains the Code’s gift meaning (Kroner I, slip op. 8):

Fifth Circuit Allows Tax Court Discretion in the Application of the Cohan Rule (1/28/14)

In Shami v. Commissioner, 741 F.3d 560 (5th Cir. 2014), here, the Fifth Circuit affirmed the Tax Court's denial R&D credits claimed by the taxpayer.  One of the taxpayer's arguments was that the Tax Court should have applied the Cohan rule, named for named for Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), here,  to allow some credits.  In rejecting the argument, the Fifth Circuit explained the "venerable" Cohan rule and its limitations, including the discretion allowed the trier of fact (bold facing supplied by JAT]:

Petitioners next assert that "[t]he use by [FSI] of [estimates of the amount of time Shami and McCall spent performing qualified services] was indisputably permissible" and that the type of documentation provided was adequately supportive. We disagree. 

First, Petitioners' claim is waived. In their initial brief, the extent of Petitioners' argument is the sentence quoted above and a citation to this court's precedent in United States v. McFerrin [570 F.3d 672 (5th Cir. 2009)], which, following the venerable Second Circuit case Cohan v. Commissioner, held that "[i]f the taxpayer can establish that qualified expenses occurred . . . , then the court should estimate the allowable tax credit." Aside from a parenthetical to the citation, Petitioners make no effort to explain the Cohan rule or how it would apply to their case. Petitioners make only the bare assertion that their use of estimates was appropriate. Petitioners therefore have waived this issue by failing to brief it adequately. 

In the alternative, Petitioners' claim fails on the merits. A line of case law—beginning with the Second Circuit's decision in Cohan—holds that if a taxpayer proves that he is entitled to a tax benefit but does not substantiate the amount of the tax benefit, the court "should make as close an approximation as it can, bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making." The underlying logic of the rule is that allowing no benefit at all "appears . . . inconsistent with [the finding] that something was spent." In McFerrin, this court held that the Cohan rule applies in the context of the § 41 credit. 

Cohan did not compel the Tax Court to make an estimate in this case. As the preceding discussion makes clear, the Cohan rule is not implicated unless the taxpayer proves that he is entitled to some amount of tax benefit. In the context of the § 41 credit, a taxpayer would do so by proving that its employee performed some qualified services. In this case, a careful reading of the Tax Court's opinion reveals that the Tax Court made no such finding. 

Even if the Tax Court had determined that Petitioners proved that Shami and McCall performed some amount of qualified services, Cohan and McFerrin are not the only case law on this issue. As the Tax Court observed, another decision of this court issued between those two cases explains that the Tax Court has discretion to make an estimate under Cohan. In Williams v. United States [245 F.2d 559 (5th Cir. 1957)], this court made clear that, even though the Tax Court "might have considerable latitude in making  estimates of amounts probably spent," the Cohan rule "certainly does not require that such latitude be employed." Our decision in Williams explicitly held that the Tax Court "may not be compelled to estimate even though such an estimate, if made, might have been affirmed." This was so because "the basic requirement is that there be sufficient evidence to satisfy the trier that at least the amount allowed in the estimate was in fact spent or incurred for the stated purpose," and "[u]ntil the trier has that assurance from the record, relief to the taxpayer would be unguided largesse."