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. 

Justice Thomas and Tax -- The Plot Sickens (10/29/23; 10/7/24)

Introduction: Today's topic is off-topic to tax procedure, although it does relate to trial of a tax case in problematic circumstances.

Justice Thomas’ most recently revealed conduct raising considerable controversy in ethics, legality (tax), and prudence is the alleged forgiveness in whole or part of a loan made to Justice Thomas by an alleged acquaintance (perhaps hanger-on) to acquire a luxury RV. Some alleged that, if the allegation is true, Justice Thomas had taxable income (lawyers call it cancellation of indebtedness (“COI”) income) or a nontaxable gift. Either characterization can create potential problems for Justice Thomas–if COI income, Justice Thomas might have tax reporting and paying obligations; if a gift, the “donor” would have tax reporting obligations.  I suggest in this post that the allegation it is both more subtle and potentially sinister than those claims.

From my days at DOJ Tax handling two cases, I believe that there is nuance that is missed in the claims discussed in the above paragraph. The two cases are Spartan Petroleum Company v. United States, 437 F. Supp. 733 (D.S.C. 1977) and Cooper v. United States, 1975 U.S. Dist. LEXIS 11633 (S.D. ALA 1975).

Together, those cases held correctly that 

(i) a cancellation of indebtedness is not treated as COI income if the cancellation is a medium to make a transfer with another tax character (in Spartan Petroleum, the cancellation of indebtedness was additional consideration for transfer of property; btw there was a Tax Management portfolio that wrongly recommended that shuffle); and 

(ii) following through on the Spartan Petroleum holding, a cancellation of indebtedness can be a means to benefit the debtor having some tax character other than COI income. Thus, the COI can represent a gift which is not taxable income to the donee (Thomas potentially) but is a reportable gift potentially subject to gift tax to the donor.  Gift tax status requires that the motive for the gift (here, if applicable, by COI) be detached and disinterested generosity which is the debtor’s (Thomas' burden to prove). If it is not detached and disinterested generosity, the teaching of Cooper is that it is taxable income, because the motive is likely expecting some benefit or advantage the debtor could provide. Cooper was a prominent Alabama politician in the Wallace governing circle and in a good position to benefit the Bank of Pineapple and its principals, one of whom by the way at the time had the highest grades ever recorded at University of Alabama and, at a very young age, had been General Stillwell’s top aide in China; and his bank held a large amount of interest free state deposits.)  I took the bank President's deposition in the Eglin Air Force prison (a country club prison); he delivered the goods. In other words, in that case the COI was income for influence–a bribe with an expected or hoped for benefit.