Source: https://taxprof.typepad.com/taxprof_blog/2018/12/lesson-from-the-tax-court-taxpayers-behaving-badly.html
Timestamp: 2019-04-20 21:13:54+00:00

Document:
1. Receipts? We Don’t Need No Stinkin’ Receipts. Magloire K. Ayissi-Etoh and Katrina D. Sharpe v. Commissioner, T.C. Memo 2018-107 (July 9, 2018). Before Judge Lauber.
During the two tax years at issue Mr. Ayissi-Etoh worked for the International Monetary Fund (IMF) in Washington D.C. He made $62k in 2012 and $207k in 2013. Ms. Sharpe was also employed, by a defense contractor Leidos, but the opinion is silent on her earnings. During the years at issue Mr. Ayissi-Etoh also owned a company, American Management & Consulting, LLC (AMC) that he had formed in 2009. In 2012 Mr. Ayissi formed a second entity, American Management & Consulting Foundation, Inc. (AMC Foundation).
The IRS issued an NOD, determining that the taxpayers had underreported income, overstated Schedule A and Schedule C deductions, and failed to pay employment taxes.
Collateral Damage: Mr. Ayissi-Etoh had the same problem that bedeviled President Obama’s Secretary of Treasury Timothy Geithner in 2009. Here’s Paul’s blog about that if you need a refresher. The IMF does not have to withhold Mr. Ayissi-Etoh’s taxes, because it is an international organization. Moreover, as Judge Lauber explained, the IMF was not responsible for employment taxes, either. It was up to Mr. Ayissi-Etoh to actually pay the full amount of self-employment taxes on his wages, even though he received a W-2 and not a 1099. This was a completely understandable error and in no way an SMH moment. But after Judge Lauber had seen all the other problems with their case, he was not about to accept Mr. Ayissi-Etoh’s Turbo Tax defense.
2. The Middle-Class Tax Shelter Scheme. Kimberly S. Nix v. Commissioner, T.C. Memo 2018-116 (July 30, 2018). Before Judge Lauber.
During the tax years at issue, 2012, 2013 and 2014, Ms. Nix earned between $92k and $94k each year. In 2012 she got hooked into selling Mary Kay cosmetics. She told Judge Lauber that part of her motivation was the 50% discount sellers received on purchases for their own use. After three years, in 2015, she quit Mary Kay.
Ms. Nix reported some minimal income from her Mary Kay activity but reported substantial expenses resulting in net losses of $18k, $45k, and $22k in each of the three years). Yep. That’ll trigger a DIF score to get you audited.
As with Mr. Ayissi-Etoh, it appears Ms. Nix used Schedule C to report personal expenses. Unlike Mr. Ayissi-Etoh, however, the IRS determined Ms. Nix’s Schedule C activity was actually a hobby and so disallowed all expenses that exceeded her minimal Mary Kay income.
Perhaps Ms. Nix’s attorney thought she was a good witness and would convince the Court of her genuine profit motive? Perhaps he did this work for free so she would not be wasting her money chasing the Red Queen? It’s hard to know what either Ms. Nix or her counsel was thinking here.
3. Damn the §274 Restrictions and Full Speed Ahead. Damon R. Becnel v. Commissioner, T.C. Memo 2018-120 (August 2, 2018). Before Judge Holmes.
In this opinion Judge Holmes describes the taxpayer as “a serial entrepreneur” who ran “a real-estate empire” in the Florida panhandle town of Destin, through the use of about 11 different business entities. Mr. Becnel was apparently a very successful real estate developer because in 2005 he spent about $2 million to buy a 67-foot fishing yacht, naming it the Britney Jean. Actually, he had one of 100% owned companies---Sunrise Beach Service, LLC---buy the boat, but Sunrise was a disregarded entity.
Mr. Becnel took the yacht to lots of fishing tournaments but otherwise, Judge Holmes writes, “one can usually find the Britney Jean behind Becnel’s house.” Specifically, Mr. Becnel never attempted to engage in any fishing-related business. He never chartered out his yacht, he did not catch and sell fish commercially. He was a real-estate developer and Sunrise Beach Services was just what it seemed: a company that provided beach amenities for beach resorts (many owned by Mr. Becnel).
As revised in December 2017, §274 now totally disallows any deduction for expanses that are attributable to either entertainment activities or entertainment facilities. For the years at issue in Becnel, however, the old version of §274 permitted deductions for entertainment activity expenses if the taxpayer could show they were directly related to the active conduct of the taxpayer’s trade or business.
SMH Moment 1: Becnel hid deductions for owning and maintaining the yacht under “charter boat expenses” even though Becnel admitted that he had never chartered the boat. He just used it. Similarly, depreciation deductions for the yacht were lumped with depreciation of similar deductions for beach chairs, boxes, and umbrellas.
A yacht is an entertainment facility if it is “owned, rented, or used by a taxpayer...in connection with entertainment.” Treas. Reg. 1.274-2(e)(2)(I). That means if Mr. Becnel had been a commercial fisherman, then he might have been able to avoid the §274(a) restriction if the yacht was used as part and parcel of that business. But, as Judge Holmes found: “Becnel is not a professional fisherman---he isn’t even in the boat business.” So what conceivable basis did Mr. Becnel have to deduct yacht expenses? SMH.
SMH Moment 2: Becnel hid deductions for his fishing tournament entry fees on his Schedule C as “dues & subscriptions.” As Judge Holmes points out, even if the expenses of acquiring and maintaining an entertainment facility are disallowed per se, expenses associated with entertainment activities that occur using the facility may still be deductible if they are directly related to the taxpayer’s business. The best Mr. Becnel could do was to say the yacht helped his real-estate business because he could use it to show potential clients a good time. Judge Holmes believed him, but that’s not the kind of direct connection that meets the former §274(a) test.
SMH Moment 3: Mr. Becnel’s attorneys---whether through inexperience or carelessness---disobeyed Judge Holmes’s standing order that the parties exchange exhibits 14 days before trial. At trial, the attorneys attempted to proffer a mass of receipts to substantiate claimed expenses. Judge Holmes rejected the proffer. The error was not fatal. It did not matter whether Mr. Becnel met the §274(d) substantiation requirements because he could not even get past §274(a). But, still, why would one ignore a standing order from the Court?
4. Riding the Expensive Hobby-Horse. Larry W. MacDonald v. Commissioner, T.C. Memo 2018-138 (August 27, 2018). Before Judge Pugh.
Mr. MacDonald is a serial hobbyist who apparently has repeatedly appeared before the Tax Court, offering the same or similar hobbyist arguments. He has been told, also repeatedly, that his arguments are stupid. This time Judge Pugh used §6673 to give him 5,000 more reasons to dismount from his hobby-horse.
5. Keeping It All In the Family. Rian D. Ray and Betsy Ray v. Commissioner, T.C. Memo 2018-160 (September 20, 2018). Before Judge Nega.
During the six tax years at issue (2006-2011) Mr. and Mrs. Ray lived on a six-acre farm in Oregon with six of their eight children ranging in age over the years from 13 to 25. During those Mr. Ray was the sole researcher and sole financial officer for a 501(c)(3) entity that he co-founded, called National Home Education Research Institute (NHERI). NHERI was apparently funded primarily by outside donations, but also generated revenue from book sales and research contracts. NHERI had no written employment contracts with any of its workers. Instead, Judge Nega found, “Mr. Ray had the exclusive authority to determine wages and salaries for all of NHERI’s workers, including himself.” And who might these other workers be? Why, they were five of Mr. and Mrs. Ray’s kids! If there were any other workers employed by NHERI they are not mentioned in Judge Nega’s opinion. And what did his kids do? Why...they were office assistants. All five!
Mr. and Mrs. Ray also engaged in a variety of consulting work related to the home education industry.
During the years at issue, Mr. and Mrs. Ray did not file tax returns. But they hopped to it quick-like-a-bunny after the IRS opened an audit for the 2010 year and then, within a couple of months, expanded the audit to all the years at issue.
On their belated returns Mr. Ray reported between $15,000 and $24,000 in gross receipts from his Schedule C consulting activity during the years at issue. He reported receiving no income from NHERI. The couple also reported zero gross receipts from Mrs. Ray’s work. During the audit, the taxpayers had such poor records that the Revenue Agent had to do a bank deposits analysis to determine income.
SMH Moment: During all six years, NHERI did not pay Mr. Ray a dime. But, during that same period, NHERI managed to pay the five child “office assistants” over $260,000---without ever issuing them a W-2 or 1099. The kids then deposited “their” money into the family’s shared OSU Credit Union’s Visa account, which the Court treated as a depository account because of the OSU Credit Union’s account policies.
As you might imagine, the Court found that “we believe that petitioners engaged in a pattern of behavior to replace what ordinarily would be taxable salary payments to Mr. Ray with what petitioners argue are nontaxable payments to their children.” No kidding.
May all of you, dear readers, have a safe and happy holiday season. I certainly hope your behavior was such that you don't end up with the proverbial coal in your stockings, a fate that may be faced by some of these taxpayers.
Keep it up, Bryan. Now that I'm retired, you and your fellow bloggers are my only remaining tie to the wonderful world of federal tax.
Why o why don't these people go to prison!
Ayissi-Etoh was a plaintiff in an ultimately unsuccessful discrimination case vs. Fannie Mae. But, on his first appeal that he did win, Judge Kavanaugh wrote a strong concurring opinion about how the single use of the "n-word" ought to be actionable. Judge Kavanaugh included this concurring opinion as one of his most important decisions in the materials supporting his Supreme Court nomination.
Very amusing read. Thank you!

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