Source: https://taxprof.typepad.com/taxprof_blog/bryan-camp/
Timestamp: 2019-04-24 18:44:11+00:00

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I have been using tax prep software since at least the early 1990’s as my tax journey has followed the dimensions of my life journey: from single to married to parent; from renter to owner to landlord; and from debtor to investor. If I have learned anything over the years about tax prep software, it is this: you cannot trust tax software to get it right.
This year, the H&R Block software wanted to give me a larger §25A American Opportunity Tax Credit (AOTC) than I was entitled to take. For reasons I describe below the fold, I let the software do that. Yes folks, I filed a false tax return! And, no, it won’t get me in trouble, for reasons that may surprise you. Today I give you a “you can do this at home” lesson on how to deal with erroneous tax prep software. Happy Tax Day.
In 17th Century warfare, armies used a primitive explosive device called a petard to help breach castles and walled cities. It was basically a bell filled with gunpowder that would be shoved in a tunnel or hole facing the wall or gate to be breached. The operator, called an enginer (pronounced “engine-ur” with emphasis on first syllable) would light the fuse and scramble back. If all did not go well, however, the enginer might be blown up (hoisted) in the resulting explosion. Thus the expression. It’s an extremely common trope in fiction starting at least as far back as Hamlet, and continuing in modern times, as this lovely time-wasting website extensively details.
In tax law taxpayers build both primitive and sophisticated devices to avoid taxation. Last week’s decision in Allen R. Davison III v. Commissioner, T.C. Memo. 2019-26 (April 3, 2019)(Judge Ashford) involves a taxpayer whose tax reduction device consisted of layering partnerships. How ironic, then, that it blew up his chances for pre-payment litigation over the merits of a tax assessment. He did not learn that unhappy lesson until both the IRS and then the Tax Court refused to let him litigate the merits of his tax liability in the CDP process. Details below the fold.
I teach my tax students that representing a taxpayer is about being the taxpayer’s voice. They must tell the taxpayer’s story as best they can fit the facts to the law. Thus, for example, in order to deduct expenses taxpayers must tell a convincing story that the expenses relate to an activity engaged in for profit. Last week's Lesson concerned taxpayers who said they had converted their former personal residence into income producing property. The story their representative told was simply too inconsistent with the facts to convince the Court. Thus they were denied a §165 deduction when they sold the home for a loss.
This week’s lesson is similar. In Edward G. Kurdziel, Jr. v. Commissioner, T.C. Memo 2019-20 (Judge Holmes), the taxpayer bought a plane, restored it, and flew it around the country. That's him flying his plane in the picture. Here's a video! What fun!
Oh, and he also took deductions for depreciation and ongoing expenses that far, far, far exceeded income from the plane. He offset those losses against his hefty airline pilot salary. The IRS eventually audited and disallowed the losses under the hobby loss rules. So the taxpayer tried to sell the Tax Court on a story of profit-making activity. In his usual airy, pun-filled, style, Judge Holmes explained why the taxpayer’s story didn’t fly. Peter Reilly calls this the coolest hobby loss case ever. He has a nice summary of the case on his Forbes blog. What I see in the case is a lesson about storytelling. One big reason the taxpayer lost here is because he told conflicting stories to different tax authorities. Telling one story to your local tax authorities and another story to the IRS is, ultimately, not a successful tax reduction strategy. You are trying to fool one of them. I thought this was a particularly apropos lesson for today, April 1. You will find the interesting details, with pictures of the crash (Mr. K was unhurt), below the fold. If that's not click-bait, I don't know what is. Who can resist seeing pictures of a crash?
The Tax Code is built on a dichotomy between business and personal. That is one of the ideas that runs throughout each semester of my basic tax class. Whether a taxpayer is entitled to deduct an item of expense depends on whether the Code classifies the expense as business or personal. In one box go expenditures needed to carry on an activity engaged in for profit. Section 162 allows taxpayers to deduct the money it takes to make money. In another box go expenditures made for personal consumption. Section 262 disallows a deduction for such expenses. One finds the same dichotomy in §165, which permits taxpayers to deduct business losses, but not non-business losses.
Sometimes it is difficult to distinguish business from personal. In life, the difference is not a dichotomy but a continuum with expenditures often made for mixed purposes. Still, taxpayer activity falls into either the deductible box or the non-deductible box. There is no in-between. The expense (or loss) is deductible or it’s not. Congress helps taxpayers figure out into which box they fall with various statues. Treasury helps them with various regulations. And courts help with decisions like two Tax Court decisions from last week.
Last week the Tax Court issued two opinions that teach lessons about distinguishing business activity from personal activity. First, Carlos Langston and Pamela Langston v. Commissioner, T.C. Memo 2019-19 (Judge Nega) presents a really nice twist on the classic problem of how to tell when a taxpayer has converted a personal residence into an income-producing property. There, the taxpayer's actual rental was not sufficient to convert a property formerly used as a personal residence into a property held for the production of income. That surprised me. Second, Edward G. Kurdzeil, Jr. v. Commissioner, T.C. Memo 2019-20 (Judge Holmes) concerns whether a taxpayer’s very expensive plane restoration activity was a business or a hobby. I will blog Langston this week and Kurdziel next week.
Generally, it’s nice to be noticed. Tomorrow is my 24th wedding anniversary and I remain truly grateful that my wife noticed me one day long ago at a contra dance at Glen Echo. That notice continues to this day, fully reciprocated.
But sometimes it’s not so nice, such as when the notice comes from the IRS. And when Congress wants the IRS to “notice” taxpayers (pun intended), it generally requires the IRS to send that notice to their last known address.
The last known address rule is critical to learn. Congress puts that rule in about 20 different statutes, helpfully listed in Rev. Proc. 2010-16. The governing regulation generally allows the IRS to comply with the rule by using the address in its Master File database. There are some exceptions. In a blog last November, I discussed one exception: certain events can trigger an IRS duty of due diligence to go beyond the address in its database.
Last week the Tax Court taught us about another exception in Damian K. Gregory and Shayla A. Gregory v. Commissioner, 152 T.C. No. 7 (Mar. 13, 2019) (Judge Buch). There, Tax Court let us know, in a fully reviewed opinion, that a Power of Attorney (Form 2848) does not have the legal effect of telling the IRS that a taxpayer has changed their official address of record. This is important because, as long-time practitioners know, Form 2848 used to work for that purpose (albeit as a backstop). Time to unlearn that old lesson! Details below the fold.
When something goes right most of the time, we generally are not prepared for when it goes wrong. Last week’s opinion in Teri Jordan v. Commissioner, T.C. Memo. 2019-15 (Mar. 4, 2019) (Judge Buch) teaches that lesson as applied to the §7502 statutory mailbox rule. It also teaches us what we need to know to avoid the unhappy outcome for Ms. Jordan.
Most folks know something about the statutory mailbox rule in §7502. Or at least think they do. Almost everyone has a general idea if they mail their tax returns or, as here, their Tax Court petition on the last day of the deadline for filing, all will be well. That generally works out for them because the U.S. mail is reliable. That reliability leads many folks to think they can print off a stamp or postage label from an internet provider and drop the petition off at their nearest U.S. Post Office (USPS). Or taking it to the counter of a Fed Ex or UPS “store” is the same as taking it to a USPS counter. Again, those actions usually result in a timely petition.
More savvy (or cautious) taxpayers, however, not only know the mailbox rule, they also know Murphy’s law. They know the best way to beat Murphy’s law of mailing is to use Registered Mail or Certified Mail. Ms. Jordan was not one of the savvy. She used a private postage label printed out from Endicia.com to mail her Tax Court petition. That proved to be a mistake. To see how her case is a lesson for all of us, read on.
Lesson From The Tax Court: No Human Review Needed For Automated Penalties?
Craig S. Walquist and Maria L. Walquist v. Commissioner, 152 T.C. No. 3 (Feb. 25, 2019) (Judge Lauber) was one of two reviewed opinions issued last week that gave the IRS important wins on the scope of §6751. In Walquist the Automated Correspondence Exam (ACE) system hit the taxpayers with a §6662 substantial understatement penalty. No IRS employee even knew about it until after the taxpayers petitioned Tax Court in response to the automated NOD. Thus, there was no supervisory approval as required by §6751(b)(1). The Court decided, however, that the IRS was entitled to the §6751(b)(2) automatic computation exception to the supervisory approval requirement.
At one level, this was an easy case against two unsympathetic taxpayer hobbyists. At another level, however, the decision may create problems down the road because the facts of the case are more modest than the scope of the Court’s language. That tension between facts and language may end up harming other taxpayers ensnared by the IRS automated processes. As usual, you will find the more complete story below the fold.
Tax law often involves line drawing. Doyle v. Commissioner, T.C. Memo. 2019-8 (Feb. 6, 2019) (Judge Holmes) teaches two line-drawing lessons, one about the §104(a)(2) exclusion for payments received on account of physical injury and the other about “above-the-line” vs. “below-the-line” deductions.
Mr. Doyle was a whistle-blower who sued his former employer after it fired him. The parties settled the case without trial. The former employer agreed to pay Mr. Doyle a total of $350,000 for lost wages and another $250,000 for emotional distress. The payments were each split evenly between 2010 and 2011. For each year the employer sent Mr. Doyle a W-2 for $175,000 and a 1099-MISC for $125,000. In addition, Mr. Doyle paid some amount in attorneys fees.
You be the judge. To deal with the $125,000 payments for emotional distress, Mr. Hunter created a fake Schedule C, with a “999999” NAICS code (“unclassified establishment”). On the 2010 Schedule C he reported the $125,000 payment, and then zeroed it out by two offsetting deductions: one for $23,584 for “legal and professional services,” and one for $101,416 for “personal injury.” Mr. Hunter prepared the 2011 in much the same way, only then the deduction for legal fees was $33,000. ”Weird”? “Bizarre”? “Fraudulent”? Take your pick.
By the time Mr. Doyle got to Tax Court, he at least had an attorney who understood the difference between an exclusion and a deduction. One issue was whether the emotional distress payments were excludable under §104(a)(2). The resolution of that issue is one of the line-drawing lessons today.
But there was a second issue in the case, one that teaches a second line-drawing lesson. Mr. Doyle’s attorney, one Steven G. Early, seems to have totally missed the second issue, involving the proper place to deduct attorneys fees. Judge Holmes missed that as well. Sadly, I must confess I also missed it. But Professor Gregg Polsky caught it (and I thank him for bringing it to my attention). So I will pass that lesson on to you. Keep reading.
Last week’s case of Steven Samaniego v. Commissioner, T.C. Memo. 2019-7 (Feb. 6, 2019) (Judge Lauber) teaches a great (and short) lesson about the Tax Court’s subject matter jurisdiction. Mr. Samaniego had asked for a CDP hearing but the Office of Appeals thought his request was untimely. So it gave him an Equivalent Hearing and issued a Determination Letter to reflect its decision. Mr. Samaniego petitioned the Tax Court. Problem: the Tax Court does not have jurisdiction to review an Equivalent Hearing. Solution: Judge Lauber treated the hearing as a CDP hearing because he found that the Office of Appeals had miscounted the applicable time period. Hey Presto! Jurisdiction. But getting Tax Court review turned out to be a Pyrrhic victory for the taxpayer, because Judge Lauber found no error.
As we gear up for post-shutdown litigation over late-filed petitions this case is a useful lesson about how the Tax Court will take seriously its obligation to determine the scope of its own jurisdiction. The case also shows the Court's willingness to look through form to substance when doing so. I see the case as a direct descendant of Marbury v. Madison, 5 U.S. 138 (1803). Details below the fold.
There are two pains in life. There is the pain of discipline and the pain of disappointment. If you can handle the pain of discipline, then you’ll never have to deal with the pain of disappointment.
Nick Saban may be a great coach, but that aphorism is unhelpful in its opaqueness. Perhaps he means that if you are disciplined enough, or prepared enough, no type of disappointment can hurt you because you will have done your best. If that’s his idea, litigators likely disagree. The pain of disappointment permeates any litigator’s professional life. Even the most disciplined litigators have to deal with the disappointment of adverse fact finding by a judge or jury.
Last week it was government litigators’ turn to feel the pain of disappointment, in the case of 2590 Associates v. Commissioner, T.C. Memo. 2019-3 (Jan. 31, 2019). The case teaches a substantive lesson about the §166 bad debt deduction and a procedural lesson about the power of fact-finders, here Judge Goeke. It's a fun case to follow a Super Bowl Sunday because it tangentially involves Nick Saben. The mainstream press erroneously types it as Nick Saban's win over the IRS. That is wrong. Saban was neither a party to the litigation nor did its outcome affect his taxes. He had already taken his winnings long before the litigation even commenced. Details and lessons below the fold.
Lesson From Congress: Overbearing Oversight?
Today’s lesson comes from Congress. It is a primer on IRS oversight. It was prompted by an amazing letter I found buried on my desk.
In an October 2015 hearing, House Ways and Means Committee member Diane Black questioned then IRS Commissioner John Koskinen about the lack of IRS responses to 10 GAO oversight recommendations from July 2015.
On October 23, 2015, Koskinen sent her a letter. The letter explained the status of the 10 oversight recommendations. It then also explained the status of 200 additional recommendations from the prior three years, recommendations the IRS had also not responded to. Of the 210 total, 167 had not yet reached their original due dates for responsive actions. The other 43 were late but had received extensions from the oversight bodies who had made the recommendations: the Government Accountability Office (GAO) and the Treasury Inspector General for Tax Administration (TIGTA).
The number 210 is not the amazing part. The amazing part is that the letter explained that during that same three-year period, the IRS has dealt with some 1,240 oversight recommendations just from GAO and TIGTA. That number does not even include the myriad directives and orders from various Congressional oversight committees, nor the yearly Congressional-mandated oversight from the National Taxpayer Advocate. Thinking about the FTE’s needed to address just these 1,240 recommendations makes me dizzy.
I think you will be impressed by the amount of oversight the IRS is subject to; I make no prediction on whether your impression will be good or bad. But I hope today's lesson helps you understand that, as the IRS re-opens with its depleted workforce, it faces more than the tsunami of correspondence from worried taxpayers, and a first return filing season under the wicked complexities of the Tax Cuts and Jobs Act. It must also keep responding to a relentless review of every facet of its operations. Most of the review is done in good faith. Some of it is not, as I explain below the fold. But either way, one can reasonably ask how much is too much. Does the amount of oversight truly make for better tax administration, or not.
Alas! A closed Tax Court issued no opinions last week. Curse that federal shutdown! But the federal district courts did issue opinions. The Administrative Office of the U.S. Courts website says they have enough money (from fees) to run through January 18th. And their opinions teach lessons as well.
Today’s lesson comes from a lawsuit filed against the United States by Mr. Nicholas Morales, Jr. in 2017. He sued under §7433, a statute that gives taxpayers a cause of action against the government when any IRS employee negligently, recklessly, or willfully "disregards" any statute or associated regulation in title 26 “in connection with any collection of Federal tax.” His Complaint alleged that IRS employees had disregarded §7122 in refusing his Offer In Compromise.
The Federal District Court for the District of New Jersey has issued two opinions in the case: Morales v. United States (Morales I) on March 26, 2018 and Morales v. United States (Morales II) on January 2, 2019. Both opinions are marked “Not for Publication.” They are not, however, marked “Not for Blogging”! That’s a good thing because they actually make for a good basic lesson about the scope and limits of §7433. You will find the lesson below the fold.
Courts and commentators often tout the voluntary nature of the United States tax system. In one sense, the claim is true. The tax determination process ultimately rests on taxpayers disclosing their financial affairs and paying what they owe---through withholding or otherwise---without overt government compulsion. It is voluntary just like stopping one's car at a red light---at midnight with no traffic---is voluntary. It takes each citizen's disciplined self-enforcement of the legal duty to keep both the tax and transportation systems running smoothly.
But saying the system is voluntary is also misleading. The discipline of self-reporting and payment cannot be divorced from the constant coercive threat of discovery and the resulting civil or criminal sanctions. It's Bentham’s Panopticon. Congress weaves together civil and criminal penalties to enforce the legal duties to report and pay taxes. It leaves the ever unpopular IRS to swing the net. By my count, Chapter 68 of the Tax Code contains 48 separate civil penalty provisions to catch out taxpayers.
Today’s lesson concerns the §6663 fraud penalty. On December 26, 2018, the Tax Court issued its opinion in Richard C. Mathews v. Commissioner, T.C. Memo 2018-212. The decision was a holiday gift to a pro se taxpayer who was contesting deficiencies (and fraud penalties) assessed well after the normal three year limitation period had expired. The IRS relied on the fraud exception in §6501(c)(1) but was unable to convince Judge Vasquez that the taxpayer had the necessary fraudulent intent. This was likely a surprising result to the IRS because the taxpayer had: (1) lied to IRS agents; (2) massively unreported gross receipts for the two years at issue and many years before that; and (3) been convicted of the §7206 crime of subscribing to false tax returns for the years at issue. To find out how the taxpayer dodged the fraud penalty bullet, read on.
T his will be my last Lesson From The Tax Court for 2018. Exam-grading season has started and I need every hour to give student exams the time and attention they deserve. I will emerge from the flood of exams by January 4th and so my next Lesson will likely appear on Monday, January 7th. Writing these blog posts is loads of fun and I appreciate the opportunity Paul has given me for sharing my thoughts with you.
For my last Lesson this year, I have saved some cases that I think will make your head shake in disbelief (SMH in text parlance). Sometimes such cases teach a useful lesson, such as the one where the taxpayer took over $100,000 in charitable deductions over several years by using the original prices of clothing she bought on clearance. That taught a useful lesson about valuation and about substantiation, so I blogged it here.
The cases today are simply object lessons. Practitioners probably don’t need this lesson. But still, it may be useful to be reminded that there are perfectly ordinary people out there---folks you might well enjoy spending the holidays with or who might make a marvelous mincemeat pie---who are either so overconfident or greedy when it comes to taxes that they end up being an object lesson for the rest of us. So as you read about the following cases, I invite you to consider whether these taxpayers (and sometimes their attorneys) were unlucky, overconfident, greedy or something else, and whether, but for the grace of God, it could have been you or one of your clients?
One of the challenges of administering the tax laws to hundreds of millions of taxpayers is recordkeeping. Since the 1960’s the IRS has increasingly met this challenge by computerizing its systems of records. As a consequence, it often no longer keeps paper copies of important documents but instead relies on accurate recordation of those documents in its computerized system of accounts. For example, when the IRS sends out a Notice of Deficiency (NOD), an IRS employee inputs data to reflect the content of the NOD and inputs to reflect the issuance of the NOD. If a taxpayer (or representative) later wants to see what was in that particular NOD, the IRS can re-print the content of that NOD but does so on a new form. That’s not a copy. It’s a reprint.
The difference between a copy and a reprint was an important to last week’s case of Jeffrey D. Gregory v. Commissioner, T.C. Memo 2018-192 (Nov. 20, 2018). There, Mr. Gregory contested the Office of Appeals’ CDP determination that the IRS had taken the proper administrative steps to assess his 2009 tax liability. In particular, Mr. Gregory argued that because the IRS was unable to produce an actual copy of the actual NOD it actually sent him, the Office of Appeals could not credibly verify that the IRS had properly sent the NOD. The IRS argued that its computer records created all the evidence necessary for the Court to apply a strong presumption of correctness that the NOD existed and had been properly mailed.
Judge Halpern’s careful and thorough opinion is well worth your time, but in case you have too much holiday shopping yet to do, today’s blog will give you the short of it. The takeaway lesson here is that the IRS does not have to have an actual copy of an NOD to show it complied with administrative requirements, so long as it has sufficient other evidence to trigger a strong presumption of correctness the courts give to IRS records.
As a young child I counted the days to Christmas starting December 1st, using advent calendars. As I grew older, advertisements taught me that not all days were equal; one counted “shopping days” differently than calendar days. As I now grow old, the Christmas season starts the day after Halloween, briefly tolled by days around Thanksgiving.
Counting days is important in tax law, both for substance (e.g. figuring holding periods, allocating expenses between business days and personal days) and procedure (e.g. applying limitation periods). Fortunately, how one counts days in tax has not changed much since I was a child. So the lesson we find in last week’s case of Randy Richardson and Melisa Richardson v. Commissioner, T.C. Memo. 2018-189 (Nov. 13, 2018), should stick with us for a while.
Richardson involves a married couple who filed a CDP petition contesting NFTLs filed against them. Shortly after filing their CDP petition they filed a bankruptcy petition and received a discharge. When the IRS denied CDP relief, the Richardsons sought Tax Court review, arguing that the IRS did not correctly account for the discharge they got in bankruptcy. They ended up before Judge Lauber. The resulting lesson is how counting days can be important to resolving the question of what taxes the IRS can later collect. Even more important, it’s a lesson on when NOT to use CDP, but to instead request an “Equivalent Hearing.” Details below the fold. You can count on it.
I love classic rock from the 70’s. Not just for all the great music, but for the way that the bands help me teach tax. For example, Fleetwood Mac teaches a lesson about §162 deductions for uniforms. I know, I know, you would think that lesson would come from the Village People, but it was Stevie Nicks who filed a petition in Tax Court after the IRS disallowed her deduction for stage clothing.
The Eagles’ classic “Hotel California” provides an excellent way to think about Tax Court procedure, as we can learn from the recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018). In that case, the Tax Court dismissed as untimely Mr. Sadek’s 2017 petition contesting a 2011 NOD that the IRS had sent Mr. Sadek. The NOD was for $25 million and Mr. Sadek has not yet had a day in court to contest that amount. Oh, sure, he can sue for a refund but only if he fully pays the deficiency. Flora v. United States, 362 U.S. 145 (1960). He could also file bankruptcy and ask the bankruptcy court to determine his tax liability under its powers in 11 U.S.C. §505. But Mr. Sadek’s best hope might come in a CDP hearing. That is what I want to explore in this post.
I think this case teaches a lesson about the relationship between the Tax Court’s deficiency jurisdiction and its CDP jurisdiction. The question is whether Mr. Sadek, who has now lost in Tax Court, will be able to contest the merits of the $25 million in a CDP hearing. To answer that question, we need to understand the Hotel California rule and how it affects a taxpayer’s ability to turn what is ostensibly a hearing about collection into a hearing about tax liability.
The rich really are different, and not just because they don't cut coupons. It often seems that they escape the rules that apply to the rest of us. Thus, there is understandable fascination when rich bad actors get a comeuppance. That is probably why so many folks blogged last week's decision about Wesley Snipes, where the Tax Court found that the Office of Appeals did not abuse its discretion in rejecting Snipes' OIC that would pay less than 4% of his $23.5 million tax liability. "Tax Girl" Kelly Erb put up this terrific post if you want the salacious details.
Today I want to look at a different bad actor, one just as rich as Snipes, albeit a bit less famous. The recent case of Daniel Sadek v. Commissioner, T.C. Memo. 2018-174 (Oct. 16, 2018), raises the question of whether the IRS is entitled to rely upon its records when sending an NOD to a rich and famous taxpayer who “everyone knew” had fled to Lebanon to ride out an FBI investigation.
In 2011 the IRS sent Mr. Sadek an NOD for over $25 million in tax deficiencies for the year 2005 and 2006. Mr. Sadek did not file his Tax Court petition until 2017. The IRS moved to dismiss because, it said, the petition was filed way after the expiration of the §6212 period to petition the Tax Court. Mr. Sadek also moved to dismiss because, he said, the NOD was not sent to his last known address. The IRS had sent the NOD to an address Mr. Sadek had left long before 2011.
The Tax Court indeed dismissed the case for lack of jurisdiction. But since the Tax Court might lack jurisdiction either because of an IRS screw-up (not properly sending the NOD) or because of a taxpayer screw-up (not timely filing a petition) it is important to understand which party messed up and why.
The case teaches a useful lesson about when and how the IRS can rely on its own records in order to meet the last known address requirement. I think Judge Goeke here got the right result, but I do question how he got there and so I offer what I (oh so modestly) believe is a better path.
In last week's blog post about Loveland v. Commissioner, we learned that declining the opportunity to go to Appeals for a post-assessment hearing did not bar the taxpayer from raising the non-appealed issue in a later CDP hearing. This was good for the taxpayer because the declined hearing was non-reviewable whereas the CDP hearing was reviewable (albeit lightly) by the Tax Court. And we all clapped when the Tax Court remanded the case to Appeals to properly consider the OIC issue and gave Appeals some guidance on how to do that. The Tax Court thought that lesson so important that it made Loveland a reviewed opinion.
This week gives a contrasting lesson. The contrast will not have you clapping. This week's case involves the more common lesson that that a pre-assessment opportunity for a hearing with Appeals does indeed preclude the taxpayer from raising the issue in a later CDP hearing. So it is not a reviewed opinion. But I also see a second lesson here, about exposure to the Trust Fund Recovery Penalty (TFRP). I see this case as one about a Payroll Service Provider who went too far in accommodating her client's needs and thereby exposed herself to the TFRP, perhaps needlessly. This lesson may make you put you hands together, but more likely in prayer for your clients who are in the business of providing payroll services.
The case is Joanna Kane v. Commissioner, T.C. Memo. 2018-122 (Aug. 6, 2018), and the details, as usual, lie below the fold.
Lesson From The Tax Court: What Is A 'Liability' For §108 Purposes?
To qualify for the insolvency exclusion in §108(a) one has to be insolvent. Section 108(d)(3) defines insolvency as "the excess of liabilities over the fair market value of assets." But nothing in the Code or Regulations defines the term "liabilities." The recent case of Richard Bryan Jackson and Nora Irene Jackson v. Commissioner, T.C. Summ. Op. 2018-43 (Sept. 17, 2018), teaches a lesson about the meaning of that word.
In February, I wrote about Discharge of Indebtedness (DOI) Income. I called it “The Phantom of The Tax Code.” Readers will recall that when a taxpayer obtains a loan, the loan proceeds are not reportable as gross income, but it is not entirely clear why. The most common reason given is that the borrowed funds do not represent a increase in wealth because they are offset by the obligation to repay. I call this the balance sheet theory. The logic of this theory means that when the obligation to repay is discharged or relieved by the creditor, that discharge increases the taxpayer’s wealth to the extent that it frees the taxpayer from the obligation. I go into more detail in my February post.
Section 108(a) reflects this balance sheet theory by allowing taxpayers to exclude DOI from gross income when they are insolvent but limiting the exclusion to the amount of the insolvency at the time of the discharge. For example, if a taxpayer is discharged from $10,000 of debt at a time when the taxpayer is insolvent by $6,000, then the taxpayer can exclude $6,000 of the DOI from income but must report the remaining $4,000 as gross income.
Today’s lesson is about what types of obligations count as liabilities for purposes of determining insolvency. It turns out that not every obligation to pay someone is a liability. To see why, read on!
In 2015, Congress added what is commonly called the “Taxpayer Bill of Rights” to the Tax Code. Currently codified in §7803(a)(3), it lays upon the IRS Commissioner the duty to ensure that IRS employees “are familiar with and act in accord with taxpayer rights as afforded by other provisions of this title.” Section 7803(a)(3) then lists 10 (natch!) rights including “the right to be informed” and “the right to appeal a decision of the Internal Revenue Service in an independent forum.” I wonder whether the person who drafted that last quoted language, or any of the folks who reviewed it, discussed whether it makes any grammatical sense for one to “appeal...in” a forum?
Putting aside the grammatical question, readers might well question the impact of these rights on IRS operations. The recent case of Paul T. Venable, II v. Commissioner, T. C. Memo. 2018-144 (Sept. 10, 2018), suggests an answer for the two rights I quoted above: the right to be informed and the right to appeal an IRS decision to an independent forum. It teaches a lesson about the rare situation where the lack of actual receipt of an IRS notice can be important to a taxpayer’s ability to get judicial review of an IRS decision. But the lesson does not come from the language in §7803(a)(3). Nope, the lesson comes from language in “other provisions” in the Code, notably the CDP provisions in §6330(c).
Congress eliminated the deduction for alimony in the December 2017 Reconciliation Act (informally called the Tax Cuts and Jobs Act). But the legislation grandfathered in alimony payments made pursuant to divorce or separation instruments executed on or before December 31, 2018. The question of whether a payment qualifies as alimony will thus still be important for many taxpayers for years to come. The short lesson from the recent decision in Jeremy Adam Vanderhal v. Commissioner, T.C. Sum. Op. 2018-41 (Sept. 5, 2018) is thus worth blogging about. Plus, it's nice to blog about one of those very rare wins for a pro se taxpayer.
This is mainly a drafting lesson: the tax effect of language in a divorce or separation instrument turns on what the language does more than what the language says it does. Here, Judge Carluzzo gives a very nice lesson on how not to be distracted by what the language says it is doing.
The recent case of Harbor Lofts Associates, Crowninshield Corporation, Tax Matters Partner v. Commissioner, 151 T.C. No. 3 (Aug. 27, 2018) teaches yet another lesson on the importance of the perpetuity requirements when claiming a charitable deduction for the donation of a conservation easement. Last October I blogged about another conservation easement case, Palmolive Building Investors v. Commissioner, 149 T.C. No. 18 (Oct. 10, 2017). I did not get into the substance of the law in that blog, but instead focused on the Golsen rule and why the Tax Court needed to put its best analytical foot forward. I referred readers to Peter Reilly’s great blog post on Palmolive for the substance.
I encourage readers who don't know the Golsen rule to review the Golsen post, because Harbor Lofts is a case that the taxpayers may appeal to the First Circuit Court of Appeals. That is important because it’s the First Circuit who disagreed with the Tax Court’s position regarding the subordination requirement at issue in Palmolive. While today’s case involves a different part of the perpetuity requirement (and so there is no First Circuit precedent to bind the Tax Court), the Tax Court is again agreeing with the IRS in reading the perpetuity requirement strictly, this time finding that a long-term lease is not sufficient to meet the perpetuity requirements. If the Tax Court’s opinion is appealed to the First Circuit, the First Circuit may decide to take the same liberal interpretation of the perpetuity requirement as it did in Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), the case that was like Palmolive.
Today’s post will therefore comment on the Tax Court’s approach to interpreting the perpetuity requirements for conservation easements. Long story short, I agree with it. The First Circuit’s liberal approach, while understandable, is wrong. This post will explain why. To do so, I will have to dip into the substantive law with the caveat, as always, that what I say is subject to correction from alert readers who know this area better than I do. In particular, I will doubtless expose my ignorance by asking why the taxpayers did not structure the donation differently. It was likely for a reason that I just cannot see. The fun starts below the fold.
I tell my students you can often see how a court opinion will go by the opening line. In the recent case of Pacific Management Group, BSC Leasing, Inc., Tax Matters Partner, Et. al v. Commissioner, T.C. Memo. 2018-131 (Aug. 20, 2018), the first sentence signals that the opinion will not end well for the taxpayers. In that sentence Judge Lauber calls their carefully calibrated ballet-like choreographed set of structured transactions a “scheme.” Darn.
Explaining why this scheme did not work took Judge Lauber over 80 pages. And while blogging all the intricacies of the case is too much for one post, I do see one lesson in the case that I think you will find worth your time, a lesson about the common law of tax.
We often get so caught up in the intricacies of the various statutory provisions in the Internal Revenue Code that we lose sight of the fact that the U.S. legal system is based on a powerful idea: judges have the power to say what the law is and are not limited to the textual sources of law found in statutes and regulations. The traditional name for the kind of law not found in legislative pronouncements is “common law.” Judges write down their interpretations and understandings of the common law in opinions that later judges can consult. We call that precedent.
The common law tradition in the U.S. legal system influences even such a highly complex statutory and regulatory area of law as tax. In this case, Judge Lauber applied various common law doctrines to supplement and inform the relevant statutory provisions: the economic substance doctrine; the reasonable compensation doctrine; and the assignment of income doctrine. Again, it would be too much to cover all of these. So I will discuss only one: the common law of assignment of labor income. It’s an appropriate lesson for this Labor Day morning.
A recent Tax Court case teaches a lesson about the §6672 Trust Fund Recovery Penalty (TFRP), and about the proper scope of a Collection Due Process hearing. In Kathy Bletsas v. Commissioner, T.C. Memo. 2018-128 (Aug. 14, 2018), the IRS found Ms. Bletsas to be a responsible person who willfully failed to turn over trust fund taxes. So the IRS assessed a §6672 penalty against her and filed a Notice of Federal Tax Lien (NFTL) to encumber all her property and rights to property. Ms. Bletsas asked for and received a Collection Due Process (CDP) hearing about the NFTL.
Represented by the indefatigable Frank Agostino (and by Malinda Sederquist), she argued that the collection decision to file an NFTL was an abuse of discretion because the IRS was getting steadily paid through an Installment Agreement (IA) with the employer and so did not need to file the NFTL against the Ms. Bletsas. And, hey, she wasn’t really a responsible person anyway!
A pair of cases over the past few weeks teach a lesson about the Affordable Care Act (ACA) premium assistance tax credit calculations. The cases are Terry Jay Grant and Twila Rose Grant v. Commissioner, T.C. Memo. 2018-119 (Aug.1, 2018) and Luis Palafox and Hilda Arellano v. Commissioner, T.C. Memo. 2018-124 (Aug. 7, 2018).
Readers are no doubt aware that the ACA (a/k/a Obamacare) requires all individuals to purchase health insurance, requires all health insurance plans to contain certain provisions, and subsidizes the purchase of health insurance via a tax credit mechanism. At the federal government level, the ACA splits up regulatory duties between HHS and the IRS. HHS regulates stuff like the content of health plans, the establishment of the health exchanges and eligibility requirements, reimbursement policies, and procedures. The IRS regulates the collection of taxes Congress enacted to fund the law, including the “shared responsibility payment” owed by taxpayers who fail to purchase health insurance (which, as Justice Roberts explained to a surprised readership, is a “tax” for constitutional purposes but not a “tax” for statutory purposes). But there are several provisions that require significant coordination between the two agencies.
The health care premium subsidies Congress put in the Tax Code are one such provision. To help certain individuals afford the mandatory health insurance coverage, Congress chose to subsidize the cost of insurance with federal funds. Congress chose a tax credit as the mechanism to implement the subsidy. Located in §36B it is there called the Premium Assistance Credit, but is commonly called the Premium Tax Credit (abbreviated PTC). Certain taxpayers can choose to take the credit as an advance, commonly called the Advance Premium Tax Credit (APTC). The APTC is paid directly to the insurance provider and not to the individual taxpayers.
This subsidy structure creates two problems. First is an awkward timing problem because taxpayers must guesstimate their eligibility for the subsidy and then true-up over a year later when they file their tax returns. Second is a communication problem because the federal monies are paid directly to the insurance provider who must then properly communicate the amounts to the taxpayers so the taxpayers can do the true-up.
The two cases teach a lesson about the timing problem and the harsh consequences for messing up the guesstimate.
This article addresses a different aspect of how equitable doctrines affect a jurisdictional time period in tax law. When one studies the case law, one finds many instances where the Tax Court—often blessed by the Courts of Appeals—laments that it may not equitably “enlarge” or “extend” jurisdictional time periods, but then accomplishes the same result through its discretionary fact-finding power. In effect, it cheats. Less dramatically, it creates fictions to cover the gap between what is and what ought to be. While denying the power to use equitable principals to modify the legal bed, it instead uses equitable principles to stretch or lop off facts to fit a procrustean conception of the relevant limitation period.
I'm back from vacation, but busy preparing for the start of classes, so I offer another Classic Lesson that I have been saving. I hope you enjoy it. I will return next week with a new Lesson based on a recent case.
I find tax more interesting than football. But I know I am not like most people. So I enjoy using the classic case of Hornung v. Commissioner, 47 T.C. 428 (1967), because it not only teaches students a bit about football history, it also helps them understand a really important tax concept: the doctrine of constructive receipt. As a bonus, it is also one of those fun cases where the taxpayer and the IRS take the opposite of their normal positions, with amusing consequences.
Paul Hornung was an outstanding football player in the 1960’s, winning a bunch of very well known awards: the Heisman Trophy, the NFL MVP award, and induction into both the professional and college football halls of fame. Here's a Sports Illustrated tribute to him.
Hornung also won a Corvette on December 31, 1961, when his team (the Green Bay Packers) beat the New York Giants for the National Football League Championship. Remember, at that time the NFL was the main football league so this was, basically, the Super Bowl. The AFL was only just starting and it was several years before the first designated “Super Bowl” game occurred between the leagues.
Hornung was selected by Sport Magazine as the game’s most valuable player. That selection came with an award: a brand-spanking new 1962 Corvette. The award was announced in Green Bay at the conclusion of the game in the late afternoon of Sunday, December 31, 1961. The car was in Manhattan. Hornung picked up the car the next week at a lunch given in his honor by the magazine. He sold the car a few months later for just over $3,000. He did not report any income from receiving the Corvette, either in 1961 or in 1962. When the IRS audited his 1962 return, he claimed that if receipt of the Corvette was income, it was income in 1961, not 1962, under the doctrine of constructive receipt. To see how that worked out for him, you will need to dive below the fold.
'm on vacation this week but I wrote up this Classic Lesson before I left so you could have something to chew on as you drink your morning beverage of choice.
Timing is at least as important in tax as it is in comedy. Although less common than it used to be before the age of direct deposit and mobile banking apps, the question sometimes arises about when must a taxpayer report as gross income a check received on December 31st but not cashed until January. The flip side is when may a taxpayer take a deduction for a check sent out on December 31st but not cashed until January.
Taxpayers tend to want to push off reporting income into a later year and tend to want to pull back deductions into the current year. Specifically taxpayers who receive a check on the last day of the year would like to say they don’t have income until they cash the check in January. But at the same time, taxpayers who write a check for a deductible expense on the last day of the year want to deduct that expense in that year and not the next.
Taxpayers cannot have it both ways. The good news is that the IRS has long allowed checks mailed on December 31st to be deductible in the year mailed, even when not cashed until January, so long as the taxpayer has truly parted control over the delivery of the check. See Treas.Reg. 1.170A-1(b).
The bad news is that taxpayers are also generally required to report checks received on December 31st as income. The rationale for that, however, is not entirely clear, as one sees in the classic case of Kahler v. Commissioner, 18 T.C. 31 (1952).
This past week I learned a lesson about partnership tax returns from the case of Inman Partners, RCB Investments, LLC, Tax Matters Partner, v. Commissioner, T.C. Memo. 2018-114 (July 23, 2018). Partnership taxation is definitely out of my comfort zone, so I am quite grateful for the help of my colleagues on the double-super-secret-tax-profs-rule-the-world listserv that Paul Caron started back in 1995, shortly after the internet got its graphical interface. They got me straight on some terminology and sent me off reading some cool stuff. Still, readers may well spot error, and if you do, please give a correction in the comments. I am especially hesitant when I think I spot an error in a Tax Court opinion as I did here. I know full well the error could be mine.
Judge Holmes held that the language in the Form 872 was strong enough to also waive the limitation on assessment for the related partnership for an earlier tax period. It might be, however, that the language worked only because of the statutory scheme then in place for partnership audits. Congress nuked that scheme in the December 2017 tax reform legislation. Does Inman give us any insights on whether the Form 872 language still works? For a quick swim through the murky waters of partnership procedure, I invite you to dive below the fold.
Last week’s post involved taxpayers whose tax troubles arose from events related to the Great Recession. Those troubles resulted in litigation and a lesson about how the Tax Court applies an “origin of the claim” test in evaluating claimed §104(a)(2) exclusions.
This week’s post also involves a taxpayer whose life took a downturn during the Great Recession. Only this week we look at the more traditional application of the “origin of the claim” test when taxpayers seek to deduct litigation expenses. In Sky M. Lucas v. Commissioner, T.C. Mem.o 2018-80 (June 11, 2018) the IRS sent Mr. Lucas an NOD asserting a tax deficiency of $1.7 million for 2010. Part of that deficiency was due to the disallowance of about $3 million in legal and professional fees related to Mr. Lucas’ divorce litigation. The multi-year litigation was a fight over some $47 million. No wonder it was expensive. In the end, Mr. Lucas got to keep most of that. Mr. Lucas thought he could deduct his litigation costs. For a great lesson in how the Tax Court applied the origin of the claim test to deny him the deduction, see below the fold.
Here at Texas Tech we require all law students to take the basic course in federal income tax. That is not because we are especially cruel, but rather because tax law touches so many other areas of practice that the faculty believes every student should have an introduction to tax. I must shape my course knowing that at least two thirds of the students do not want to become tax lawyers. One tack I take is to highlight tax issues that regularly come up in other practice areas such as family law and litigation.
A case from the Tax Court last week teaches a useful lesson about the intersection of tax with litigation practice. Jacques L. French and Sherry L. French v. Commissioner, T.C. Summary Op. 2018-36 (July 12, 2018) involves taxpayers seeking to exclude a settlement payment under §104(a)(2), the section that allows taxpayers to exclude from gross income the amount of damages received because of personal physical injury or physical illness.
We usually think about the “origin of the claim” test in the §162 context, where courts use it to decide when taxpayers may deduct expenses associated with litigation. In fact, just this last week I saw another Tax Court opinion that involves this application of the origin of the claim test. I may blog that next week, unless something else catches my eye.
This week, however, I think it is useful to see how the Tax Court takes a very similar approach to deciding when a taxpayer can exclude a damage award under §104(a)(2). In both situations, it is the nature of the claim asserted in litigation that governs the potential exclusion or the potential deduction. Looking at §104(a)(2) also allows me to give a shout out to the Tax Court's newest Special Trial Judge, Diana L. Leyden. Her carefully constructed opinion shows us exactly how the Tax Court applies this “origin of the claim test” in the §104(a)(2) context. It makes for a nice lesson from the Tax Court.
Lesson From The Tax Court: Naked Assessments!
The Notice of Deficiency (NOD) is almost always clothed with a presumption of correctness. Some might say “cloaked” or “shrouded” are a better terms because what the presumption does is shield all that happened prior to the NOD from judicial scrutiny. Courts will generally not go behind the NOD to examine how the IRS came up with its numbers unless and until the taxpayer gives the court a good reason to disbelieve the NOD (or successfully invokes §7491(a), the provision that shifts the burden of production from the taxpayer to the IRS).
It is easy to apply the presumption of correctness in situations where the NOD is simply denying deductions or exclusions. That is because the taxpayer already bears the burden of proving an entitlement to deductions and exclusions. So if the taxpayer cannot come up with the proof, then too bad, so sad.
It is more difficult to apply the presumption in situations where the NOD asserts that the taxpayer failed to report gross income. In that situation, the IRS must have some basis for the assertion of omitted income. That is, the presumption of correctness does not allow the IRS to just make up numbers. In the seminal case of United States v. Janis, 428 U.S. 433 (1976), the Supreme Court said that “where the assessment is shown to be naked and without any foundation” then the burden shifts to the IRS to show facts that link the taxpayer to the alleged omitted income. I really love the delightfully mixed metaphor the Fifth Circuit used in Carson v. Commissioner, 560 F.2d 693, 696 (5th Cir. 1977): "The tax collector's presumption of correctness has a herculean muscularity of Goliath-like reach, but we strike an Achilles' heel when we find no muscles, no tendons, no ligaments of fact."
Two recent Tax Court cases teach a lesson on what “ligaments of fact” suffice to prevent an NOD from being “naked and without any foundation.” In both of these omitted income cases, the IRS was able to produce enough facts to get back the presumption, but in very different ways. The cases are: Gerald Nelson v. Commissioner, T.C. Memo. 2018-95 (June 28, 2018); and Mohammad Najafpir v. Commissioner, T.C. Memo. 2018-103 (July 3, 2018).
Sometimes I get irritated. When I do I speak in short sentences. Really short. So when I read Judge Buch’s opinion in the recent case of Gary Gaskin and Jessie Gaskin v. Commissioner, T.C. Memo. 2018-89 (June 20, 2018), I was struck by his frequent use of short sentences. Really short. Kinda like he was really irritated. And why wouldn’t he be? Mr. Gaskin had filed admittedly fraudulent tax returns but now wanted to contest the fraud penalties! Mr. Gaskin thought he should escape fraud penalties because he had later filed amended returns that had, in his view, cured the fraud. Judge Buch's opinion teaches an important lesson we should all learn. I call it the “one return rule.” It’s a short lesson. You will find it below the fold.
I avoid inventory accounting in my basic tax class. It is taxing enough (pun intended) to teach students the basics of depreciating business equipment and business realty and the interplay of §167, §179, §168(k) and §168(a) (in that order). I remind them that they are learning to be tax lawyers and not tax accountants: if they cannot do the numbers, hire a CPA. So I only mention cost of goods sold (COGS) concepts in passing. Also, I’m pretty clueless about the subject.
In real life, however, inventory accounting can be crucial, and you had better have good representation when the IRS questions your numbers. That is the lesson I see in the recent case of Laurel Alterman and William A. Gibson v. Commissioner, T.C. Memo. 2018-83 (June 13, 2018), a case involving poor representation of a medical marijuana business. Disclaimer: not only do I not teach COGS but I also never practiced it, so if you dive below the fold, you may catch me out in error. I know for some readers that is actually an incentive to read on---kind of like waiting for a crash on the racetrack. But if you find yourself guffawing at something, please do not hesitate to publicize the error in the comments section. And remember, at least I’m not representing anyone!
Lesson From The Tax Court: Where Is A Retiree's Tax Home?
The last couple of weeks have seen Tax Court cases with several interesting lessons. The one I choose today is Roger G. Maki and Lilane J. Gervais v. Commissioner, T.C. Summary Op. 2018-30 (June 6, 2018). It teaches a lesson about what constitutes travel “away from home” for purposes of the §162 deduction. I posted a basic lesson (here) on this issue late last year. The wrinkle in today’s case is that the taxpayer was retired and traveled from his home in the Seattle metro area to a house he had inherited, ostensibly to manage the surrounding land for eventual timber sales. The Tax Court decided the travel was deductible. I question whether that’s the right outcome here — it seems to me this was just a commute — but notice this is just a Summary Opinion. That means it can still teach a lesson, even if it carries no precedential weight.
Tax reminds me of the children’s poem that starts “I have a little shadow.” Tax is the shadow (sometimes not so little) that follows all of us throughout life. Put another way, every activity in life throws a tax shadow. And life is not simple. I submit that much of tax complexity is a reflection of life’s complexity, including people’s relationships with one another. And we all know how relationships can get complicated. Last week’s case of Joseph Engesser v. Commissioner, TC Summary Opinion 2018-29 (June 4, 2018), not only illustrates this idea, but it also shows how certain parts of the Tax Code’s complexity hits lower income taxpayers particularly hard. They must deal with one of the gnarliest tax issues in the Code: §152, the section that defines who is a dependent.
Four cases from the last couple of weeks illustrate the continued fallout from the Tax Court’s recent about-face in its reading of §6751(b)(1). Graev v. Commissioner, 149 T.C. No. 23 (Dec. 20, 2017)(commonly called Graev III because it was the Tax Court’s third published opinion regarding Mr. Graev’s case). The good folks at Procedurally Taxing have been following Graev III’s impact here, here and here (to name a few). These four cases add a new wrinkle.
In all four cases, the Service had failed to produce evidence in the initial trial that it had complied with §6751(b)(1). And for good reason. All four cases had gone to trial before the Court issued its opinion in Graev III. At the time of trial the Tax Court’s fully reviewed position on §6751(b)(1) was that consideration of penalty approval was premature when contesting an NOD.
In all four cases the Service asked the Tax Court to re-open the record to allow it to introduce the theretofore-unrequired-but-now-required evidence. The cases were heard by three different Tax Court judges. In two cases, the Court allowed the record to be reopened and in two cases the Court refused. Taken together, the cases illustrate how the fallout from the Tax Court’s Graev decision continues to elevate procedure over substance. As a result, similarly situated taxpayers receive very different outcomes based both on which IRS attorneys work the cases, what information the attorneys have, perhaps most importantly, which Tax Court judge decides. Four cases, three judges, two opposing outcomes, all in one discussion, waiting for you below the fold.
Who Are The Tax Professors?
The 4th Annual Texas Tax Faculty Workshop at Texas Tech on June 1st went splendidly with robust discussion fueled by plenty of caffeine and carbs. I thought it would be fun to post a picture of the 11 of us when ended up being able to attend. After all, tax profs are usually just names on a page. But we are persons too! Here's proof. From left to right are: Bret Wells (UH); Bryan Camp (Texas Tech); Denney Wright (UH and NYU); Andy Morris (A&M); Bruce McGovern (South Texas); Cal Johnson (UT); Terri Helge (A&M) standing behind Dennis Drapkin (SMU); Bill Byrnes (A&M)(giving thumbs up); Steve Black (Texas Tech) standing behind Jack Manhire (A&M).
For abstracts of each paper, see below the fold.
A truism is a saying that is so commonly accepted as true that it needs no further explanation. For example: "never get involved in a land war in Asia.” Today’s lesson shows us a tax truism: never take tax advice from the person selling you the deal. In RB-1 Investment Partners, Eric Reinhart, Tax Matters Partner v. Commissioner, T.C. Memo. 2018-64 (May 14, 2018), the taxpayer received millions of dollars from the sale of a business and invested in a complex transaction that the promoter promised would magically wipe away the gain with no actual economic loss (except fees). When the taxpayer got caught, it conceded the merits, but attempted to avoid imposition of a 40% penalty under §6662 by arguing reasonable reliance on an opinion letter from the law firm promoting the scheme. I explain below the fold the taxpayer’s argument, why it failed, and what we can learn.

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