IRS Tax Cases, Rulings and Changes in the Federal Law

By Lauren G. Hughes

Wise & Reber LC

Tax Cases

1. In re Bowman, 632 B.R. 64 (Bankr. E.D. La. 2021)

Bowman was a bankruptcy case in which the debtor, a widow, objected to a claim filed by the IRS in the amount of $96,759 by asserting that she qualified for innocent spouse relief under Code Sec. 6015. After the Court walked through (1) the validity of the claim (it was a valid claim) and (2) the burden of proof (because the claim was valid, the dispute for such claim shifted to the debtor), the Court denied the widow’s motion for summary judgment finding that there was a genuine fact dispute as to whether she did in fact qualify for equitable relief under Code Sec. 6015(f).

The Court noted: “[A]s a general rule, when married persons file a joint income tax return they become jointly and severally liable for the tax due with respect to that return.” In re Wyly, 552 B.R. 338, 464 [117 AFTR 2d 2016-1508] (Bankr. N.D. Tex. 2016). But “under certain circumstances, such liability could be unfair.” Id.

Pursuant to Section 6015(f) of the Internal Revenue Code, a spouse may obtain relief from tax liability if she can establish that under “all the facts and circumstances, it is inequitable to hold [her] liable for any unpaid tax.” Haggerty v. Comm’r, 505 F. App’x 335, 337 [111 AFTR 2d 2013-411] (5th Cir. 2013) (quoting 26 U.S.C. § 6015(f)). “The Commissioner has issued revenue procedures to guide courts in determining whether a requesting spouse is entitled to relief from joint and several liability.” Id. Revenue Procedure 2013-34 provides guidance in this case regarding whether the Debtor is entitled to equitable relief under Section 6015(f) and lists seven general conditions for relief. See Rev. Proc. 2013-34, 2013-43 I.R.B. 397, § 4.

Those conditions include

(1) The requesting spouse filed a joint return for the taxable year for which she seeks relief; (2) Relief is not available to the requesting spouse under §§ 6015(b) or (c); (3) The claim for relief is timely; (4) No assets were transferred between the spouses as part of a fraudulent scheme by the spouses; (5) The non-requesting spouse did not transfer “disqualified assets” to the requesting spouse as that term is defined in § 6015(c)(4)(B); (6) The requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and (7) The income tax liability from which the requesting spouse seeks relief is attributable in full or in part to an item of the non-requesting spouse or an underpayment resulting from the non-requesting spouse’s income and only to the extent the liability is attributable to the nonrequesting spouse. In her request for innocent spouse relief, the Debtor attached a copy of her husband’s Certificate of Death, a letter from her family physician addressing the Debtor’s mental health condition, a copy of her Request for Innocent Spouse Relief submitted to the IRS, a copy of Revenue Procedure 2013-34, and a schedule purported to be generated by the IRS listing tax liability amounts which would have been due by the Debtor if the liability had been based solely on her income for the years 2009 to 2013. The Debtor believed that she submitted sufficient evidence that satisfied her burden to demonstrate that no genuine issue of material fact exists regarding her qualification as an innocent spouse under Section 6015(f).

While the IRS relied in large part on sworn documents, the IRS asserted that the evidence alone did not absolve the fact that genuine issues of material fact existed as to whether the Debtor qualifies for equitable relief under Section 6015(f).

The Court agreed with the IRS and found that insufficient evidence had been presented to determine whether the Debtor, as a matter of law, qualified for equitable relief under Section 6015(f). Although taxpayer submitted the documents outlined above, she failed to satisfy threshold requirements for relief, including regarding whether income tax liability from which she sought relief was attributable in full or in part to item of husband or underpayment resulting from his income. She also failed overall factors test.

The key takeaway from Bowman is that when applying for innocent spouse relief, the applicant must take care that each factor listed in Section 6015(f) be carefully met in the application process.

2. Estate of Lee v. Commissioner (TC Memo 2021-92)

In a memo opinion, the Tax Court determined that an estate’s executor was personally liable for the estate’s unpaid estate taxes because he made distributions of estate assets knowing that the estate owed the taxes.

An executor is personally liable for the unpaid “claims” of the U.S. to the extent the executor distributes assets from the estate when either (1) the estate was insolvent at the time of the distribution, or (2) the distribution rendered the estate insolvent and the executor had knowledge or notice of the U.S.’s claim. 31 USC §3713(b). A “claim” includes an estate’s federal tax liability.

In April 2006, the IRS sent Mr. Frese, a licensed attorney who was Executor of the estate of Kwang Lee, a notice of deficiency claiming the estate owed over $1,000,000 in estate tax. Executor promptly filed a petition in the Tax Court disputing the estate tax claim.

Executor distributed $640,000 of estate assets. As a result of this distribution, the estate retained assets of only $183,000, which was not enough to satisfy the possible estate tax claim.

In March 2010, the Tax Court issued a decision finding the estate owed $536,151 in estate tax.

In 2013, the IRS sent the Executor a notice of federal tax lien. In response to the lien notice, Executor submitted an offer-incompromise based on doubt as to collectibility, to settle the estate tax claim.

The IRS declined the offer-in-compromise as too low because it determined that the estate’s reasonable collection potential included amounts it could collect from Executor under the federal priority statute.

The estate argued that Executor didn’t have knowledge or notice of the estate tax claim as required under the federal priority statute. As a result, he wasn’t personally responsible for the estate tax claim so the IRS couldn’t collect from Executor.

The Court ruled that the Executor was personally liable for estate tax claim. According to the Tax Court, the Executor had both knowledge and notice of the estate tax claim in February 2007 when he distributed the estate’s assets.

First, the Tax Court found that the Executor had notice of the estate tax claim because in April 2006 he received a deficiency notice from the IRS. According to the Tax Court, a notice of deficiency with respect to estate tax liabilities received by an executor before the distribution of estate assets satisfies the notice requirement in the federal priority statute.

Second, the Tax Court determined the Executor had actual knowledge of the estate tax claim because he was a named party in the Tax Court petition the estate filed disputing the deficiency notice it received in April 2006.

The Tax Court also noted that the Executor, a licensed attorney, made the February 2007 distribution knowing that the IRS had determined an estate tax deficiency against the estate, and that an action disputing that deficiency claim was pending before the Tax Court. Under these circumstances, Executor “made the February 2007 distribution at his own peril and any advice he may have received” from a tax professional regarding the distribution did not absolve him from liability.

3. Johnson v. Nat’l Collegiate Athletic Ass’n, Civil Action 19-5230 (E.D. Pa. Aug. 25, 2021)

In Johnson, the plaintiffs were all student athletes in a variety of sports and National Collegiate Athletic Association (NCAA) schools. While the NCAA is not an unfamiliar organization to most, in its most basic form, the NCAA is an association that regulates intercollegiate sports and has jurisdiction over approximately 1,100 schools and nearly 500,000 student athletes. It has multi-year, multi-billion dollar contracts with broadcasters ESPN, CBS, and Turner Sports to show sporting events between NCAA member schools, and it distributes shares of those broadcasting fees to its member schools. All member schools in the NCAA have agreed not to pay students to participate in intercollegiate varsity sports.

The NCAA and member colleges exercise significant control over the student athletes. For example, the NCAA has bylaws which apply to all student athletes, and the bylaws address “recruitment, eligibility, hours of participation, duration of eligibility, and discipline.” The student athletes are supervised by coaching and training staff, and NCAA Division I member schools are required to have adult supervisors maintain time sheets for participants. They also have handbooks that contain standards for controlling student athletes’ performance and conduct.

NCAA D-I member schools impose discipline, including suspension and dismissal from a team, in instances of specified misconduct. NCAA D-I member schools also publish supplemental handbooks with standards used to control the performance and conduct of student athletes both on and off the field. These handbooks contain rules regarding agents, prohibiting certain categories of legal gambling, and restricting social media use, including restrictions on making derogatory comments about other teams. NCAA D-I member schools also have team policies that restrict the legal consumption of alcohol and legal use of nicotine products by student athletes.

Based upon these factual allegations, the complaint asserted that student athletes are the employees of Defendants, including the associated schools defendants (ASD). The athletes asserted claims for violations of the Fair Labor Standards Act (FLSA) 29 U.S.C. § 200 et seq., the Pennsylvania Minimum Wage Act (“PMWA”), the New York Labor Law,(“NYLL”), and the Connecticut Minimum Wage Act (“CMWA”) and that they are employees of the schools and thus are entitled to be compensated. The ASD moved to dismiss the complaint pursuant on the ground that they do not employ the student athletes.

The court determined that out of several tests for determining an employment relationship, the one best suited in this situation was Glatt v. Fox Searchlight Pictures Inc., 811 F.3d 528, 536-37 (2d Cir. 2016), which examined the relationship between interns and their employer. The Glatt court outlined a list of factors that put more reliance on who the primary beneficiary is in the relationship. For example, some of the factors include

• The extent to which the intern and employer understand that there is no expectation of compensation (any express or implied promise of compensation supports a finding that the worker is an employee); • The extent to which the internship provides training that would be similar to that which would be given in an educational environment; • The extent to which the internship is tied to the intern’s formal education program by integrated coursework or the receipt of academic credit; • The extent to which the internship accommodates the intern’s academic commitments by corresponding to the The REPorTer 9

academic calendar; • The extent to which the internship’s duration is limited to the period in which the internship provides the intern with beneficial learning; • The extent to which the intern’s work complements, rather than displaces, the work of paid employees while providing significant educational benefits to the intern.

The court noted that it is important in these cases to look to the economic realities of the relationship in determining employee status under the FLSA.

The court analyzed the facts pursuant to those set forth the Glatt case, and held that the complaint plausibly alleges that student athletes are employees of the ASD under the Glatt test and denied the motion for summary judgment.

4. Gaston v. Commissioner (T.C. Memo. 2021-107)

In Gaston, the taxpayer began an acting career following her retirement from marketing. She took several business deductions related to her acting pursuits, but clearly showed on her return that she had a clear profit objective in pursuing an acting career — that her acting career was not just a hobby in which she was attempting to offset her expenses. Notably, she secured roles in feature-length films; she spent 35-45 hours per week researching, applying, or auditioning for other roles; trained to enhance her skills through acting and voice lessons; retained an assistant and agent to help her obtain new roles; and otherwise carried on activity in a businesslike manner.

The IRS denied these deductions and stated that the taxpayer couldn’t have had genuine profit objective because her daughter was a famous actress and the taxpayer could have had her daughter help her secure more roles if she was rejected. Essentially, the work she did in furthering her acting career, and the expenses she incurred, were superfluous because of her relationship with an established, successful actor.

Ultimately, the deductions she took in relation to her acting pursuits were shown to be proper, however, the taxpayer failed to show that another side activity (jewelry sales) was engaged in for profit; rather, the fact that she devoted only 10 hours per week, didn’t seek out expert in industry, and that she didn’t make sustained effort to sell to general public and had only intermittent sales to former associates, showed lack of profit objective for that activity.

5. Nelson v. Comm’r, T.C. Memo. 2020-81 (U.S.T.C. Jun. 10, 2020)

The Nelson decision was a gift tax deficiency case involving taxpayers’ gift and sale to a family trust of limited partner interests in a family partnership whose primary asset comprised stock interest in a family holding company. The Tax Court affirmed the deficiency.

The taxpayer reported that the transfers were fixed dollar amounts, but when reviewing the plain language of the transfer instruments, the Court determined that the transfers were actually specific percentages of the limited partner interests. The language specifically provided that the sale was for “TWENTY MILLION AND NO/100THS DOLLARS ($20,000,000.00) as of January 2, 2009, as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment …”

The transferred interests are expressed in the transfer instruments as an interest having a fair market value of a specified amount as determined by an appraiser within a fixed period. The clauses hang on the determination by an appraiser within a fixed period; value is not qualified further, for example, as that determined for federal estate tax purposes. See, e.g., Estate of Christiansen v. Commissioner, 130 T.C. 1, 14-18 (2008) (upholding gift clause providing fair market value “as such value is finally determined for federal estate tax purposes”), aff’d, 586 F.3d 1061 (8th Cir. 2009); Estate of Petter v. Commissioner, 2009 WL 4598137, at *11-*16 (upholding gift clause transferring the number of units of a limited liability company “that equals one-half the minimum * * * dollar amount that can pass free of federal gift tax by reason of Transferor’s applicable exclusion amount” along with a clause providing for an adjustment to the number of units if the value “is finally determined for federal gift tax purposes to exceed the amount described” in the first clause).

The Court specifically stated “fair market value” here already is expressly qualified. By urging us to interpret the operative terms in the transfer instruments as transferring dollar values of the limited partner interests on the bases of fair market value as later determined for federal gift and estate tax purposes, petitioners ask us, in effect, to ignore “qualified appraiser * * * [here, Mr. Shrode] within * * * [a fixed period]” and replace it with “for federal gift and estate tax purposes.” While they may have intended this, they did not write this.

Any attempts by the taxpayer to analogize the language as a formula clause were also rejected. The IRS deficiency calculation was upheld.

6. Smaldino v. Commissioner (T.C. Memo. 2021-127)

Smaldino owned and operated numerous rental properties in southern California. He placed 10 of these properties in Smaldino Investments LLC, which he owned through a revocable trust. In 2013 he transferred about 8% of the LLC class B member interests to the Smaldino 2012 Dynasty Trust, an irrevocable trust that he had created a few months earlier for the benefit of his children and grandchildren. Around the same time, petitioner purportedly transferred about 41% of the LLC class B member interests to his wife, Agustina Smaldino, who purportedly retransferred them to the Dynasty Trust the next day.

On Smaldino’s 2013 gift tax return, he reported as a taxable gift only the approximately 8% of the LLC class B membership interests he had transferred directly to the Dynasty Trust. The IRS determined that Smaldino had actually made a taxable gift to the Dynasty Trust of 49% of the class B membership interests, including the approximately 41% interest that passed

from Smaldino to the Dynasty Trust indirectly through Mrs. Smaldino. After revaluing the LLC interests, respondent determined that Smaldino had a $1,154,000 gift tax deficiency for 2013.

This case involved the indirect gift doctrine. The Court reviewed the operating agreement for the LLC, looked at whether Mrs. Smaldino had any real incidents of ownership, and whether or not this transaction was in appearance only. Ultimately, the Court determined that the “substance over form” principle weighed in favor of the IRS and upheld the deficiency. Of importance to the Court

(1) The Operating Agreement expressly prohibited Mrs.

Smaldino from owning any interest in the LLC. (2) Mrs. Smaldino testified that she would not have disposed of the interest in any other way than gifting it to the LLC. (3) Mrs. Smaldino testified that her husband planned to make arrangements for her outside of the LLC if she used her estate and gift tax exemption to make the gift to the Dynasty Trust. (4) The tax return for the LLC in the year in question did not report Mrs. Smaldino as an owner. (5) Mrs. Smaldino never reported any of the income tax earnings or ownership on her own personal return.

While there were several other factors that the Court reviewed, it is important for practitioners to be aware in this climate of the indirect gift doctrine and to be careful of “substance over form” in every gifting transaction you may do with clients.

Rulings

1. PLR 202133005

In PLR 202133005 (Aug. 20, 2021), the IRS, in a private letter ruling, stated that the division of a common trust fund for the grantors’ children and more remote descendants into separate trusts for each child and his or her descendants would cause no adverse income or generation-skipping transfer tax consequences. In particular, the IRS stated that

(1) The pro-rata transfer of assets from the original trust into the newly created trusts will not result in treating any property of the original trusts as being paid, credited, or distributed for purposes of Code Sec. 661 or the regulations thereunder, and will not result in realization of income, gain, or loss by the original trust, the newly created trusts, or any beneficiary. (2) The newly created trusts will be treated as separate trusts for federal income tax purposes pursuant to Code

Sec. 643(f). (3) The tax basis that the newly created trusts will have in the assets of the original trust will be the same as the tax basis of the original trust immediately before the transfer of those assets. (4) Each historic asset of the original trust will have the same holding period immediately after the transfer to the newly created trusts that it had immediately before

the transfer. (5) Each of the newly created trusts will succeed to, and take into account, an equal portion of any net operating loss carryforward, net capital loss, and other tax attributes, including passive activity losses and credit carryforwards and statutory depletion deductions, of the original trust, and each asset transferred to the newly created trusts will have the same tax attributes immediately after the division that it had immediately before the division. (6) The GST inclusion ratio of the newly created trusts will be the same as that of the original trust.

2. Late Portability Elections – Reminder!

The IRS, in seven private rulings, allowed executors to make a late election of portability for a decedent’s estate, because the estate was under the filing threshold. In each ruling, the decedent died, survived by a surviving spouse. The value of each decedent’s gross estate was less than the basic exclusion amount in the year of death, including lifetime taxable gifts. In each ruling, the IRS allowed a late election for portability.

The IRS does not permit a late portability election when the estate is over the filing threshold, even if no estate tax was owed due to the marital, charitable, or other deductions.

Please note: Rev Proc 2017-34, 2017-26 IRB 1282 permits executors to file a late estate tax return electing portability without a private ruling, if: (i) the executor files a complete and properly prepared estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return), by the second anniversary of the decedent’s death; (ii) the executor states at the top of the form that the return is “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A)”; (iii) the decedent was survived by a spouse; (iv) the decedent died after December 31, 2010; (v) the decedent was a U.S. citizen or resident on the date of death; (vi) the executor is not otherwise required to file an estate tax return because the gross estate was less than the filing threshold; and (vii) the executor did not file a timely estate tax return. This procedure cannot be used for estates that are above the filing threshold, even if no tax was due because of the marital or charitable deduction.

Changes in Federal Law

1. Infrastructure Investment and Jobs Act

On November 5, 2021, Congress passed a $1.2 trillion bipartisan infrastructure bill known as the Infrastructure Investment and Jobs Act (the Bill). The Bill includes $550 billion in new spending on infrastructure during the next five years. The Bill was initially passed by the Senate in August, but was stalled in the House of Representatives for several months. Notably, several Democrats insisted that the Bill be tied to the Build Back Better Act. This was eventually rejected.

modernization of public transit, including addressing the repair backlog of more than 24,000 buses, 5,000 rail cars, 200 stations and thousands of miles of track and power systems; removal of lead pipes to improve the quality of drinking water; expansion of the nation’s freight and passenger rail network, including the construction of new rail corridors and transit lines; reduction of commute times by alleviating rail and roadway congestion; extending broadband internet access to rural areas, low-income families and tribal communities; and enhancement of grant and loan programs that support passenger and rail safety.

The Bill includes investments in the following areas:

Passenger and Freight Rail

The Bill allocates $66 billion to eliminate Amtrak’s maintenance backlog, modernize the Northeast Corridor and extend rail service outside of the northeast and midAtlantic. The Bill allows Congress to take additional action to invest another $36 billion for rail by 2026.

Public Transit

The Bill allocates $39 billion to modernize transit, including repairing and upgrading bus and rail fleets and extending transit services to more communities.

Roads, Bridges, and Major Projects

The Bill allocates $110 billion for roads, bridges and major projects, including $40 billion of funding for bridge repair, replacement and rehabilitation and $16 billion for major projects that would be too large or complex for traditional funding programs.

Electric Vehicle Infrastructure

The Bill includes $7.5 billion to invest in a national network of electric vehicle chargers.

Electric Buses

The Bill includes $2.5 billion for zero emission buses, $2.5 billion in low emission buses and $2.5 billion for ferries.

Airports, Ports and Waterways

The Bill provides $17 billion for port infrastructure and $25 billion in airport repairs, maintenance and emission and congestion reduction.

Safety

The Bill provides $11 billion for transportation safety programs to reduce crashes and fatalities, with a particular focus on bicyclists and pedestrians.

Power Infrastructure

The Bill designates $65 billion for upgrades to power infrastructure, research and development of transmission and electricity distribution technologies, and smart grid technologies.

Reconnecting Communities

The Bill provides $1 billion to reconstruct street grids and other infrastructure as part of an effort to reconnect

Water Infrastructure

The Bill allocates $50 billion to protect against droughts and floods and for investment in other weatherization to reduce the impact of climate change, including $3.5 billion in flood mitigation assistance grants.

Drinking Water

The Bill allocates $55 billion to drinking water, wastewater, and storm water infrastructure funding.

High-Speed Internet

The Bill includes $65 billion to bring high-speed internet to every American through broadband infrastructure improvement and expansion, and by requiring service providers who receive federal funding to offer a low-cost plan, thereby improving price transparency and increasing competition.

Environmental Remediation

The Bill includes $21 billion to remediate environmental hazards, including the clean-up of superfund and brownfield sites.

About the Author

Lauren G. Hughes, McPherson, is a member of Wise & Reber LC and practices in the areas of estate planning, estate and trust administration, and business law. She received her Bachelor of Arts in both English and American studies from the University of Kansas in 2013 and her law degree from the University of Kansas School of Law in 2016.

She currently serves on the University of Kansas School of Law’s Board of Governors. In 2020, Lauren was named the Kansas Bar Association’s Outstanding Young Lawyer of the Year.

Email: lhughes@bwisecounsel.com