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Flume v. Commissioner (T.C. Memo. 2020-80)

On June 9, 2020, the Tax Court issued a Memorandum Opinion in the case of Flume v. Commissioner (T.C. Memo. 2020-80). The primary issue before the court in Flume was whether the petitioners had subpart F income.

Burden of Proof in Unreported Income Cases

Generally, the IRS’s determinations regarding income set forth in a notice of deficiency are presumed correct and the taxpayer bears the burden of proving otherwise. See Tax Court Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). However, in cases (such as this one) involving unreported income, the IRS bears the burden of first producing or providing “some reasonable foundation” that connects the taxpayer with the income-producing activity. See Blohm v. Commissioner, 994 F.2d 1542, 1549 (11th Cir. 1993), aff’g T.C. Memo. 1991-636; Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991), aff’g in part, rev’g in part T.C. Memo. 1990-68. Once the IRS has made such a showing, the burden of proof shifts to the taxpayer to prove by a preponderance of the evidence that the IRS’s determinations of unreported income are arbitrary or erroneous. Helvering v. Taylor, 293 U.S. 507, 515 (1935).

Subpart F Income in a Very Simplified Nutshell

To understand subpart F income, we must first define two key terms – “U.S. Shareholder” with respect to a foreign corporation, and “controlled foreign corporation” or “CFC.” With respect to any foreign corporation, a U.S. shareholder is a U.S. person who “owns” or is “considered as owning,” 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. See IRC § 951(b); see also IRC § 958 (definition of “own” and “considered as owning”). In turn, a CFC is a foreign corporation, so long as more than 50% of the shares or voting power of the stock is directly or constructively owned by U.S. shareholders on any day during the taxable year of the foreign corporation.

A U.S. shareholder of a CFC must generally include in his gross income his pro rata share of the CFC’s “subpart F income” for the year. Vetco, Inc. & Subs. v. Commissioner, 95 T.C. 579, 585-86 (1990); see IRC § 951(a)(1). Under IRC § 954(a)(1) and IRC § 954(c)(1), subpart F income includes dividends, interest, and the excess of gains over losses from the sale or exchange of certain property. A CFC’s current earnings and profits are generally determined according to rules substantially similar to those applicable to domestic corporations. See IRC § 964(a); Treas. Reg. § 1.964-1(a).

(T.C. Memo. 2020-80) Flume v. Commissioner

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