On January 2, 2020, the Tax Court issued a Memorandum Opinion in the case of Gebman v. Commissioner (T.C. Memo. 2020-1). The issue presented in Gebman v. Commissioner was whether the taxpayers had substantiated any of their positions with regard to their deficiencies, penalties, or relief sought, and if not, were their positions frivolous.
Penalizing Whack-A-Doodlery, the Tax Court’s Prerogative in Gebman v. Commissioner
In this deficiency and penalties case, the Tax Court’s distaste for the petitioners was held close to the vest for most of the opinion, until the last, when Judge Nega imposed the delay and frivolity penalty of IRC § 6673(a), which is generally reserved for the most insistent and recalcitrant whack-a-doodles that the Tax Court has the unfortunate obligation to listen to.
Mr. and Mrs. Gebman, allegedly the innocent victims of criminal conspiracies, were just such whack-a-doodles.
Not only did they wax idiotic about subjects as diverse as the Federal Reserve, the transfer of World War I gold to London, the story of American’s hedging, as well as the Federal Election Commission and State Board of Elections, they seemed somewhat obsessed with Teddy Roosevelt’s role in all of the above. Finally, they referred their own case to the FBI for investigation (ostensibly regarding the aforementioned criminal conspiracies against them).
Unfortunately, much of their whack-a-doodling is relegated to the final footnote of the opinion, so we do not get a perfect sense of the doodalotry that made Chief Counsel orally move at the end of trial for the imposition of the IRC § 6673(a) penalty, or the utter persistence of their collective crazytalk that persuaded the Tax Court to grant the ore tenus motion. What is clear, however, is that the Tax Court’s “ample warnings” went unheeded, and Judge Nega had to ask one too many times for the petitioners to remove their tin foil helmets in his courtroom.
General Burdens of Proof and Production
The taxpayer bears the burden of proving the IRS’s determinations in a notice of deficiency to be erroneous.[1] The taxpayer bears the burden of production as to any factual issue, which if satisfied by producing sufficient, credible evidence, shifts the burden to the IRS to disprove such evidence.[2] Conversely, the IRS bears the burden of production with respect to evidence regarding liability for penalties, including, as here, the accuracy-related penalty of IRC § 6662(a).[3]
Burdens as to Deductions
With respect to deductions claimed, the taxpayers bear the burden (1) to demonstrate that the deductions were allowable under the Code, and (2) to substantiate the expenses giving rise to the deductions by maintaining and producing adequate records that permit the IRS to determine the taxpayer’s liability.[4]
This, of course, presupposes that the “expenses” were actually incurred, rather than being a figment of the petitioners’ clearly over-active imagination. In the present case, the petitioners claimed Schedule E deductions, but provided no documents to substantiate any expenses. No one was more shocked than me…except, perhaps, the Gebmans.
Burden as to Net Operating Losses (NOLs)
A net operating loss (NOL) for any given year is the sum of the NOL carryovers and carrybacks to that year.[5] The taxpayer bears the burden of proof regarding both the existence of NOLs for prior years and the NOL amounts that may properly be carried forward to the years at issue.[6] To substantiate a NOL, the taxpayer must file with its return a statement setting out the amount of the NOL, all facts pertinent thereto, and a detailed schedule showing the computation of the NOL deduction.[7]
Merely submitting past tax returns reporting the losses is not enough, just as merely reporting a loss on a tax return does not, itself, substantiate the loss.[8] Self-serving testimony avails the taxpayer nothing, whether in exam or at trial, especially where, as her, the petitioners had already demonstrated a dearth of credibility.
Taxability of IRA Distribution and Early Withdrawal Penalty
Any amount distributed from an IRA is includible in gross income by the recipient in the manner provided under IRC § 72.[9] If, however, the recipient of an IRA distribution “rolls over” the distributed amount (no later than the 60th day after receipt) into another qualifying IRA (a “rollover contribution” under IRC § 408(d)(3)), the distribution is excluded from the taxpayer’s gross income pursuant to IRC § 408(d)(3)(A).
Distributions from an IRA, like any other “qualified retirement plan,” as defined in IRC § 4974(c), are subject to a 10% additional tax (sometimes referred to as an “early withdrawal penalty”) before the taxpayer reaches the age of 59-1/2.[10] There are certain exceptions to the 10% additional tax, like old age and disability.[11] Unfortunately for the Gebmans, being nuttier than your Aunt Ethel’s fruitcake is not such a disability.
Innocent Spouse Relief
Married taxpayers may file joint returns. IRC § 6013(a). If the taxpayers elect to file jointly, each spouse implicitly agrees to be jointly and severally liable for the entire tax due for that year. IRC § 6013(d)(3). A taxpayer-spouse who’s been done wrong by the other (ne’er-do-well) spouse may seek relief from joint liability by seeking innocent spouse relief. See IRC § 6015(a).
The requesting spouse bears the burden of proving that he or she is entitled to IRC § 6015 relief. Tax Court Rule 142(a); Alt v. Commissioner, 119 T.C. 306, 311 (2002), aff’d, 101 F. App’x 34 (6th Cir. 2004). The factual requirements for innocent spouse relief are numerous and specific, and it is not nearly as easily granted as one might assume given the innocuous name of the remedy.
The first method of relief, contained in IRC § 6015(b) requires that the taxpayer establish that (1) a joint return was made, (2) there is an understatement of tax on the return, (3) the understatement is attributable to erroneous items of the non-requesting spouse, (4) the taxpayer did not know and had no reason to know of the understatement when the return was signed, it is inequitable to hold the requesting spouse liable for the understatement, and timely relief under IRC § 6015(b) was elected.[12] All five conditions must be met for relief to be awarded.[13]
An erroneous item is generally attributed to the individual whose activities gave rise to the item.[14] Further, the Tax Court attributes erroneous items to the spouse who reported or claimed the items improperly on the return.[15]
Alternatively, a requesting spouse may attempt to pull on the Tax Court’s heartstrings and appeal to equity. Looking at all of the facts and circumstances – which must be proved by the requesting spouse – the Tax Court may relieve the requesting spouse from joint and several liability, but only if it would be manifestly “inequitable” to hold the requesting spouse liable for any unpaid tax or deficiency.[16] To this end, Rev. Proc. 2013-34 provides guidelines for the IRS to follow when determining whether a requesting spouse qualifies for equitable relief under IRC § 6015(f).
When Spouse Requesting Innocent Spouse Relief is the Sole Income Earner
The Gebman v. Commissioner case presents an interesting scenario, insofar as the requesting spouse was the sole income earner. Although Mrs. Gebman made all of the couple’s money (as an attorney for an investment bank), Mr. Gebman, by all accounts a dutiful (albeit crazy) house husband, prepared and filed the tax returns. The Tax Court noted that it would be inequitable to relieve Mrs. Gebman from liability on her own items of income while leaving Mr. Gebman responsible for paying the tax.
However, the Tax Court makes two observations that are curious. First, the Tax Court observes that Mr. Gebman did not prevent Mrs. Gebman from reviewing the returns. Second, the court observes that Mr. Gebman did not try to conceal or hide anything from Mrs. Gebman.
If it is generally inequitable to hold a non-income-earner liable for the tax attributable to the innocent-spouse-relief-seeking-spouse, why would it matter if Mr. Gebman prevented Mrs. Gebman for not reviewing the returns or that he concealed or hid anything from her?
Certainly, under these circumstances, he may be liable for penalties, but what about the tax?
Candidly, I do not think that the court meant to leave this door open in the slightest—no matter how narrow the slit of light that might shine through—but it does beg the question.
Accuracy Related Penalties – Generally and as Applied to NOLs
When underpayment is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax, the IRS may assert a 20% penalty.[17] “Negligence” is defined as any failure to make a reasonable attempt to comply with the provisions of the Code, and “disregard” is qualified as a careless, reckless, or intentional disregard.[18] An understatement of income tax is substantial if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000.[19]
In the case of an NOL carryover, the penalty for negligence or disregard of rules or regulations applies to any portion of an underpayment for the year to which the NOL is carried that is attributable to negligence or disregard of rules or regulations in the year in which the carryback or carryover of the loss arose.[20] Similarly, the substantial understatement penalty applies to any portion of an underpayment for a year that is attributable to a “tainted item” in the loss year.[21]
The determination of whether an understatement is “substantial” for a carryover year is made with respect to the return for that year.[22] A “tainted item” is any item for which there is neither substantial authority nor adequate disclosure with respect to the loss year.[23]
The Delay and Frivolity Penalty of IRC § 6673(a)
The first lesson they should teach at pro se litigant school is not to piss off the judge…especially when he asks more than once (“ample” times, as here) for you to rein in the crazy talk. Because there is no pro se litigant school, and because the Gebmans couldn’t hold in the crazy for even couple of hours, they ended up reaping what their nutty little seeds sowed to the tune of $25,000.
The Tax Court may impose a $25,000 penalty whenever you piss it off, a lot and often. More precisely, the Tax Court may impose the penalty pursuant to IRC § 6673(a)(1) whenever it appears that the taxpayer has instituted or maintained a proceeding primarily for delay or has adopted (and zealously advocated) a position that is frivolous or groundless.[24]
Just as when someone asks you if you’re a god, you say yes (Ray), when a court asks you to shut your damn yapper, you say yes (your honor).
Footnotes:
[1] Tax Court Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
[2] IRC § 7491(a).
[3] IRC § 7491(c).
[4] INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992) (allowable deductions); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934) (same); IRC § 6001 (maintenance of records and provision of same to IRS); Higbee v. Commissioner, 116 T.C. 438, 440 (2001) (burden of substantiation); Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976) (same).
[5] IRC § 172(a).
[6] See Tax Court Rule 142(a); Keith v. Commissioner, 115 T.C. 605, 621 (2000).
[7] Treas. Reg. § 1.172-1(c).
[8] See Coburn v. Commissioner, T.C. Memo. 2014-113, *8; see also Gould v. Commissioner, 139 T.C. 418, 447 (2012), aff’d, 552 F. App’x 250 (4th Cir. 2014).
[9] See IRC § 408(d)(1).
[10] IRC § 72(t)(1), (t)(2)(A)(i).
[11] See IRC § 72(t)(2).
[12] IRC § 6015(b)(1)(A)-(E); Treas. Reg. § 1.6015-2(a).
[13] Alt, 119 T.C. at 313.
[14] Treas. Reg. § 1.6015-1(f)(1).
[15] Kellam v. Commissioner, T.C. Memo. 2013-186.
[16] IRC § 6015(f).
[17] IRC § 6662(a), (b)(1), (b)(2).
[18] IRC § 6662(c); Treas. Reg. § 1.6662-3(b)(1), (2).
[19] IRC § 6662(d)(1)(A).
[20] Treas. Reg. § 1.6662-3(d)(1).
[21] Treas. Reg. § 1.6662-4(c)(1).
[22] Id.
[23] Treas. Reg. § 1.6662-4(c)(3)(i).
[24] See Coleman v. Commissioner, 791 F.2d 68, 71 (7th Cir. 1986); Bruhwiler v. Commissioner, T.C. Memo. 2016-18, at *10.
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