Federal Case Law Nelson A. Toner Bernstein Shur Portland, Augusta - - PowerPoint PPT Presentation

Federal Case Law

Nelson A. Toner Bernstein Shur Portland, Augusta and Manchester

Wednesday, November 4, 2015 1 18th Annual Maine Tax Forum -Nov2014

Overview of Cases

10/5/2015 18th Annual Maine Tax Forum -Nov2014 2

Name of Case Holdings Code Sections Patrick v. Commissioner 7th Circuit No. 14-2190 August 26, 2015 Qui tam award paid to taxpayer is

• rdinary income and not capital

gain. 61, 1222 Kline v. Commissioner T.C. Memo 2015-144 August 5, 2015 Taxpayer and wife materially participated in their boat charter business and losses were not limited under passive activity rules. 469 Broadwood Investment Fund LLC v. U.S. 2015 U.S. App. LEXIS 13501 (9th Circuit) August 3, 2015 Circuit court reverses summary judgment ruling for IRS that partnerships were shams; cites Culbertson case as basis for factors to review.

Overview of Cases

Name of Case Holdings Code Sections Wyatt v. Commissioner T.C. Summ. Op. 2015-31 April 20, 2015 Hospital loans funds to doctor under guarantee agreement; forgiveness of loan is COD income. 61(a)(12) Grenier v. U.S. 116 AFTR 2d 2015-5324 US Ct. Fed. Claims July 22, 2015 Taxpayer’s attempt to retroactively change approach to reflect closed transaction reporting and capital gain is impermissible change of accounting. 446(e)

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 3

Overview of Cases

Name of Case Holdings Code Sections Qinetiq U.S. Holdings v. Commissioner T.C. Memo 2015-123 (July 2, 2015) Stock issued to shareholder not deductible as compensation; stockholder contributed cash for stock and stock not subject to substantial risk of forfeiture. 83 Bell v. Commissioner T.C. Memo 2015-111 June 15, 2015 Sale of sole proprietorship assets to wholly-owned corporation re- characterized to capital contribution. 351 Substance over form principle

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 4

Patrick v. Commissioner

• Taxpayer and co-worker jointly file qui tax action

under False Claims Act claiming that taxpayer’s employer had defrauded the government. Employer marketed equipment and treatment as

• vernight procedure allowing larger Medicare

reimbursement when in fact treatment could performed on an outpatient basis.

• Government intervened in the case and reached

settlement with employer for $75 million. Taxpayer received $5.9 from the settlement funds.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 5

Patrick v. Commissioner

• Taxpayer reported qui tam award as capital gain.
• Taxpayer argued that award arose from “property

held by the taxpayer” that the taxpayer had “the right to exclude others from using it.” The court disagreed that the taxpayer possessed property

• r that others could not have used the same

information to bring a qui tax action.

• 7th Circuit confirmed the holding of the Tax Court

that the payments were ordinary income.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 6

Kline v. Commissioner

• Taxpayer is commercial pilot for Southwest Airlines. He

and his wife start a boat chartering business in BVI.

• Taxpayer markets charters and skippers some of the
• charters. Taxpayer hired a management company to

book charters, collect money from customers, and clean and maintain the boats.

• Taxpayer and wife did not keep a contemporaneous log
• f time spent on charter business, but using e-mail and
• ther records were able to produce evidence of time
• spent. They ran the charter business, promoted the

charter business, planned the charters and determined the guests’ needs during the charter.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 7

Kline v. Commissioner

• IRS concedes that taxpayer and wife are engaged in a

business.

• Respondent argues that they did not “materially”

participate in the business and may not deduct losses from the charter business against other non-passive income.

• Taxpayer and wife argue that they do materially participate.

They produce evidence that together they participate in the charter business more than 100 hours each year and no

• ther individual (even the workers of the management

company) participate for more hours.

• Court holds that taxpayer and wife has satisfied one of the

tests for material participation in Temp. Reg. §1.469- 5T(a)(3).

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 8

Broadwood Investment Fund LLC v. U.S.

• District court grants summary judgment in

favor of IRS, ruling that partnerships were shams and formed for the purposes of created tax losses for one of the partners.

• Ninth Circuit reverses the decision and

remands the case back to the district court.

• Ninth Circuit cites Commissioner v.

Culbertson, 337 U.S. 733 (1949) the iconic partnership tax case.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 9

Broadwood Investment Fund LLC vs. U.S.

• A partnership is disregarded for tax purposes when the

partners did not really and truly intend to join together for the purpose of carrying on a business and sharing in its profits and losses. This is a consideration of all of the facts.

• According to the Ninth Circuit, the question is whether the

parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.

• The taxpayers presented sufficient evidence that the

partnerships were created for a business purposes and that the partners intended to share profits and losses from the enterprise to create a “genuine issue of material fact.”

• Therefore, the summary judgment was reversed.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 10

Wyatt v. Commissioner

• In order to entice a young physician to a rural Florida

community, the local hospital enters into a revenue guarantee agreement with the young physician.

• Under the agreement, if the physician’s gross revenues

do not meet a stated threshold amount, then the hospital will loan the young physician the difference, thus guaranteeing a stated flow of funds.

• The amount loaned to the young physician was due

and payable at the end of twelve months unless the young physician remained active at the local hospital and in the community, then the loan would be forgiven

• ver a term of 36 months.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 11

Wyatt v. Commissioner

• The physician and the IRS agreed that the amounts

received by the physician from the hospital was a loan.

• The physician did not treat the amounts forgiven as

income because the loan was a non-recourse loan. He was not personally liable for the repayment of the loan if he remained on the staff of the local hospital and he continued his medical practice in the community.

• The Tax Court disagreed and found the transaction a

loan and ruled that the forgiveness of the amount due created cancellation of debt income subject to tax.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 12

Grenier v. U.S.

• Taxpayer was president of Advanced Bionics. He received stock options.
• By merger, Advanced Bionics became a subsidiary of Boston Scientific.
• Taxpayer’s options were vested and then cancelled. In exchange, taxpayer given

the choice of one time payment of cash or a smaller cash payment and the right to an earn-out payment based upon the success of four product lines of Advanced

• Bionics. Taxpayer selected the second option.
• The taxpayer reported the initial cash payment as compensation. The taxpayer did

not report the value of the earn-out right because its value was speculative, consistent with information from Boston Scientific and Advanced Bionics given to the shareholders of Advanced Bionics. This approach reflects an open transaction approach.

• In each of the second year and the third year after the merger, an earn-out

payment is made to taxpayer. The taxpayer reported the payments as compensation.

• Five years after the merger, Boston Scientific and Advanced Bionics enter into a

negotiated settlement to provide for an early end to the earn-out payments and to “de-merge” the two companies.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 13

Grenier v. U.S.

• In the fifth year after the merger, taxpayer received his first “earn-out buyout”

payment and in the next year, taxpayer received the second and final buyout

• payment. Taxpayer reported both payments as compensation.
• The taxpayer amended his returns for the years of the earn-out buyout payments

and treated the payments as capital gain. In the narrative of the return the taxpayer stated that he was seeking to amend the manner is which he reported both the original buy-out right and the two buyout payments.

• The IRS argued that the taxpayer’s refund claims were premised upon a change in

accounting method for which the IRS consent was required but not obtained and therefore the refund could not be granted. In an exhaustive opinion, the Court carefully reviewed the meaning of a “method of accounting” and the exceptions

• thereto. Based upon this analysis, the Court determined that the taxpayer’s

approach caused a difference in the timing of income and therefore was a change in method of accounting. Because no consent had been obtained, the refund could not be granted.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 14

Qinetiq U.S. Holdings v. Commissioner

• Mr. Hume forms DTRI in early 2002 and makes an S corporation election.
• Later in 2002, Mr. Hume and Mr. Chin enter into discussions for Mr. Chin to

join the company. Each of Mr. Hume and Mr. Chin contributed a nominal amount to the company and in return Mr. Hume received 4,500 shares of voting stock and Mr. Chin received 4,455 shares of voting stock and 445 shares of non-voting stock. A contemporaneous board vote stated that the company would enter into both an employment agreement and a shareholders agreement with Mr. Hume and Mr. Chin at some point in the future and would also enter into an employment agreement and restrictive stock agreement with other workers.

• The shareholders agreement states that Mr. Hume and Mr. Chin own

certain stock of the company. The agreement also contains a buy-out agreement stating that if a stockholder’s employment with the company is terminated during the first 20 years, the stockholder must sell his stock back to the company for a discounted price.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 15

Qinetiq U.S. Holdings v. Commissioner

• Since the issuance of the initial stock, Mr. Hume and Mr. Chin have reported this

stock on the S corporation return for the corporation and the corporation allocated its profits and losses to Mr. Hume and Mr. Chin based upon this stock ownership.

• Since the initial formation of the company, the company issued restricted stock

subject to restricted stock agreements containing vesting schedules. Mr. Hume and Mr. Chin received restricted stock.

• In 2008, DTRI merged into Qinetiq and Qinetiq paid $123 million as merger
• consideration. On the day of the closing, the board and shareholders of DTRI

voted that all restrictions on voting and non-voting stock were waived and that such stock was fully vested.

• Qinetiq reported a compensation deduction under section 83 because all of the

stock of DTRI was no longer subject to a substantial risk of forfeiture. The court disagreed because (1) the stock issued to Mr. Chin was not issued to him in “connection with the performance of services but in exchange for a contribution and (2) even if it was subject to a risk of forfeiture such risk was not substantial because DTRI would not have enforced the risk of forfeiture against Mr. Chin.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 16

Bell v. Commissioner

• Taxpayer is licensed real estate broker.
• Taxpayer operated his business as sole proprietorship. As

business increased, taxpayer decided to incorporate his business.

• Taxpayer and his new corporation entered into a purchase

agreement under which taxpayer sold his sole proprietorship and its assets to the new corporation. At the time that the agreement was signed, the new corporation had no assets.

• Under the terms of the purchase agreement the taxpayer

received monthly payments. The new corporation provided no security for the purchase price and not promissory note was signed.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 17

Bell v. Commissioner

• The taxpayer reported the sale as an installment sale and any gain

from the sale as capital gain. The new corporation depreciated the purchased assets based upon an allocation of the purchase price.

• The issue before the court was whether the transfer of assets to the

new corporation was a capital contribution or sale.

• The court reviewed 11 factors and concluded that the transaction

more closely resembled a capital contribution.

• The court then applied the rules of sections 351 and 362 to

determine the tax consequences to the taxpayer (no gain or loss) and the new corporation (basis and depreciation) and determined that payments to the taxpayer under the agreement were dividends.

November 4, 2015 18th Annual Maine Tax Forum -Nov2014 18