The Week of January 11 – January 15, 2021

Kenneedy v. Comm’r, T.C. Memo. 2021-3 | January 12, 2021 | Copeland, E. | Dkt. No. 5687-17W

• Opinion

Short Summary:  Petitioner appealed, pursuant to § 7623(b)(4), three determinations of the Whistleblower Office (WBO) of the Internal Revenue Service (IRS) that declined to make awards to him.  Petitioner filed a single whistleblower claim, but the WBO split it into three distinct claims. Petitioner’s whistleblower claim alleged that three taxpayers and related subsidiaries owed $150,103,245 in unpaid excise taxes, penalties, and interest. The IRS processed the claims, and it took no action against two of the taxpayers, and no change resulted from the examination of the third taxpayer.  Petitioner challenged the WBO’s determinations. The Tax Court held that the WBO did not abuse its discretion in declining any awards to Petitioner.

Key Issue:  Whether the WBO abused its discretion in declining to award the Petitioner any amount under his whistleblower claims when it took no action against two taxpayers and issued no changes after the examination of the third taxpayer.

Primary Holdings: 

• The WBO did not abuse its discretion in declining to award any amount to Petitioner.

Key Points of Law:

• Section 7623allows the IRS to give an award for information that the IRS uses to collect tax or bring to trial persons guilty of violating internal revenue laws. The section provides for both discretionary and mandatory awards.
• Discretionary awards are paid under section 7623(a); whether an award is paid and the amount of such an award is entirely within the WBO’s discretion. See 301.7623-1(a), Proced. & Admin. Regs. However, if the proceeds in dispute exceed $2 million; and, in the case of an individual taxpayer, gross income exceeds $200,000 for any taxable year, then an award between 15% and 30% of collected proceeds must be paid to the whistleblower. See sec. 7623(b)(1), (5).
• Additionally, for a whistleblower to be eligible to receive an award under section 7623(b), two basic requirements must be met: (1) the IRS, on the basis of information the whistleblower provided, must bring an administrative or judicial action, and (2) the IRS must collect proceeds as a result of the action. Cooper v. Commissioner, 136 T.C. 597, 600 (2011).
• Congress has authorized that whistleblowers may seek judicial review of their award determinations.  7623(b)(4). This right does not apply to all award determinations; whistleblowers may only seek judicial review of award determinations made under section 7623(b).
• The Tax Court will not review an operating division’s decision whether to audit a target taxpayer in response to a whistleblower claim.
• Further, the Tax Court does not have the authority to require an operating division to explain its decision not to audit.

Insight:  The Kennedy decision demonstrates the basic process for appealing WBO decisions on whistleblower claims.  Of important note, the Tax Court pointed out that it will not review specific actions of the WBO and IRS, such as a decision to not audit a targeted taxpayer. All that the Tax Court will do is review the WBO’s final determination of the award for an abuse of discretion—generally a high standard to meet as the petitioner.

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Ramey v. Comm’r, 156 T.C. No. 1| January 14, 2021 | Toro, J. | Dkt. No. 6986-19L 

• Opinion

Short Summary:  The IRS mailed to the taxpayer’s actual and last known address a notice of intent to levy for the taxpayer’s 2012 and 2016 tax years.  The notice was sent by certified mail, return receipt requested.  The notice advised the taxpayer of his right to seek a Collection Due Process (CDP) hearing within 30 days after the date of the notice.

The taxpayer had the same address as several businesses.  Three days after the IRS mailed the notice, the United States Postal Service (USPS) left the notice at the taxpayer’s address with a person who was neither the taxpayer’s employee nor authorized to receive mail on the taxpayer’s behalf.

The taxpayer requested a CDP hearing, and the IRS treated the request as untimely.  After the IRS sustained the levy action, it issued a decision letter.  The taxpayer filed a petition with the United States Tax Court.

Key Issue:  Whether the Tax Court had jurisdiction over the petition?

Primary Holdings: 

• The Tax Court had no jurisdiction over the taxpayer’s case because the IRS issued the proposed notice of levy to the taxpayer’s actual and last known address.

Key Points of Law:

• The Internal Revenue Code authorizes the IRS to levy property or property rights of any person who is liable for any tax and has failed to pay that tax after proper notice and demand. 6631, 7701(a)(11)(B), (12)(A)(i).  Because the power to levy is a strong remedy for collecting unpaid tax, the Code gives a taxpayer the right to a hearing with the IRS Office of Appeals (IRS Appeals), sec. 6330, and generally bars the IRS from making a levy unless the IRS notifies the taxpayer in writing of the right to a hearing before the levy is made.  Sec. 6330(a) and (b).  The IRS must provide the required notice “not less than 30 days before the day of the first levy.”  Sec. 6330(a)(2).
• The Code provides three acceptable ways of providing the notice: (1) in person; (2) left at the dwelling or usual place of business of such person; or (3) sent by certified or registered mail, return receipt requested, to such person’s last known address.  6330(a)(2); Treas. Reg. § 301.6330-1(a)(3), Q&A-A8(i).  The taxpayer, in turn, must request the hearing “during the 30-day period” set out in the statute.  Sec. 6330(a)(2), (3)(B).
• If a CDP request is received by the IRS and deemed untimely, the IRS will conduct an equivalent hearing. Reg. § 301.6330-1(a)(3), Q&A-C7.  The equivalent hearing “generally will follow Appeals procedures for a CDP hearing” with one major distinction:  instead of issuing a notice of determination, “Appeals will issue a Decision Letter.”  Id.
• The Tax Court has consistently held that its jurisdiction under section 6330(d)(1) depends on (1) the issuance of a valid notice of determination and (2) a timely filed petition. Offiler v. Comm’r, 114 T.C. 492, 498 (2000); see also Wilson v. Comm’r, 131 T.C. 47, 50 (2008).  When a taxpayer fails to make a timely request for a hearing under section 6330 and IRS Appeals makes no determination pursuant to section 6330, the Tax Court has no jurisdiction under section 6330(d) “because there is no Appeals determination for this court to review.”  Offiler, 114 T.C. at 498.
• A decision letter issued after an equivalent hearing generally is not considered a determination under section 6330 and is therefore insufficient to invoke the Tax Court’s jurisdiction. See, e.g., Moorhous v. Comm’r, 116 T.C. at 269-270. But the Tax Court has recognized that a decision letter issued after a timely request for a hearing under section 6330 “is a determination for purposes of section 6330(d)(1),” regardless of the label IRS Appeals places on the document.  Craig v. Comm’r, 119 T.C. 252, 259 (2002).
• So long as the IRS properly addresses the notice to the taxpayer’s last known address and selects the correct type of service from the USPS—either certified or registered mail, with return receipt requested—the IRS complies with the terms of the statute. And while some courts have held that the IRS must do more in certain analogous cases—for example, if the correct address is in doubt or if there are clear indications that the notice was not delivered—none of those circumstances is present here.

Insight:  As the Ramey decision shows, taxpayers should ensure that they file timely responses to IRS notices, including a notice of proposed levy.  Because Mr. Ramey missed the deadline to file a request for a CDP hearing, he will be required to either pay the full amount of tax due and sue the government for a refund or attempt to negotiate with the IRS’ collection officers outside the purview of the Tax Court.

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Filler v. Comm’r, T.C. Memo. 2021-6| January 13, 2021 | Copeland, J. | Dkt. No. 23581-17 

• Opinion

Short Summary:  The taxpayer was a well-known neurosurgeon.  Throughout his career, he used his skills to develop and patent technology—he is listed as an inventor on 11 patents that were granted in the United States, Europe, and/or Japan from 1996 through 2006.  He has also written numerous articles and books and has presented and lectured on subjects such as surgery, neurology and medical imaging, including the technology he created.

In an effort to develop a neurography imaging business and provide financial incentives for the use of a patent, the taxpayer and others formed a new corporation, NG, Inc., to license the patented technology from another entity, Washington Research Foundation (WRF).  The taxpayer was a 75% shareholder of NG, Inc.  For his 2014 tax year, the taxpayer treated certain distributions from NG, Inc. related to the patent as capital gain.  In addition, the taxpayer claimed certain NOL carryforwards on his 2014 return due to losses he claimed occurred with respect to patent litigation in 2012.

Key Issue:  Whether the taxpayer:  (1) properly reported $100,000 of income received as capital gain rather than ordinary income; (2) is liable for self-employment tax; (3) is entitled to deduct a net operating loss (NOL) carryover originating in tax year 2012; and (4) is liable for a penalty under Section 6662(a).

Primary Holdings: 

• (1) The taxpayer is not entitled to capital gain treatment on the transfer of the patent because: (a) NG, Inc. and the taxpayer were related persons, making Section 1235(a) inapplicable; and (b) the taxpayer failed to prove he had a “sale or exchange.”  (2) The taxpayer is liable for self-employment tax because he failed to brief the issue and admitted that he was carrying on a trade or business.  (3) The taxpayer is not permitted a NOL carryover originating in tax year 2012 because he failed to establish his entitlement to the loss in 2012.  (4) The taxpayer is liable for the accuracy-related penalty—he has failed to show reasonable cause because he is a highly educated doctor, lawyer, professor, and inventor.

Key Points of Law:

• Generally, the IRS’ determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving error. Rule 142(a); INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992).
• Section 1235(a) provides that a transfer (other than by gift, inheritance, or devise) of all substantial rights to a patent by any holder shall be treated as the sale or exchange of a capital asset held for more than 1 year (e., long-term capital gain) regardless of the period the asset is held or whether the payments are in consideration of the transfer are contingent upon the productivity, use, or disposition of the property transferred. However, Section 1235(a) does not apply if the transferee is a related person.  Sec. 1235(d).  An individual shareholder and corporation are considered related persons if the individual owns 25% or more of the stock of the corporation directly or indirectly.  Secs. 267(b)(2), (c), 1235(d).  A “transfer by a person other than a holder or a transfer by a holder to a related person is not governed by section 1235.”  Treas. Reg. § 1.1235-1(b).  Instead, the tax consequences of such transactions are determined under other provisions of the Code.  Id.
• When section 1235 does not apply to the transfer of rights in a patent, the character of the gain is determined under other provisions of the Code. Reg. § 1.1235-1(b); Rev. Rul. 69-482.
• Section 1222(3) generally provides that gain from the sale or exchange of capital assets held for more than one year will result in long-term capital gain.
• It is well established that the transfer by the owner of a patent of the exclusive right to manufacture, use, and sell the patented article in a specific territory constitutes a sale of the patent, and that the question of whether an instrument constitutes an assignment or a mere license does not depend upon the name by which it is called but upon the legal effect of its provisions. Waterman v. MacKenzie, 138 U.S. 252 (1891); see also Glen O’Brien Movable Partition Co. v. Comm’r, 70 T.C. 492, 500 (1978).  Thus, the use of the term “royalty” to describe the remuneration received is not determinative of its nature as a mere license (thus ordinary income) for tax purposes.  Waterman, 138 U.S. at 252.  Whether a certain transaction constitutes a sale or exchange is based on a review of the circumstances surrounding the transaction as a whole.
• If a person acts as a conduit or middleman, then he or she did not acquire a sufficient interest for a subsequent transfer to qualify as a sale or exchange. See Juda v. Comm’r, 90 T.C. 1263, 1281-1282 (1988), aff’d, 877 F.2d 1075 (1^st 1989).  Payments received by a transferor in his or her capacity as a middleman is not sufficient to qualify for capital gain treatment as defined in section 1222(3).
• Section 1401 imposes self-employment tax on the amount of self-employment income for each taxable year. Self-employment income is defined as “the net earnings from self-employment derived by an individual . . . during any taxable year.”  1402(b).  “Net earnings from self-employment” is defined as the gross income derived from any trade or business carried on by the individual, less deductions. Sec. 1402(a).  The term “trade or business” has the same meaning under section 1402(a), defining “net earnings from self-employment,” as under section 162.  Sec. 1402(c); Bot v. Comm’r, 118 T.C. 138, 146 (2002), aff’d, 353 F.3d 595 (8^th Cir. 2003).
• “Trade or business” under section 162 has been interpreted to mean an activity conducted “with continuity and regularity” and with the primary purpose of making income or a profit. Comm’r v. Groetzinger, 480 U.S. 23, 35 (1987).  The carrying on of a trade or business for purposes of self-employment tax generally does not include the performance of services as an employee.  1402(c)(2).
• To the extent a taxpayer does not pursue an argument on brief with respect to an issue, the issue can be deemed conceded. See Mendes v. Comm’r, 121 T.C. 308, 312-313 (2003).
• Section 172 allows a taxpayer to deduct an NOL for a tax year. A taxpayer may generally deduct as an NOL for a tax year an amount equal to the sum of the NOL carryovers and carrybacks to that year.  172(a).  An NOL is defined as the excess of deductions over gross income for a particular tax year, with certain modifications.  Sec. 172(c) and (d).
• Section 165(a) permits a deduction for any loss sustained during a tax year and not compensated by insurance or otherwise. Realization is required before a loss may be recognized for tax purposes.  165(a); U.S. v. S.S. White Dental Mfg. Co., 274 U.S. 398, 401 (1927).  Taxpayers are eligible to claim a loss deduction if the following three requirements are met:  (1) there is a closed and completed transaction; (2) fixed by identifiable events; and (3) the loss is actually sustained.  Treas. Reg. § 1.165-1(b), (d).  There is no “closed and complete transaction, fixed by identifiable events” for a mere fluctuation in the value of property owned by the taxpayer.  Sunset Fuel Co. v. U.S., 519 F.2d 781, 783 (9^th Cir. 1975).
• Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related penalty on any underpayment of federal income tax which is attributable to negligence or disregard of rules or regulations or a substantial understatement of income tax. Section 6662(c) defines negligence as including any failure to make a reasonable attempt to comply with the provisions of the Code and defines disregard as any careless, reckless, or intentional disregard.  Reg. § 1.6662-3(b)(1) and (2).  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.  Sec. 6662(d)(1)(A).
• Section 6751(b)(1) requires the initial determination of certain penalties to be “personally approved (in writing) by the immediate supervisor of the individual making such determination.” Graev v. Comm’r, 149 T.C. at 492-93.
• Section 6664(c)(1) provides an exception to the section 6662(a) penalty to the extent it is shown that there was reasonable cause for any portion of the underpayment and the taxpayer acted in good faith. The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all the pertinent facts and circumstances.  Reg. § 1.6664-4(b)(1).  The most important factor is the extent of the taxpayer’s efforts to assess his or her proper tax liability.  Id.

Insight:   The Filler decision demonstrates the difficulties taxpayers can face in claiming long-term capital gain treatment with respect to patents under Section 1235 as well as substantiating NOL carryforwards from prior years.  Because these issues are often times complex, taxpayers may attempt to hire legal counsel to assist in meeting their burden of proof in Tax Court proceedings.