One decision slipped by us last week, but it was Thanksgiving, so we had other priorities. On a lighter note (we all know there is nothing light about Thanksgiving), there are no timies this week!

And there is another reason for optimism! In a few weeks it will be December 21 – the shortest day of the year. Given how difficult and weird most days have been this year, the shorter, the better. Right?

TRIBUNAL DECISION

Matter of Almonte; Division’s Rep.: Ellen Krejci; Petitioner’s Reps.: Leon Greenspan and Michael Greenspan; Return Preparer Penalty Under Former Tax Law § 685(aa)(1) (by Chris Doyle) 

In this case, the Tribunal addressed whether it was appropriate for the Division to impose a preparer penalty on Petitioner under a statute that had expired, and whether it was appropriate for that penalty to be imposed at the maximum amount allowed. The ALJ determined that the Division was permitted to impose a penalty for conduct that occurred while the former statute was in effect, and that imposing the maximum penalty was OK. We wrote about that determination here.

In brief, the Division found that Petitioner prepared a bunch of individual income tax returns, and over 50% of those returns claimed deductions that were unusual for the cohort of taxpayers for which the returns were prepared. This was all discovered by mid-February 2015, so half-way through the filing season for 2014 returns. The Division sent a letter saying, in essence, “you’d better make sure that your clients have proper documentation for these weird deductions.” Then the Division took a closer look at the returns and found that, for 713 of them, there was no proof of entitlement to the deductions claimed. On June 30, 2015, the Division issued a Notice of Deficiency to Petitioner asserting a $713,000 penalty, which was the maximum $1,000-per-return penalty. Of interest: The Notice was issued the day before the penalty statute was deemed repealed.

Petitioner argued that the repealed penalty could not be enforced against her, that the proof of how the Division determined the preparer penalty was inadmissible hearsay, and that the penalty was disproportionate. The ALJ ruled in favor of the Division on all of these points, and the Tribunal affirmed the ALJ’s Determination.

On the first issue, the Tribunal found “that when considering whether an expired penalty statute applies to specific acts, it is the timing of the acts designated for the penalty under the statute that determines when such penalties are incurred.” Strike one.

Regarding the issue of whether the Division was required to show, with admissible proof, the method by which it determined the penalty, the Tribunal stated: “[P]etitioner’s argument that hearsay evidence is insufficient to comprise substantial evidence allowing the Administrative Law Judge to draw reasonable inferences in rendering a determination runs counter to established law. It has been recognized that relevant and probative hearsay evidence is admissible in administrative proceedings . . . .”  The Tribunal also seemed to indicate that the Division has no obligation to prove that it had a rational basis for the Notice it issued. This is contrary to my understanding. But inasmuch as this part of the Decision was not necessary to the ultimate conclusion, I am not going to worry about it too much. Anyway, strike two.

As to the last issue, the Tribunal noted that “[P]etitioner has pointed to no legal basis that the Division is required for any reason to consider a penalty in any amount less than the maximum.” The Tribunal’s decision suggests that the Division does not need to contemplate a penalty less than the maximum, and, on this point, I respectfully disagree with the Tribunal. The former penalty statute itself provides a legal basis for requiring the Division to consider penalties less than the maximum. It states that, if a preparer did not have a reasonable belief that a tax return position was more likely than not correct, the preparer “shall pay a penalty of up to one thousand dollars with respect to such return . . . .”  As a result of the “up to” language, the Commissioner has the discretion to assert a penalty ranging between $0.01 and $1000 per return. It is black letter law that in exercising discretion, administrative agencies must not act in an “arbitrary and capricious” manner. (Prestige Towing and Recovery, Inc., (3d Dep’t, June 17, 2010)). “Action is arbitrary and capricious when it ‘is without sound basis in reason and is . . . taken without regard to the facts.’” (Id.) In my humble opinion, when given a range of permitted penalties, it is arbitrary and capricious to not consider the magnitude of the penalty to be imposed. In other words, if one does not apply reason to the decision, then the decision “is [literally] without sound basis in reason.”

In this instance, the Division’s witness testified that the maximum penalty was imposed “based upon the ‘egregious nature of the full case,’ and because [Petitioner’s] conduct regarding preparing returns claiming other losses did not change even after receiving two letters from the Office of Professional Responsibility advising her of what was required of her as a tax preparer.” So the Tribunal may have decided that the Division’s approach was not arbitrary and capricious. But there is no indication of the basis on which the Division concluded this particular case was egregious, and there are no facts cited in the decision corroborating that the conduct complained of continued after the advice letters were sent. For that matter, the decision does not find as fact that Petitioner received the advice letters or that she did not adjust her conduct after receipt of the letters. Nor is there any indication of the standard applied by the Division to determine the magnitude of penalty to be asserted. The Tax Appeals Tribunal is comprised of three smart and reasonable people. So I expect there is more in the complete record (to which we are not privy) supporting the assertion of the maximum penalty. So, strike three.

DETERMINATION

Matter of DiLaurenti; Judge Galliher; Division’s Rep.: Linda Farrington; Petitioner’s Rep.: David Sobel; Article 22 (by Chris Doyle)

The Division performed an audit on Petitioner and his wholly-owned S corporation for the 2011-2012 tax years. On his federal tax returns for those years, Petitioner reported management fee income that was offset by legacy net operating losses (“NOLs”). Those NOLs, apparently, arose prior to the 2003 tax year. Surprise! Petitioner, who is sickly and ancient, was unable to verify that there were losses or that they were of the magnitude reported on his returns. The documents supporting the losses were lost in Hurricane Sandy. (Memo to self: Write a fusion Gotham-country-western song this weekend called “Burden Unsatisfied,” with the following chorus using a GCDF GCDCG major chord progression: “My days of reckless living . . . manifest in cruel rewards . . . . The ex-spouse got my condo . . . Hur’cane Sandy, my records. And injury on insult . . . the tax court thinks I lied! . . . And with no substantiation . . . my burden’s unsatisfied.”)

The NOL substantiation is problem one. Problem two, at least according to the Division, was that Petitioner’s S corporation didn’t really “stick the landing” on the replacement property side of an IRC 1031 like-kind exchange (“LKE”).

The Judge determined that:

1. The Division had a rational basis for the Notice of Deficiency it issued.
2. The management fees Petitioner received were income, and without sufficient proof of offsetting NOLs (see below), it was rational for the Division to conclude that Petitioner had unreported income.
3. Petitioner, a New York State and City resident, needed to file a New York income tax return if he was required to file a Federal income tax return.
4. Petitioner did not bear his burden of proving the existence or magnitude of the legacy NOLs he claimed were available to carry to the tax years at issue; the Division did not have a duty to seek out the information relating to the NOLs from the IRS.
5. Petitioner was entitled to tax-deferred rollover treatment only with respect to the S corporation’s investment of a portion of the relinquished property’s sale proceeds in another building (the replacement property). The excess of the sale proceeds received from the sale of the relinquished property over the value of the replacement property was potentially-taxable “boot”.
6. Petitioner did not bear his burden of proving that certain partnership interests the S corporation purchased with a portion of the proceeds from the sale of the relinquished property were “like-kind property.” In particular, the Judge found that Petitioner had not proven that the partnerships at issue had made IRC § 761 elections that may have converted the partnership interests into like-kind property.
7. There was no basis for the abatement of penalties.

We have seen an uptick in New York audits of like-kind exchanges. The rules applicable to like-kind exchanges are complicated and strict, and wise taxpayers will be sure to get qualified advisors to opine on the efficacy of any planned like-kind exchange before attempting it.