Federal Case Law Nelson A. Toner Bernstein Shur Portland, Augusta and Manchester Wednesday, November 4, 2015 18th Annual Maine Tax Forum -Nov2014 1
Overview of Cases Name of Case Holdings Code Sections Patrick v. Commissioner Qui tam award paid to taxpayer is 61, 1222 7 th Circuit No. 14-2190 ordinary income and not capital August 26, 2015 gain. Kline v. Commissioner Taxpayer and wife materially 469 T.C. Memo 2015-144 participated in their boat charter August 5, 2015 business and losses were not limited under passive activity rules. Broadwood Investment Circuit court reverses summary Fund LLC v. U.S. judgment ruling for IRS that 2015 U.S. App. LEXIS partnerships were shams; cites 13501 (9 th Circuit) Culbertson case as basis for factors August 3, 2015 to review. 10/5/2015 18th Annual Maine Tax Forum -Nov2014 2
Overview of Cases Name of Case Holdings Code Sections Wyatt v. Commissioner Hospital loans funds to doctor 61(a)(12) T.C. Summ. Op. 2015-31 under guarantee agreement; April 20, 2015 forgiveness of loan is COD income. Grenier v. U.S. Taxpayer’s attempt to retroactively 446(e) 116 AFTR 2d 2015-5324 change approach to reflect closed US Ct. Fed. Claims transaction reporting and capital July 22, 2015 gain is impermissible change of accounting. November 4, 2015 18th Annual Maine Tax Forum -Nov2014 3
Overview of Cases Name of Case Holdings Code Sections Qinetiq U.S. Holdings v. Stock issued to shareholder not 83 Commissioner deductible as compensation; T.C. Memo 2015-123 stockholder contributed cash for (July 2, 2015) stock and stock not subject to substantial risk of forfeiture. Bell v. Commissioner Sale of sole proprietorship assets to 351 T.C. Memo 2015-111 wholly-owned corporation re- Substance over June 15, 2015 characterized to capital contribution. 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 overnight 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 or that others could not have used the same information to bring a qui tax action. • 7 th 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 of time spent on charter business, but using e-mail and other 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 other 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 over 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
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