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The U.S. Tax Court settled a case in July between a landlord and a tenant who wasn’t paying rent – and the court came down on the side of the tenant.

John E. Burgess owned a piece of land that he rented to Dennis Mineni. The land was used as an overflow parking lot for Mineni’s business, Atwater Flea Market. The two men had a handshake agreement that required Mineni to pay Burgess $2,000 (later reduced to $1,500) a month for the use of the land.

Burgess failed to file income tax returns for the years 1999 through 2007. The IRS assessed taxes for each unfiled year, and the total amount was almost $5 million.

Because of the assessment, Burgess was considered a delinquent taxpayer. This designation allows the IRS to place a levy upon a taxpayer’s property or rights to property.

Burgess brought up tax-protestor-type arguments, claiming that he is not a federal citizen and therefore is not subject to the jurisdiction of any federal institution or law, including but not limited to Congress, the IRS and the Social Security Administration.

Burgess felt that he did not owe any federal income tax and that the levy placed against him was invalid.

Mineni’s business was required by law to report the rent payments made to Burgess on IRS Form 1099. A copy of the Form 1099 was sent to Burgess and another copy was submitted to the IRS as required. The IRS became aware of Burgess’s income through the Form 1099.

The IRS sent a notice of levy to Atwater Flea Market, which was now incorporated and renamed Franklynn Properties, Inc. Through payments made by his business, Mineni honored the notice of levy by paying his monthly rent payment directly to the IRS instead of Burgess.

Over a 21-month period, Franklynn Properties, Inc., paid $31,500 to the IRS.

Under Internal Revenue Code Section 6332, anyone in possession of property, or rights to property, that belongs to a delinquent taxpayer upon whom a levy has been made must surrender to the IRS the property or rights to the property. Failure to honor the levy may result in personal liability.

The person who surrenders the property or rights to the property to the IRS will be discharged from any obligation or liability to the delinquent taxpayer. Immunity under IRC Section 6332 has been interpreted generously to protect people who honor levies.

The U.S. government requested and received summary judgment on the grounds that Mineni is immune from suit for his surrender of rental payments, owed to Burgess, to the IRS under an IRS levy.

So Mineni was not required to reimburse Burgess for the rent payments that were sent to the IRS. In fact, he is to continue making the rent payments directly to the IRS until such time as the levy is found invalid or stopped (John E. Burgess, Plaintiff, v. Dennis Mineni, Defendant/Dennis Mineni, Counterclaim-Plaintiff, v. John E. Burgess, United States of America, Counterclaim-Defendants, U.S. District Court, Eastern District of California, 2015-2 U.S.T.C., July 20, 2015).

The U.S. Tax Court recently upheld the IRS’s frivolous return position, costing a taxpayer $10,000 in fines.

Mark A. Lovely failed to file tax returns for 2005, even though he admitted that he had received compensation from Tradewinds Airline, Inc., and Triad International Maintenance Corp. He claimed the compensation did not constitute “wages” and therefore it was not taxable income.

Each of Lovely’s employers issued to him a Form W-2 Wage and Tax Statement. Because the IRS receives a copy of every W-2, the agency knew that Lovely had earned income and a requirement to file a tax return.

Using this information, the IRS prepared a substitute return for Lovely and assessed income tax, penalties and additions to tax.

In July 2009, Lovely prepared a Form 1040X, Amended U.S. Individual Income Tax Return. He claimed that he had no income for the tax year at issue, which was 2005. He in fact had $29,500 worth of taxable compensation for that year. He requested that the federal income tax amount of $1,475.37, which had been withheld from his wages, be refunded to him.

In September 2012, Lovely followed a similar procedure. This time he filed a 1040X requesting a refund of $781.51.

The IRS determined that both Forms 1040X submitted by Lovely had constituted frivolous returns and assessed a $5,000 fine for each one submitted.

In a collection due process hearing with the IRS, Lovely contested the $10,000 in fines assessed by the IRS for his having submitted frivolous returns. He claimed he did not receive a statutory notice of deficiency and did not have a proper opportunity to dispute the fines.

Both of the issues raised by Lovely are defenses to the existence of the amount of the tax liability according to the Internal Revenue Code. The tax liability in this case was the $10,000 in fines.

The IRS brought up some prior court cases that supported the position that issuing a statutory notice of deficiency and allowing the taxpayer an opportunity to dispute the tax are not required when the taxpayer’s original position on the 1040X is frivolous.

Lovely agreed that he had received compensation for his services but contended that it was not taxable income because he didn’t work for the federal government. The court ruled that his tax-protestor-type arguments in support of his position were frivolous.

Taking all of the facts and circumstances of the case into account, the Tax Court ruled in favor of the IRS and upheld the $10,000 in fines (Mark A. Lovely v. Commissioner, T.C. Memo 2015-135, July 27, 2015). ■

Qualified education expenses under the American Opportunity Tax Credit are basically tuition, fees and course materials.

The tuition must be paid to an eligible educational institution. An “eligible educational institution” is generally any accredited public, nonprofit or proprietary (private) college, university, vocational school or other postsecondary institution.

Student activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. Student health fees are not included as part of this expense. They are considered a medical expense.

Course materials include books, equipment and supplies. You do not have to purchase these items directly from the school to include them. Books included in the credit are the textbooks needed for the course. Supplies include highlighters, pens, pencils, etc. An example of equipment is a laptop computer.

If you do not purchase your course materials from the university bookstore, those qualified education expense items will not be included on the Form 1098-T that you receive from the university. You will need to enter these expenses – in addition to the expenses listed on the Form 1098-T – when preparing your income tax returns.

Qualified education expenses never include personal expenses. Room and board, insurance, medical expenses, transportation and similar personal, living or family expenses are examples of personal expenses.

The amount of qualified education expenses is reduced by the amount of a qualified scholarship, which is excluded from gross income, as well as tax-free fellowship grants, the tax-free part of employer education assistance and veterans’ educational assistance. The amount of the scholarship will be provided to you on Form 1098-T. ■

from the IRS

If you have something called qualified dividend income, it receives special tax treatment.

Qualified dividend income is defined as dividends received during the tax year from a domestic corporation or a qualified foreign corporation. It is taxed at the lower preferential capital gains tax rates.

A domestic corporation is a corporation incorporated within the United States. A qualified foreign corporation is a corporation incorporated in a possession of the United States or a corporation eligible for benefits of a comprehensive income tax treaty with the United States that the secretary of the Internal Revenue Service determines is satisfactory.

In contrast, ordinary dividends are fully includable in gross income. An ordinary dividend is any distribution made by a corporation to its shareholders whether in money or property. The amount of the dividend is the amount of cash received plus the fair market value of any property received, if applicable.

You pay tax on ordinary dividends at your ordinary income tax rates. Your tax bracket determines the rate of income tax that you pay. There are currently seven ordinary income tax rates or brackets.

However, if the corporation’s dividends meet the criteria for qualified dividend income treatment, the lower preferential tax rates apply, as shown in the table below:

Ordinary Income Tax Rate Qualified Dividend Rate

10% 0%

15% 0%

25% 15%

28% 15%

33% 15%

35% 15%

39.6% 20%

These rates are applicable for individuals, estates and trusts.

Investments in tax-deferred retirement vehicles such as a regular IRAs, 401(k)s and deferred annuities do not receive any benefit from the preferential rate reduction.

Distributions from these accounts are taxed at ordinary income tax rates even if the funds represent dividends paid on the stocks held in these accounts.

There is a 60-day holding period requirement to qualify for the preferential qualified dividends rate. You have to hold a stock at least 60 days within a 121-day period, which begins 60 days before the ex-dividend date and ends 60 days after.

The ex-dividend date is the day after the date of record, which is the date on which all shareholders who own a particular stock will receive a dividend for that period of time.

Obviously, following the rules and qualifying for the preferential qualified dividends rate can result in a substantial tax savings. ■

Courts

Ordinary and necessary business expenses are not deductible when a trade or business consists of trafficking in controlled substances prohibited by federal law, under a recent decision by the 9th U.S. Circuit Court of Appeals.

Martin Olive owns a business called the Vapor Room, located in San Francisco, Calif.

He appealed the Tax Court’s decision to disallow the deduction of all of his business expenses for 2004 and 2005. The Vapor Room had $236,502 of business expenses in 2004 and $417,569 of business expenses in 2005.

The Internal Revenue Code (IRC) defines “gross income” and allows a business to deduct from its gross income all of the ordinary and necessary expenses paid or incurred during the taxable year in carrying on the business. The difference between the two items is the business’s net income.

The IRC also has some exceptions to what is deductible as an ordinary and necessary business expense. One exception is IRC Section 280E, which disallows the amount paid or incurred during the taxable year for the purpose of carrying on any trade or business consisting of trafficking in controlled substances.

The test for determining whether an activity constitutes a trade of business is whether the activity was entered into with the dominant hope and intent of realizing a profit.

The Tax Court in applying the profit test determined that the only business activity that was engaged in by the Vapor Room was the sale of medical marijuana. Medical marijuana, while legal to sell in the state of California, is still considered to be a controlled substance for federal government purposes.

The Tax Court found that the only income-generating activity in which the Vapor Room engaged was its sale of medical marijuana. Marijuana was the only item for which the Vapor Room charged a fee.

It offered other services and amenities for which it did not charge a fee. For example, it provided vaporizers, food, drink, yoga, games, movies and counseling. The business offered the free items hoping to lure in customers to its dispensary to buy its medical marijuana.

Because marijuana is a controlled substance, IRC Section 280E disallows the deduction of any expenses related to this activity.

Thus, the appeals court affirmed the Tax Court’s decision to deny the Vapor Room a deduction for what it had considered the ordinary and necessary business expense associated with its operation (Martin Olive v. Commissioner, U.S. Court of Appeals, Ninth Circuit, No. 13-70510, July 9, 2015). ■

Nonemployee compensation received in exchange for services rendered is taxable income, despite tax protester arguments to the contrary.

Stephan Foryan, a resident of the state of Washington and an apparent tax protester, did not file a tax return for 2009. He also did not make any estimated tax payments for the 2009 tax year.

Foryan admits to having received nonemployee compensation for services rendered, but he told the U.S. Tax Court that the compensation was not taxable. He mistakenly relied on a court case from 1920 to support this argument. Unfortunately for him, a 1955 Supreme Court case superseded the 1920 case, making it not applicable to the present matter.

Internal Revenue Code Section 61(a) provides that “gross income means all income from whatever source derived,” including compensation for services.

Using information obtained from third parties, the IRS had calculated Foryan’s income for 2009 to be $137,282. Against this income, Foryan was allowed a self-employment income tax deduction of $8,460, a standard deduction of $5,700 and a personal exemption of $3,650.

Foryan had been involved in a prior court case a few years earlier regarding a tax matter. He lost that case, and the court put him on notice regarding raising tax protester arguments.

The same situation arose in this case. The court rejected Foryan’s arguments as frivolous tax protester arguments. In addition, the court fined him $1,000 because it felt that his position in this case was frivolous or groundless.

Therefore, the court agreed with the IRS in this case, finding that Foryan had received $137,282 in compensation for services performed at various farms during the year and including that amount in his gross income for 2009. He was allowed the deductions calculated by the IRS (Stephan Foryan v. Commissioner, U.S. Tax Court, T.C. Memo 2015-114, June 22, 2015). ■

As I get ready to head off on vacation, I ran across a couple of articles on CFOs taking more working vacations. Robert Half Management Resources performed a study as to how often CFOs check in with the office during summer vacation. The percentage of time is increasing from their responses in 2012. It’s so easy now with everyone being so plugged in. Only 32% don’t anticipate checking in at all.

Robert Half Management Resources offers suggestions for allowing yourself to get away:

Set expectations: Let colleagues know if you plan to check in, if at all.
Appoint a successor: Select a point person to handle inquiries and requests in your absence. Include him or her on your out-of-office message.
Trust your team: Let your staff handle as much as they can.
Manage your return: Appropriately schedule the initial days of your return.

I’m a bit of an “all in or all out” person. When I’m in town I’m tied to my work. Some call me a workaholic. However, when I’m gone, I’m usually “gone.” Why? Because I do trust my team to take care of things. Our firm involves other staff in client relationships so that they can handle matters when the key contact person is out. I don’t worry when I’m gone.

We promote work-life balance because it’s meaningful to the Millennials, but we all need an opportunity to take some time to recharge. Sure, we may pay for it by putting in extra time before we leave and then on our return. But I do believe it is important to recharge. Your perspective is much better when you’ve had a chance to clear your mind and enjoy some personal relationship time.

I’m heading off to spend some quality travel time with my future daughter-in-law. One to one time. How often will that opportunity happen?

So, even as I feel guilty about taking off, it won’t last long. Until I return.

The one-year IRS pilot program to provide relief to plan administrators who didn’t file required retirement plan returns on Form 5500-EZ expires June 2, 2015. So, anyone wanting to take advantage of the penalty relief program should act fast.

This penalty relief is available to:

➜ Certain small business (owner-spouse) plans and plans of business partnerships

➜ Certain foreign plans

Small business plans provide retirement benefits only for the owner and the owner’s spouse.

The late filing penalty for 5500-EZs is $25 per day, up to a maximum of $15,000 per return. A business being assessed the maximum penalty for four years’ worth of unfiled returns could pay as much as $60,000 in penalties if it were not for this pilot program.

Under the program, no penalty or other payment is required to be paid for late filing. The applicant must include a complete Form 5500 Series Annual Return/Report, including all required schedules and attachments, for each year that the applicant is seeking penalty relief.

All of the delinquent 5500s must be sent directly to the IRS. The businesses cannot file through the Department of Labor’s EFAST2 filing system. Filing through the EFAST2 filing system results in returns being processed as they normally would be, with applicable late-filing penalties being assessed.

Plans subject to ERISA are not eligible for this program.

A foreign plan is a retirement plan maintained outside the United States, primarily for nonresident aliens. A foreign plan is eligible for relief if the employer that maintains the plan is a domestic employer or a foreign employer with income derived from sources within the United States.

At the end of this pilot program, the IRS will consider whether it should be replaced with a permanent one. If a permanent program is established, the IRS will charge businesses a fee to take part in the program. ■

The Internal Revenue Service provides many different educational products, webinars and videos to help small businesses thrive.

Take child care services as an example. The IRS webinar “Tax-Related Guidance for Child Care Providers” provides information that would be beneficial for a provider just starting out in the business as well as anyone who is relatively new in the business.

Most small businesses employ CPAs to handle their financial needs, but having some knowledge of what is going on regarding the financial side of the business is important.

The child care webinar is broken down into four main topics:

1. Child Care Income – This section covers various types of income that must be reported. Some examples are:

➜ Income from contracts specifying charges, terms and responsibilities

➜ Late pick-up or early drop-off fees

➜ Registration fees

2. Child Care Expenses – This section focuses on what criteria must be met for an expense to be deductible. Some examples of topics covered in this section are:

➜ The business must be a for-profit activity. Remember, hobby losses are not deductible.

➜ The expense must be ordinary and necessary.

➜ An allocation must be made for business/personal expenses. Only the business portion is deductible.

➜ Personal expenses are never deductible.

3. Special Rules – A hot button for child care providers is the business use of the home. The webinar covers the special method used to compute the business use percentage of a home available only for daycare service providers.

4. Other Expenses – There are some expenses common to the daycare industry. The webinar discusses how to deal with these expenses:

➜ Food consumed by daycare recipients, including the USDA food reimbursement program

➜ Supplies such as games, books, child-proofing devices, toys and diapers

➜ Depreciation expenses

Child care is only one of several businesses that can benefit from the targeted IRS educational products. Check out the various webinars and videos at www.irsvideos.gov. ■

It might seem like driving expenses to some, but to the IRS, it’s commuting.

Lonnie Bartley, a construction supervisor for Far West Contractors Corp. in California, was denied a deduction for nearly $25,000 in business expenses because the Tax Court said they were actually nondeductible commuting expenses.

Bartley’s job required him to travel to various job sites in the metropolitan Los Angeles area, mainly Redondo Beach and El Segundo.

Far West did not provide Bartley with a vehicle, nor did it reimburse him for mileage.

On his 2010 Form 1040 return, Bartley claimed $24,448 in auto-related expenses on Form 2106 EZ, Unreimbursed Employee Business Expenses. He also had $2,482 in other unreimbursed expenses.

The IRS sent Bartley a deficiency letter regarding the 2010 return. It was challenging the large amount of deductions on the Form 2106. In this situation, the taxpayer bears the burden of proof and must substantiate the deductions.

When expenses involve passenger automobiles and traveling while away from home, deductions are not allowed unless the taxpayer substantiates by adequate records or sufficient evidence the following three items:

1. The amount of the expenditure or use

2. The time and place of the expenditure or use

3. The business purpose of the expenditure or use

The business purpose test is usually not met if commuting is involved. There are two exceptions to this general rule.

The first exception permits a taxpayer to deduct transportation expenses incurred in going between a taxpayer’s residence and a temporary work location outside the metropolitan area where the taxpayer normally lives and works.

The second exception permits a taxpayer to deduct commuting expenses between the taxpayer’s residence and a temporary work location, regardless of distance, if the taxpayer also has one or more regular work locations away from the taxpayer’s residence.

Bartley did not meet the first exception to the commuting rule because he both lived and worked in the metropolitan Los Angeles area. He did not meet the second exception because the two job sites where he worked were determined by the court not to be temporary work locations because he already had worked at both the Redondo Beach and El Segundo locations for well over a year. Temporary work locations are usually job sites worked at for less than a year.

Bartley did not meet one of the exceptions to the commuting rule. Therefore, he did not meet the business purpose part of the three-part test that must be met to deduct automobile expenses.

The court ruled the $24,448 in auto-related expenses was nondeductible (Lonnie J. Bartley and Kimberly A. Bartley v. Commissioner, U.S. Tax Court, T.C. Summary Opinion 2015-23, March 31, 2015). ■