Another Reason Tax Professors Don’t Need to Invent Hypotheticals 

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Today’s guest post is from Professor James Edward Maule, a colleague of mine and Keith’s at Villanova’s Charles Widger School of Law, who many moons ago taught Stephen in Villanova’s Graduate Tax Program. This post originally appeared earlier this month in Mauled Again, Jim’s eclectic blog that in his words offers “more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies.” Jim’s blog was an inspiration to us, and his creative mind and far-reaching interests have touched on many topics (in the last few weeks alone he has discussed a proposal to include driver license numbers to reduce identity theft, taxation of powerball winnings, and genealogy). He also years ago when I transitioned from the tax clinic to teaching doctrinal courses offered up a generous series of posts that contained his views on how and what to teach in a Basic Income Tax Course, leading a tax prof colleague to refer to Jim as the “Yoda of tax teachers.”

In this post, Jim offers some thoughts on a recent Tax Court case that has the ingredients of a bad movie, but also sweeps in some interesting procedural issues relating to collateral estoppel and rescission. Les

A recent Tax Court decision, Blagaich v. Comr., T. C. Memo 2016-2 should provide some interesting classroom questions for those teaching the basic federal income tax course. It also is providing some interesting insights for myself, and hopefully for readers of MauledAgain (and now Procedurally Taxing).

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The taxpayer was involved in a romantic relationship with Lewis E. Burns from late 2009 until early 2011. During 2010, when the taxpayer was 54 and Burns was 72, he transferred to her property worth at least $743, 819, including cash and a Corvette. At the end of November in that year, the taxpayer and Burns entered into a written agreement intended to confirm their commitment to each other and to provide financial accommodation for her. They had no intention to marry and the agreement was, at least in some respects, intended to formalize their “respect, appreciation and affection for each other” in the way a marriage otherwise would do. The agreement provided that the parties “shall respect each other and shall continue to spend time with each other consistent with their past practice”, and that both “shall be faithful to each other and shall refrain from engaging in intimate or other romantic relations with any other individual”. The agreement also required Burns to make an immediate payment of $400,000 to the taxpayer, which he did. Soon thereafter, the relationship soured, an on March 10, 2011, the taxpayer moved out of Burns’ house, and on the next day he sent her a notice of termination of the agreement. Shortly thereafter, he concluded that she had been involved in a romantic relationship with another man throughout the relationship between himself and the taxpayer.

In late March of 2011, Burns sued the taxpayer in the Circuit Court for the Eighteenth Judicial District, DuPage County, Illinois, seeking nullification of the agreement, return of the Corvette and a diamond ring, and an order directing the taxpayer to return cash “and other accommodations” that Burns had provided to her, totaling more than $700,000. On April 8, 2011, Burns caused there to be filed with the IRS a Form 1099-MISC, reporting a transfer to the taxpayer of $743,819 in 2010. Based on the Form 1099, the IRS asserted a deficiency against the taxpayer, who filed a petition in the Tax Court on March 8, 2013. The IRS learned of the state court action and in May of 2103 requested the taxpayer’s attorney to provide copies of depositions taken in the case, any filings and motions relating to the Form 1099-MISC, and the fraudulent inducement claim asserted by Burns. In October 2013, the taxpayer moved for a continuance, reporting that the IRS did not object, and the Tax Court granted the motion. At some point during this time, Burns died.

In November 2013, after trial, the state court found that the taxpayer had fraudulently induced Burns to enter into the agreement, and entered a judgment ordering her to pay $400,000 to Burns’ Estate. The court held that the Corvette, the ring, and $273,819 in checks were “clearly gifts” to the taxpayer that she was entitled to keep. Subsequently, the executors of the estate caused an amended Form 1099-MISC to be issued, reporting $400,000 of income, and noting that the taxpayer had paid the $400,000 pursuant to the state court order.

The taxpayer then moved in the Tax Court for summary adjudication. The taxpayer relied on two arguments.

First, the taxpayer argued that $343,819 of the amount transferred to her by Burns was excluded from gross income as “clearly gifts.” She also argued that the IRS was estopped by the state court decision from denying that this amount represented gifts. The IRS argued that it was not so estopped because it was not a party nor in privity with any party in the state court action. The Tax Court agreed with the IRS and rejected the taxpayer’s collateral estoppel claim. The court rejected the idea that the IRS was estopped because it took steps to keep itself informed about the state court action. It also rejected the argument that the IRS bound itself to the outcome of the state court case by agreeing to a continuance in the Tax Court proceedings.

Second, the taxpayer also argued that the $400,000 portion of the transfers was not gross income under the doctrine of rescission. In other words, because she returned the money she ought to be treated as having not received it in the first place. The IRS argued that the doctrine of rescission was not applicable because the taxpayer did not return the $400,000 to Burns in 2010. The Tax Court agreed with the IRS, explaining that the doctrine of rescission is a narrow exception to the claim of right doctrine, which requires cash method taxpayers to include gross income in the year received if acquired without consensual recognition, express or implied, of an obligation to repay and without restriction as to disposition. The doctrine of rescission applies if the amount that is received is returned within the same taxable year. The Tax Court rejected the taxpayer’s reliance on cases in which the obligation to return the amounts that had been received had been acknowledged in the year of receipt even though actual repayment was made following that year, because in this instance the taxpayer did not acknowledge, in 2010, any obligation to return the $400,000.

Accordingly, the Tax Court issued an order denying the taxpayer’s motion for summary adjudication. Whether any portion of the $743,819 constitutes gross income to the taxpayer, or can be excluded as a gift, remains to be decided. Though it has been reported that the $400,000 payment for being monogamous was gross income, the taxpayer still has the opportunity to argue that the amounts received were gifts, particularly the amounts received before she and Burns entered into the agreement. Whether she succeeds remains to be seen.

For students in the basic federal income tax class, the question is simple. “Suppose your romantic partner pays you to remain monogamous. Do you have gross income?” When a student objects that “no one does that,” there now is proof that people do. Perhaps not very many people, but sometimes the most interesting tax cases arise from activities in which very few people participate.

 

Comments

  1. Thank you for your discussion of Blagaich. I too used it in a recent blog post at http://keystone-acct.com/blog/. I wonder how popular claiming the doctrine of rescission will become in the near future.

  2. Bob Kamman says:

    Great story, bad timing. Should have saved it for Valentines Day.

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