Couple Required To Include Social Security Disability and Discharge of Indebtedness Income; Theft Loss Denied (Seaver, TCM)

A married couple was required to include in income Social Security disability benefits received by the wife and was not entitled to exclude discharge of indebtedness income arising from the forgiveness of certain credit card debt. Although the Social Security disability benefits reduced the amount the wife was entitled to receive tax-free under a private long-term disability (LTD) policy, the LTD policy only entitled the wife to receive benefits on top of what she received from Social Security. Pursuant to Code Sec. 86, the Social Security benefits were required to be included in income.

The credit card debt which was relieved had been incurred for legal fees that the couple's attorney allegedly promised that they would be entitled to recoup. When the couple discovered they were not entitled to recoup such fees, they disputed the credit card charge and were relieved of the liability. Although the couple acknowledged that they were not eligible for any exception under Code Sec. 108 for discharge of indebtedness income, they claimed they should have been entitled to an offsetting theft loss for the attorney's misrepresentation. The couple failed, however, to establish that the alleged misrepresentation constituted a theft. Futhermore, even if such theft had occurred, it would have been deductible in a later year when the litigation concluded and they discovered they were not entitled to recoup the fees.

K.A. Seaver, TC Memo. 2009-270, Dec. 58,002(M)

Other References:

Code Sec. 86

CCH Reference - 2009FED ¶6421.17

Code Sec. 108

CCH Reference - 2009FED ¶7010.25

Code Sec. 165

CCH Reference - 2009FED ¶10,101.103

Tax Research Consultant

CCH Reference - TRC INDIV: 6,204

CCH Reference - TRC SALES: 12,150

CCH Reference - TRC INDIV: 54,100

CCH Reference - TRC INDIV: 54,254

Specified Costs and Attorney Fees Awarded For IRS Misconduct (Hongsermeier, TCM)

The IRS was required to pay specified taxpayers' costs and attorney fees associated with remand proceedings attributable to the IRS's misconduct during the "Kersting" tax shelter project litigation. The proceedings for which fees and costs were awarded were directly related to the IRS's sanctionable conduct.

CCH Comment. The IRS attorneys' unreasonable conduct involved arranging secret settlements with two of the test-case plaintiffs involved in the "Kersting" tax shelter test cases. The effect of these settlements was to pay the test-case plaintiffs' attorney to provide the appearance of independent representation of the test-case plaintiffs in the test-case trial. The Ninth Circuit Court of Appeals held that the IRS's conduct was a fraud upon the court (Dixon, 2003-1 USTC ¶50,194) and remanded the remaining 27 cases to the Tax Court to settle the remaining cases on the same terms as those secretly settled. The Tax Court recently imposed similar sanctions against the IRS with respect to attorneys who worked in the same proceedings on a contingency fee basis (Dixon, Dec. 57,766). The Tax Court plans to address fees incurred by other attorneys involved in the proceedings in a future opinion.

Related decision sub nom Dixon, CA-9, 2003-1 USTC ¶50,194.

R.F. Hongsermeier, TC Memo. 2009-273, Dec. 58,005(M)

Other References:

Code Sec. 6673

CCH Reference - 2009FED ¶39,790.451

Tax Research Consultant

CCH Reference - TRC LITIG: 6,816.15

California --Sales and Use Tax: City Barred From Invoking Pay First Rule in Litigation with OTCs

The city of Anaheim was barred from invoking the constitutional pay first requirement in litigation that arose when the city assessed a local transient occupancy tax against a number of online travel companies (OTCs). The pay first rule applies only to actions against the state or an officer of the state and the local ordinance did not contain a similar requirement.

Under Article XIII, Section 32, of the California Constitution, a taxpayer who wishes to challenge the assessment of a state tax must pay the disputed amount of tax before seeking recourse in the courts to recover the amount assessed. That provision, however, applies only to actions against the state or an officer of the state. After the city assessed the tax and interest against the OTCs, the OTCs, without first paying the assessed amounts, filed actions in superior court that sought mandamus and declaratory relief against the city and its administrative hearing officer. The city cited the pay first rule and demurred to the petitions on the ground that the OTCs had not paid the taxes allegedly due prior to filing suit. The superior court overruled the demurrers and the appellate court denied the city's petition for writ of mandate.

Moreover, the local transient occupancy tax ordinance did not contain a pay first requirement and it did not provide taxpayers with an adequate remedy at law, such as a refund procedure, to challenge the legality of the tax. As such, the city had no statutory authority to impose a pay first requirement on the OTCs. The city argued that a pay first requirement should be imposed based on the public policy underlying Article XIII, Section 32. The appellate court, however, held that the city could not rely on a public policy argument because the taxes the city seeks to collect from the OTCs do not represent a predictable income stream on which the city has come to rely. Although the transient occupancy tax has been in effect since 1977, the city had sought to collect the tax only from hotel operators until 2007 when the city issued a notice of audit to the OTCs regarding unpaid taxes. The city had not collected any of the taxes it claimed the OTCs owed.

The appellate court limited its holding to the procedural issue of whether the OTCs could seek mandamus and declaratory relief in the superior court without first paying the taxes. The court did not consider issues relating to the merits of the OTC claims, such as whether they are "operators" as defined in the ordinance, the applicability of Proposition 218, the possibility of criminal sanctions for nonpayment of the tax, or the due process concerns that arise from the fact that the city seeks to impose the transient occupancy tax for a seven-year period in which the OTCs had no notice that the city considered them subject to the tax.

Other References:

Explanations at ¶60-480

Illinois --Corporate Income Tax: Sales From Mobile Sales Unit Twice a Year Created Nexus

The Illinois Department of Revenue stated that making sales in Illinois once or twice a year from a mobile sales unit would not qualify as a de minimus exception for corporate income tax nexus purposes. The taxpayer conducted a substantial amount of activity in Illinois that is protected under P.L. 86-272, with 8% of their total sales in the state coming from the mobile unit. State regulations provide that an unprotected activity that is not de minimus standing alone does not become de minimus because the taxpayer also conducts a large amount of protected activities within the state. Additionally, the use of a mobile sales force in Illinois likely would be considered an activity regularly conducted in the state on a regular basis or pursuant to company policy.

Other References:

Explanations at ¶10-075