Friday, April 1, 2022

Tax Court in Brief | Bats Global Markets Holdings, Inc. v. Commissioner | Deductibility of Domestic Production Gross Receipts

The Tax Court in Brief – March 28th – April 1st, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of March 28, 2022, through April 1, 2022

Bats Global Markets Holdings, Inc. v. Comm’r, 158 T.C. No. 5 | March 31, 2022 |Kerrigan, J. | Dkt. No. 1068-17

Short Summary: Bats Global, a registered securities exchange, developed a trading platform software that operated electronic markets for trading equity securities. Bats Global was subject to the Securities Exchange Act of 1934 and the Regulation National Market System rules promulgated by the SEC. Bats Global’s customers were organizations that were members of applicable trading exchanges. The customers were required to accept terms of agreement and to agree to abide by the applicable exchange rules, both of which included authority or terms for the prescription of dues, fees, and charges. Bats Global’s software was paired with other open-source software that Bats Global did not develop. Customers used their own hardware to connect with Bats Global’s hardware in its data center. Bats Global charged a monthly, logical port fees for physical wire connections as well as routing fees for routing orders and transaction fees for when securities orders were executed (collectively, Fees). For each of tax years 2011, 2012, and 2013, Bats Global sought to deduct approximately $1,000,000 in Fees. The IRS denied the request and issued deficiencies for the amounts sought as deductions.

Issue: Whether Bats Global’s gross receipts from the Fees are domestic production gross receipts (DPGR)—and are therefore deductible—pursuant to 26 U.S.C. § 199 and related Treasury Regulations (26 C.F.R. § 1.199-1, et. seq.).

Note: 26 U.S.C. § 199 was enacted in 2004 to provide a tax deduction for certain domestic production activities, but the statute and its related regulations were repealed for tax years beginning after December 31, 2017.

Primary Holdings:

The Fees were derived from services, not the direct use of software, see Reg. § 1.199-3(i)(6)(iii), and, except for limited exceptions not met by Bats Global, gross receipts derived from the performance of services do not qualify as DPGR under Treas. Reg. § 1.199-3(i)(4)(i)(A). The fact that the applicable exchanges use software to operate does not convert Bats Global’s trade execution services into the provision of software for customers’ direct use.
In sum, Bats Global claimed the gross receipts from its Fees as DPGR. All three categories of Fees at issue—transaction fees, routing fees, and logical port fees—were derived from services Bats Global performed for customers in the course of operating Bats Global’s securities exchanges. The Fees were not derived from providing customers access to computer software for their direct use, and they therefore do not meet the requirements of Treasury Regulation § 1.199-3(i)(6)(iii) (repealed, 2017). Thus, Bats Global is not entitled to treat the gross receipts from the Fees as DPGR under Treas. Reg. § 1.199-3(i)(6)(iii) because the Fees were not derived from providing customers access to computer software for their direct use.

Key Points of Law:

Burdens of Proof. Generally, the IRS’s determinations are presumed correct, and the taxpayer bears the burden of proving the Commissioner’s determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the IRS if the taxpayer establishes that he or she complied with the requirements of 26 U.S.C. § 7491(a) to substantiate items, to maintain required records, and to cooperate fully with the IRS’s reasonable requests.
Statutory Construction The plain meaning of a regulation governs if the regulation is not ambiguous, and the courts must consider the text, structure, history, and purpose of a regulation before concluding that it is genuinely ambiguous. See Safe Air For Everyone v. EPA, 488 F.3d 1088, 1097 (9th Cir. 2007). Treasury regulations must be interpreted in the context of the statute they are designed to explicate. Bank of New York v. United States, 526 F.2d 1012, 1018 (3d Cir. 1975). Regulations are not an opportunity to amend a statute. United States v. Calamaro, 354 U.S. 351, 359 (1957); Koshland v. Helvering, 298 U.S. 441, 447 (1936).
DPGR Requirements. To be domestic production gross receipts (DPGR) the Fees must satisfy the requirements of Treasury Regulation § 1.199-3(i)(6)(iii)(B) (repealed, 2017): (1) that they were derived from providing customers access to computer software for the customers’ direct use while connected to the internet or any other public or private communications network; and (2) that a third party derived gross receipts from the lease, rental, license, sale, or other disposition of substantially identical software.
Section 199 Deduction. As in effect during the years in issue, §199(a) allowed a deduction equal to 9% of the lesser of (1) the qualified production activities income (QPAI) of the taxpayer for the tax year, or (2) taxable income for the tax year. The amount of the deduction is determined pursuant to § 199(b). DPGR includes gross receipts derived from any lease, rental, license, sale, or other disposition of qualifying production property (QPP) that was manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or in significant part within the United States. § 199(c)(4)(A)(i)(I). The term “derived from the lease, rental, license, sale, exchange, or other disposition” (collectively, Disposition) is limited to the gross receipts directly derived from the Disposition of QPP, and applicable federal income tax principles apply to determine whether a transaction is a lease, rental, license, sale, exchange or other disposition, a service, or some combination thereof. Treas. Reg. § 1.199-3(i)(1)(i).
QPP includes computer software, being “any program or routine or any sequence of machine-readable code that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine.” § 199(c)(5)(B); Treas. Reg. § 1.199-3(j)(3)(i).
Generally, gross receipts derived from the performance of services do not qualify as DPGR. Treas. Reg. § 1.199-3(i)(4)(i)(A). There is an exception for receipts derived from engineering or architectural services performed in the U.S. § 199(c)(4)(A)(iii). Gross receipts from construction performed in the U.S. are also included. § 199(c)(4)(A)(ii). In the case of an embedded service, that is, a service for which the price, in the normal course of the taxpayer’s business, is not separately stated from the amount charged for the lease, rental, license, sale, exchange, or other disposition of QPP, DPGR includes only the gross receipts derived from the disposition of QPP and not any receipts attributable to the embedded service.
Computer Software. DPGR includes gross receipts derived from the Disposition of computer software MPGE by the taxpayer in whole or in significant part within the U.S. § 199(c)(6)(i). With one limited exception, services related to software do not constitute qualified gross receipts for these purposes. Treas. Reg. § 1.199-3(i)(6)(ii), (iii).
In order for the Fees to be treated as DPGR, the requirements of Treasury Regulation § 1.199-3(i)(6)(iii) must be met. A taxpayer must show (1) that the Fees were derived from providing customers access to computer software MPGE in whole or in significant part by petitioner within the U.S. for customers’ direct use while connected to the internet or any other public or private communications network; and (2) that either a self-comparable exception or a third-party comparable exception within the regulations is met.
Logical Port Fees. Gross receipts from internet access services do not constitute gross receipts derived from a Disposition of software. See Reg. § 1.199-3(i)(6)(ii). Connection to (for example) the logical ports in Bats Global’s situation, is akin to internet access rather than direct use as described in Treasury Regulation § 1.199-3(i)(6)(iii)(B). The logical port fees in issue are payments for access to Bats Global’s private communications network, and thus, the logical port fees are not DPGR. See Treas. Reg. § 1.199-3(i)(6)(v) (example 3).
Routing Fees. Routing fees charged for the routing and trade execution services performed for (for example) Bats Global’s customers are not derived from customers’ access to software for their direct use as required for deductibility purposes under section 199 and related Treasury Regulations.
Transaction Fees. Securities trading transaction fees likely constitute a fee for the execution of services. Thus, such fees are not deductible under section 199 and related Treasury Regulations.
Third-Party Comparable Exception. Treasury Regulation § 1.199-3 contains exceptions: the self-comparable exception or the third-party comparable exception. See Treasury Regulation § 1.199-3(i)(6)(iii)(B). To qualify for the third-party comparable exception, a third party must derive gross receipts from the Disposition to its customers of software that is substantially identical to the taxpayer’s online software in a tangible medium or by download. See In order to be substantially identical in this regard, a third-party vendor’s computer software must (1) from a customer’s perspective, have the same functional result as petitioner’s online software and (2) have a significant overlap of features or purpose with petitioner’s online software. See id. § 1.199-3(i)(6)(iv)(A).

Insights: As indicated, the key statute—26 U.S.C. § 199—and related Treasury Regulations in issue in Bats Global were repealed for tax years beginning after December 31, 2017. Thus, the applicability of the technical analysis in Bats Global may be limited on a go-forward basis. However, the Internal Revenue Code currently contains section 199A (Qualified business income), and it, together with Treasury Regulations § 1.199A-1, et. seq., may provide a taxpayer with favorable deductibility for certain domestic production gross receipts. See, e.g., 26 C.F.R. § 1.199A-8 (Deduction for income attributable to domestic production activities of specified agricultural or horticultural cooperatives).

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Standing to Challenge Zoning Decisions

City of Dallas v. Homan

Dallas Court of Appeals, No. 05-20-01111-CV (March 31, 2022)

Justices Carlyle, Smith, and Garcia (Opinion available here)

Kelli Hinson

Katherine Homan filed a declaratory judgment action claiming that an amended zoning ordinance was invalid. The City of Dallas filed a plea to the jurisdiction, arguing Homan had no standing to challenge the ordinance. The trial court disagreed, denied the plea to the jurisdiction, and granted summary judgment in favor of Homan on her declaratory judgment claim that the ordinance is invalid. The City appealed.

The Dallas Court of Appeals agreed Homan had standing to contest the ordinance. Standing to challenge a government action requires a showing that the plaintiff suffered a particularized injury apart from the general public. So, in the context of a zoning decision, a plaintiff has standing “when the zoning affects the plaintiff differently than other members of the general public.” The Court noted that the Texas Legislature has created a mechanism for parties living within 200 feet of a proposed zoning change to receive notice and have the opportunity to protest the change. The Court found this to be a recognition that property owners within 200 feet of a proposed zoning change face a greater risk of injury to the use, enjoyment, and value of their property than the general public. This is a sufficient interest in the process to confer standing.

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Cryptocurrency: The Basics of Tax Treatment and Recognition

Cryptocurrencies might, simplistically, be defined as virtual currencies that use cryptography to secure transactions which are digitally recorded on a widely distributed ledger. The ledger technology uses independent digital systems to timestamp and harmonize transactions. The cryptocurrencies associated with a ledger are often called “coins” or “tokens”.

Cryptocurrency can be acquired in multiple ways. This post covers only common methods, such as purchase, gift, or airdrop following a hard fork. A hard fork occurs when a ledger is subject to modifications that “break” compatibility with an earlier protocol; in other words, each leg of the fork follows different “rules” so the blockchain ledger is split into an original chain and new chain. Hard forks sometimes result in the creation of a new cryptocurrency. An airdrop is a method of distributing cryptocurrency units to the ledger addresses of individual taxpayers. Airdrops sometimes, but not always, follow hard forks. While blockchain technology is interesting, and an elementary understanding of its technological mechanics is useful, it is the tax consequences of the receipt and disposition of cryptocurrency which is the subject of this post.

Tax Basis

The Internal Revenue Service (IRS) views virtual currencies as property. Under the Code, property will have a tax basis. A taxpayer’s basis in cryptocurrency is typically the amount spent to acquire it, inclusive of fees, commissions and acquisition costs. However, the tax bases of cryptocurrencies can also depend on the method by which it is acquired:

If cryptocurrency is acquired for other property or services, tax basis equals the cryptocurrency’s fair market value on the date of receipt.
If cryptocurrency is gifted, the donee follows historical property tax rules: (i) for purposes of determining gain, the donor’s tax basis carries over to the donee, plus any gift tax paid; and (ii) for purposes of determining loss, basis is the lesser of the donor’s basis or fair market value of the cryptocurrency at the time the gift was received. If the donor’s basis cannot be substantiated, the recipient’s basis is zero.
For cryptocurrency received in an airdrop after a hard fork or as part of a promotion, tax basis equals the fair market value once the taxpayer has dominion and control over the cryptocurrency received.

Select Income Recognition Issues

Cryptocurrency from an airdrop is considered received when recorded by the ledger, but the lack of recordation may not prevent income recognition if facts suggest a taxpayer has constructive receipt of the cryptocurrency. If a taxpayer gains the right to sell or transfer a cryptocurrency, then the taxpayer almost certainly includes the value of the cryptocurrency in income when those rights arise, because those rights give the holder dominion and control over the underlying asset. The IRS has published guidance that amplifies Rev. Rul. 2019-24, where taxpayers had income without an airdrop because there was a classic accession to wealth via dominion and control over cryptocurrency.

Interestingly, taxpayers should consider what actions constitute dominion and control over cryptocurrency. Consider the receipt of cryptocurrency from an unsolicited airdrop. Cash method taxpayers usually include items providing gross income in the year of constructive receipt. Despite that, the IRS has provided that in some cases where taxpayers receive unsolicited property (otherwise includable in gross income under Code Section 61), such property is only accounted for in income if the taxpayer displays acceptance of the property by factually exercising control over the property.

Taxpayers should also consider gain recognition upon disposition of cryptocurrencies, and the application of the net investment income tax to such a disposition. As an example, assume a taxpayer realizes $100 in gross income from the time the taxpayer exercises dominion and control over chain split coins. Using the basis rules above, the taxpayer’s basis in the chain split coins is $100. The taxpayer later disposes of the chain split coins for $170. The $70 gain on disposition is an item of gross income, but may also be subject to the net investment income tax under Code Section 1411. This is because some cryptocurrency might be classified as a “commodity” under Code Section 475(e)(2)(A). In other words, the net investment income tax may apply to the disposition of certain cryptocurrencies because of the combination of Code Sections 475 and 1092.

The comments relate only to a small sample of cryptocurrency tax issues. Future guidance is expected from the IRS and individual state taxing authorities and has been specifically requested by many tax practitioners and tax practitioner groups.

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Tax Court in Brief | Golditch v. Commissioner | Collection Due Process and Frivolous Arguments

The Tax Court in Brief – March 28th – April 1st, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of March 28, 2022, through April 1, 2022

Golditch v. Comm’r, T.C. Memo. 2022-26 | March 29, 2022 |Lauber, J. | Dkt. No. 7726-20L

Short Summary: Jason Golditch—a “serial non-filer”—challenged collection for deficiencies determined by the IRS through “substitute for returns” prepared by the IRS for tax years 2011 and 2012. Based on the tax liability thereby determined, the IRS sent various notices of federal tax liens and rights to a hearing. In response, Golditch did not request a hearing, and he did not petition the Tax Court for regress. Years later (2019), the IRS sent a levy notice, and Golditch requested a collection due process (CDP) hearing, claiming that he did not receive earlier notices of deficiency. Golditch then failed to provide any of the forms requested by the IRS and he did not call in to the telephone conference as scheduled. A “last chance” letter was sent to Golditch, and he did nothing in response. A notice of determination upholding the levy notice was issued, and Golditch petitioned the Tax Court, claiming that he did not receive prior notices and challenging the underlying tax liability.

Primary Holdings:

Golditch is not entitled to challenge his underlying liability because (1) he received (or deliberately refused to accept) notices of deficiency that were mailed to his last known address—and Golditch’s unsupported statement that he “did not recall receiving notice” was insufficient; (2) the IRS later sent, and Golditch admitted receiving a lien notice, and he did not file a CDP hearing request at that time; and (3) Golditch failed to submit any evidence to dispute his underlying liabilities at the CDP hearing. No abuse of discretion existed.
And, because Golditch’s arguments of “non-receipt of notices” were frivolous, an additional penalty of $2,000 was imposed.

Key Points of Law: 

A taxpayer may dispute liability for a frivolous return penalty under section 6702 at a CDP hearing and on review of the CDP determination in the Tax Court, in the absence of any other opportunity to contest it. In that instance, the section 6702 penalty is the underlying liability, and the taxpayer is entitled to de novo review of the penalty so long as the taxpayer has raised a meaningful challenge to the penalty at the CDP hearing. But, if the taxpayer fails to make a meaningful challenge to the penalty, the Tax Court reviews for abuse of discretion.
To determine whether the IRS settlement officer abused his or her discretion, the Tax Court evaluates whether the officer (1) properly verified that the requirements of applicable law or administrative procedure have been met, (2) considered any relevant issues the taxpayer raised, and (3) considered whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary. 26 U.S.C. § 6330(c)(3).
A notice of deficiency is sufficient if mailed to the taxpayer at his or her last known address, which is generally the address appearing on the taxpayer’s most recently filed and properly processed federal tax return. See 26 U.S.C. § 6212(b)(1); Treas. Reg. § 301.6212-2(a); Hoyle v. Comm’r, 131 T.C. 197, 200, 203–04 (2008), supplemented by 136 T.C. 463 (2011).
“If [a] taxpayer previously received a CDP Notice . . . with respect to the same tax and tax period and did not request a CDP hearing with respect to that earlier CDP Notice, the taxpayer had a prior opportunity to dispute the existence or amount of the underlying tax liability.” Treas. Reg. § 301.6330-1(e)(3), Q&A-E7.
A taxpayer may dispute an underlying tax liability in a CDP case only if the taxpayer properly raised that issue at the CDP hearing. Giamelli v. Comm’r, 129 T.C. 107, 113 (2007). “An issue is not properly raised if the taxpayer fails . . . to present to Appeals any evidence with respect to that issue after being given a reasonable opportunity.” Treas. Reg. § 301.6330- 1(f)(2), Q&A-F3
A “CDP hearing may, but is not required to, consist of a face-to-face meeting.” Treas. Reg. § 301.6330- 1(d)(2), Q&A-D6.
A substitute for return is not invalid simply because the Secretary of the Treasury does not sign it in person. Section 7701(a)(11)(B) defines the term “Secretary,” as used in the Internal Revenue Code, to mean “the Secretary of the Treasury or his delegate.” Arguing otherwise is a frivolous argument.
Section 6673(a)(1) gives the Tax Court discretion to require a taxpayer to pay the Government a penalty of up to $25,000 when the taxpayer, among other things, takes a frivolous or groundless position, or a position primarily for delay in proceedings before the Court.

Insights: This is a case that demonstrates the age-old mantra: The law helps those who help themselves–the vigilant, rarely the sleeping, and never the acquiescent. Ignoring IRS notices is not an advisable course of action. And, taxpayers should refrain from taking frivolous positions in CDP proceedings. What is “frivolous” might be in the eyes of the beholder, based on the facts and circumstances of the case. However, the IRS has issued—and taxpayers should be aware of—notices on positions that the IRS deems are frivolous. See I.R.S. Notice 2010-33, 2010-17 I.R.B. 609. By taking a frivolous position, the taxpayer then sets himself or herself up for additional penalty of up to $25,000, which is determined by the discretion of the Tax Court. It is also advisable to avoid that.

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Tax Court in Brief | Addis v. Commissioner | Collection Due Process and Frivolous Positions

The Tax Court in Brief – March 28th – April 1st, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of March 28, 2022, through April 1, 2022

Addis v. Comm’r, T.C. Memo. 2022-24 | March 28, 2022 |Urda, J. | Dkt. No. 12140-20L

Short Summary: Taxpayer, Jonah Addis (“Addis”) filed a delinquent tax return for his 2014 tax year. He reported zero dollars of income and a refund due. Third-party reporting showed that Addis had received income of $42,795 in 2014. The IRS assessed a $5,000 penalty for his taking a frivolous position. A notice of intent to levy was issued. Addis requested a hearing, which was conducted by correspondence. Addis claimed, among other things, that the federal tax laws did not apply to him. Addis’s request for relief from levy was denied. Addis sought review of the determination of the IRS’s Office of Appeals that upheld a notice of intent to levy.

Primary Holdings:

The record showed that the settlement officer conducted a thorough review of the materials relevant to Addis’s Collection Due Process (“CDP”) request and verified that applicable requirements were met. Addis neither alleged in his petition nor argued that the settlement officer failed to consider “whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.” See 26 U.S.C. § 6330(c)(3)(C). Addis’s frivolous arguments are not relevant, and he failed to raise a meaningful challenge. Thus, the settlement officer did not abuse his discretion in not considering them.

Key Points of Law:

A taxpayer may dispute liability for a frivolous return penalty under section 6702 at a CDP hearing and on review of the CDP determination in the Tax Court, in the absence of any other opportunity to contest it. In that instance, the section 6702 penalty is the underlying liability, and the taxpayer is entitled to de novo review of the penalty so long as the taxpayer has raised a meaningful challenge to the penalty at the CDP hearing. But if the taxpayer fails to make a meaningful challenge to the penalty, the Tax Court reviews for abuse of discretion.
Section 6330(c)(4)(B) provides that an “issue may not be raised at the [CDP] hearing if . . . the issue meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A).” Those clauses bar a taxpayer from raising an issue that is based on a position that the Secretary has identified as frivolous. See 26 U.S.C. § 6702(b)(2)(A). Where a taxpayer relies exclusively upon arguments that the IRS has identified as frivolous, the taxpayer will not be deemed to have raised a meaningful challenge. In that instance, the Tax Court must determine whether the settlement officer committed an abuse of discretion.
To determine whether the IRS settlement officer abused his or her discretion, the Tax Court evaluates whether the officer (1) properly verified that the requirements of applicable law or administrative procedure have been met, (2) considered any relevant issues the taxpayer raised, and (3) considered whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary. 26 U.S.C. § 6330(c)(3).
Section 6673(a)(1) gives the Tax Court discretion to require a taxpayer to pay the Government a penalty of up to $25,000 when the taxpayer, among other things, takes a frivolous or groundless position in proceedings before the Court.

Insights: Taxpayers should refrain from taking frivolous positions in CDP proceedings. What is “frivolous” might be in the eyes of the beholder, based on the facts and circumstances of the case. However, the IRS has issued—and taxpayers should be aware of—notices on positions that the IRS deems are frivolous. See I.R.S. Notice 2010-33, 2010-17 I.R.B. 609. By taking a frivolous position, the taxpayer then sets himself or herself up for additional penalty of up to $25,000, which is determined by the discretion of the Tax Court. It is advisable to avoid that.

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Tax Court in Brief | Villanueva v. Comm’r | Net Operating Losses and Carry Forward

The Tax Court in Brief – March 28th – April 1st, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of March 28, 2022, through April 1, 2022

Villanueva v. Comm’r, T.C. Memo. 2022-27 | March 31, 2022 |Goeke, J. | Dkt. No. 19781-18

Short Summary: Villanueva reported a loss of $112,375 on Form 4797, Sales of Business Property, attached to his 2013 return, from the disposition of a condominium. He reported a date of loss as August 5, 2013, although a mortgage lender had foreclosed on the condo in May 2009 and Villanueva lost possession of the condominium on that date. The IRS disallowed the reported loss in full.

Primary Holdings:

Villanueva sustained the loss in 2009 when the foreclosure occurred. Thus, the deduction, if allowable, would have been for 2009. Villanueva was not permitted to carry forward any portion of that loss to 2013 because he incorrectly reported the disposition of the condo and he did not include a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto. Accordingly, the IRS’s determination was proper.

Key Points of Law:

Taxpayers bear the burden of proving (and substantiating with adequate records) their entitlement to any deductions claimed. Rule 142(a); INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992); 26 U.S.C. § 6001.
Taxpayers are entitled to deduct losses sustained during the taxable year that were not compensated for by insurance or otherwise. 26 U.S.C. § 165(a). A loss is treated as sustained during the taxable year in which the loss occurs as evidenced by a closed and completed transaction and fixed by identifiable events occurring in such taxable year. Treas. Reg. § 1.165-1(d)(1). A loss resulting from a foreclosure sale is typically sustained in the year in which the property is disposed of and the debt is discharged from the proceeds of the foreclosure sale. Eisenberg v. Comm’r, 78 T.C. 336, 344 (1982).
In general, a taxpayer is entitled to deduct, as a net operating loss (NOL) for a taxable year, an amount equal to the sum of the NOL carryovers and carrybacks to that year. 26 U.S.C. § 172(a). NOL is treated as sustained during the taxable year in which the loss occurs as evidenced by a closed and completed transaction and fixed by identifiable events occurring in such taxable year. Treas. Reg. § 1.165-1(d)(1). An NOL generally must be carried back 2 years and then carried forward 20 years. § 172(b)(1)(A).
The taxpayer bears the burden of establishing both the existence of the NOL and the amount that may be carried forward to the year at issue. Rule 142(a); see Keith v. Comm’r, 115 T.C. 605, 621 (2000). The taxpayer must establish that the NOL was not absorbed in the years preceding the particular year for which the NOL deduction is sought. 26 U.S.C. § 172(b)(2), (c).
A taxpayer claiming an NOL deduction must file with his return “a concise statement setting forth the amount of the [NOL] deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the [NOL] deduction.” Treas. Reg. § 1.172-1(c).

Insights: Deductions are a matter of legislative grace. Taxpayers are entitled to deduct losses sustained during the taxable year that were not compensated for by insurance or otherwise. Taxpayers must substantiate that the loss is attributable to a trade or business or in a profit-motive endeavor, and adequate documentation must be maintained to evidence the applicable loss. The Code and Treasury Regulations have mechanisms for carrying forward and reporting net operating losses. However, the taxpayer must be prepared to submit a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the loss deduction. See Treas. Reg. § 1.172-1(c).

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Summary of Tax Crimes for Tax Procedure Class (3/31/22)

This past Tuesday, I was a guest lecturer at Jim Malone’s UVA Law Class on Tax Procedure. My subject was tax crimes. I circulated in advance a pdf summary of the topic here (which I have changed slightly as indicated in red). The summary is taken from the corresponding section of my Federal Tax Procedure Book Practitioner Edition but stripping out the footnotes and modifying the text as I thought appropriate). Readers of this blog can download the summary here. SSRN links to download either the Student or Practitioner Editions of the book are here.

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