IRS Practice and Procedure News Briefs for June 2020

Why this Case is Important: Sometimes it is unclear whether a payment constitutes a loan to the recipient, which is not subject to income tax, or income, which is taxed. This case is an example of when a payment that looks like a loan is actually taxable income.

Facts: The taxpayer in Novoselsky was a Chicago-based class action attorney. From 2009 through 2011, he was trying to put together certain class action lawsuits with doctors as plaintiffs. Because he did not have the money to fund these lawsuits, he convinced some doctors to give him the funds he needed. With each of these individuals, he signed a “Letter Agreement for Litigation Support,” which characterized the money he received as a loan that would be repaid at the successful conclusion of the lawsuit. Some attorneys also agreed to help fund these lawsuits, and again the taxpayer signed “loan” documents agreeing to repay them from attorney fees awarded by the court, if any. The taxpayer raised approximately $400,000 in 2009 and $1 million in 2011. Because he considered the funds to be loans, he did not report them as income or pay taxes on them. The IRS audited his 2009 and 2011 income tax returns and determined that the funds should have been reported as income. It issued him notices of deficiency assessing a total tax liability of almost $540,000 and penalties in excess of $100,000. The taxpayer filed a Tax Court petition contesting these assessments.

Law and Conclusion: Section 61(a) of the Internal Revenue Code broadly defines gross income to include “all income from whatever source derived.” Under this rule, most receipts of cash constitute gross income and are taxable. However, because loans must be repaid, loan proceeds do not constitute income and are not taxed. The issue in this case is whether the funds received by the taxpayer were loans for income tax purposes. Courts have held that, to be considered a loan, the obligation to repay “must be unconditional and not contingent on some future event.” If the obligation to repay only arises on the occurrence of a future event, a valid debt does not exist for federal income tax purposes. In this case, the payments to the taxpayer only had to be repaid if his class action lawsuits were successful. Because the taxpayer’s obligations to repay were contingent on future events, the Court held that the payments to the taxpayer were not loans. Instead, the Court characterized them as advance payments for services to be provided by the taxpayer. That being the case, the payments were taxable income to the taxpayer, and the Court found in favor of the IRS.

Why this Case is Important: With so many IRS filings having to be filed by a specific deadline to be considered valid, it is important to observe these deadlines and carefully follow IRS filing procedures. This case is an example of the harsh consequences of not doing so.

Facts: In this case, the taxpayer, through its attorney, was attempting to file Tax Court petitions to contest notices of deficiency issued by the IRS assessing taxes and penalties in excess of $1.3 million. The deadline to file the petitions was April 22, 2015. The taxpayer’s attorney readied the petitions for filing on April 21, 2015 and instructed his assistant to have them delivered to the IRS using its overnight delivery service. The assistant used the FedEx “First Overnight” service, the quickest service offered by FedEx, and the petitions were scheduled to be delivered at 8:30 A.M. on April 22. However, when the FedEx driver attempted to deliver the petitions, he could not reach the delivery point for some reason and the delivery was rescheduled for the following day. It was ultimately delivered on April 23. The IRS responded to the petitions by filing a motion to dismiss, arguing that the Tax Court did not have jurisdiction over the petitions based on them not having been filed by the filing deadline. The Court agreed and dismissed the case. The taxpayer appealed this dismissal to the Ninth Circuit Court of Appeals.

Law and Conclusion: To protect taxpayers who mail a document on time only to have that document delivered after a filing deadline, Section 7502(a)(1) of the Internal Revenue Code provides that if a document is received by the IRS, it will be deemed to have been delivered on the document’s postmark date (the “mailbox rule”). However, for the mailbox rule to apply, the document must be sent using a service that appears on the IRS’s of approved delivery services. This list includes registered mail, certified mail, and certain other private delivery services. As of 2015, the list of approved private delivery services had not been updated since 2004. While the list did include certain FedEx services, because the “First Overnight” service did not exist in 2004, it was not included on the list of approved services. That being the case, under a strict reading of Section 7502, the taxpayer did not mail its petitions using an IRS-approved service and the mailbox rule did not apply. Accordingly, the date of delivery of the petitions was the date they were actually received by the IRS – April 23, 2015, one day after the petitions’ filing deadline. Based on the filing deadline not having been met, the Appeals Court found in favor of the IRS and upheld the Tax Court’s dismissal.

If you would like more details about these cases, please contact me at 312-888-4113 or jnesser@lavellelaw.com.