Holding

The Tax Court decided that the IRS was right to make a supplemental assessment under §6204 after it mistakenly set Hough Beck & Baird Inc.’s employment tax liability at zero. The court ruled in favor of the IRS and allowed the proposed levy.

Why It Matters

• The decision confirms that the IRS need not file an erroneous refund suit under §7405 to recover money it mistakenly returned to a taxpayer.

• The method of recovery depends on the source of the error. The IRS may use a supplemental assessment when the original assessment materially misstated the tax liability.

• A different rule may apply when the IRS correctly assessed and fully collected the tax but later issued a refund because of an unrelated payment-processing or accounting error.

• The decision gives the IRS access to the ordinary administrative collection process, including liens and levies, when a timely supplemental assessment corrects a materially defective original assessment.

• The holding does not authorize reassessment of every erroneous refund. The IRS must identify a material defect in the original assessment and act within the applicable assessment period.

The decision is consequential because the Tax Court had not directly resolved when an IRS calculation error makes an assessment “imperfect” under §6204. The Court adopted the approach already used by the Second, Seventh, and Ninth Circuits.

At the same time, the outcome largely follows established appellate precedent. Hough Beck & Baird was based in Washington, so an appeal would ordinarily go to the Ninth Circuit. The Ninth Circuit had already approved a supplemental assessment in materially similar circumstances.

Key Facts

Hough Beck & Baird Inc. is a Seattle landscape architecture firm.

The company timely filed Form 941 for the quarter ending March 31, 2021. It correctly reported federal employment tax of $121,003 and made three deposits totaling the same amount.

The company did not claim an employment tax credit.

The IRS nevertheless treated the company as entitled to a credit. It assessed the company’s employment tax liability as zero and treated the $121,003 in deposits as an overpayment.

The IRS refunded $121,003 to the company, plus $89 of interest.

After learning about the refund, the company’s accountant contacted the IRS. An IRS representative stated that the refund resulted from COVID-related employee retention credits available to certain employers.

In May 2023, the IRS sent Letter 6552 stating that the company might have received a refund to which it was not entitled. The company did not respond or repay the amount.

On July 17, 2023, the IRS reversed the credit and made a supplemental assessment of $121,003. The IRS also charged $12,582 of interest as of that date.

The company did not pay the assessed balance.

In April 2024, the IRS issued a final notice of intent to levy. The company requested a collection due process hearing and disputed the underlying liability.

The IRS Independent Office of Appeals sustained the proposed levy. The company then petitioned the Tax Court.

Statutory Framework

Section 6201 authorizes the IRS to determine and assess taxes imposed by the Internal Revenue Code.

An assessment records the taxpayer’s liability in the government’s accounts. When the IRS rejects the liability shown on a return, it may calculate and record a different amount.

Section 6204 permits the IRS to make a supplemental assessment when an existing assessment is “imperfect or incomplete in any material respect.”

A supplemental assessment generally must comply with the three-year assessment limitation period under §6501.

After making a timely assessment, the IRS generally has ten years to collect the liability under §6502.

Section 7405 separately authorizes the government to file a civil action to recover an erroneous refund. Different limitation periods apply to those suits under §6532(b).

The dispute concerned which recovery mechanism applied. The company argued that the IRS had issued an erroneous refund after the tax was correctly assessed and paid. The IRS argued that its original assessment was materially defective because it recorded the liability as zero.

Arguments

Taxpayer argued:

• The company correctly reported and fully paid its employment tax liability.

• The original assessment was complete and accurate in all material respects.

• The IRS later returned money that the company had already paid.

• Once a correctly assessed tax has been paid, the liability is extinguished.

• The refund created a separate erroneous refund claim rather than a continuing employment tax liability.

• The government could recover the money only by filing a civil erroneous refund action under §7405.

• Because the government did not file such an action, the IRS could not collect the amount through a levy.

Government argued:

• The IRS did not correctly assess the company’s reported employment tax liability.

• The IRS mistakenly applied a credit and assessed the liability as zero.

• The zero assessment understated the actual liability by the entire $121,003 reported on the return.

• That error made the original assessment imperfect in a material respect.

• Section 6204 authorized the IRS to correct the error through a supplemental assessment.

• The timely supplemental assessment supported the IRS’s administrative collection action.

Court’s Reasoning

• The IRS recorded the company’s original employment tax assessment as zero. It did not merely issue a refund after correctly assessing the reported liability.

• The zero assessment resulted from the IRS’s mistaken application of an employment tax credit that the company had never claimed.

• The assessment understated the company’s liability by $121,003, which represented the full amount shown on the company’s return.

• An assessment that records no liability when the taxpayer actually owes $121,003 contains a material defect.

• Section 6204 does not limit supplemental assessments to taxpayer errors or newly discovered facts. The provision also applies when the IRS itself causes the material defect.

• The Ninth Circuit’s decision in Brookhurst, Inc. v. United States closely matched the facts. There, the IRS mistakenly assessed employment taxes at an amount below the amount reported and paid, issued a refund, and later made a supplemental assessment. The Ninth Circuit upheld the reassessment and collection by levy.

• The Seventh Circuit reached a similar result in United States v. Frontone. The IRS miscalculated the taxpayers’ liability, issued a refund, and later made an accurate supplemental assessment. The Court treated the continuing claim as one for the original tax liability.

• The Second Circuit also recognized in Johnson v. United States that the IRS may use a supplemental assessment to replace an invalid or defective original assessment.

• These cases establish that an IRS calculation error can make an assessment imperfect or incomplete in a material respect.

• The company relied heavily on O’Bryant v. United States, but the Tax Court found that case materially different.

• In O’Bryant, the IRS correctly assessed the negotiated tax liability and the taxpayers paid it in full. The IRS later posted the payment twice and issued a refund because its records incorrectly showed an overpayment.

• The error in O’Bryant concerned the posting of a payment, not the assessment amount. The original assessment remained correct.

• Hough Beck & Baird’s account presented the opposite sequence. The IRS first calculated and recorded the tax liability incorrectly, then issued a refund because the defective assessment created an apparent overpayment.

• The distinction determines the available recovery mechanism. A refund caused by a defective assessment may support a supplemental assessment. A refund caused solely by a payment-posting error may require an erroneous refund action.

• The company’s original payment did not extinguish the liability because the IRS returned the same amount after incorrectly recording the liability.

• The ultimate source of the government’s claim remained the company’s first-quarter 2021 employment tax liability. The government was not attempting to collect a new or unrelated obligation.

• The IRS made the supplemental assessment within the applicable assessment period.

• The supplemental assessment therefore supported the proposed levy under the ordinary collection rules.

Result

The Tax Court granted the IRS’s motion for summary judgment, denied the company’s cross-motion, and sustained the proposed levy.

The Takeaway

Tax professionals should first figure out why the IRS issued an erroneous refund before assuming a lawsuit is needed. If the assessment was seriously wrong, the IRS may be able to fix it under §6204 and use its usual collection process.

This decision does not remove the difference between reassessments and erroneous refund lawsuits. The key difference now depends on the type of accounting error, not just on whether the taxpayer got money from the IRS.

List of Citations

• §6201: Authorizes the IRS to determine and assess federal taxes.

• §6203: Governs the method of assessment by recording the taxpayer’s liability.

• §6204(a): Authorizes a supplemental assessment when an assessment is materially imperfect or incomplete.

• §6501(a): Generally requires the IRS to assess tax within three years after the return is filed.

• §6502(a)(1): Generally gives the IRS ten years after assessment to collect the liability by levy or Court proceeding.

• §7405: Authorizes the government to bring a civil action to recover an erroneous refund.

• §6532(b): Establishes the limitation period for erroneous refund suits.

• United States v. Galletti, 541 U.S. 114 (2004): Explains that an assessment records the taxpayer’s liability in the government’s books.

• Brookhurst, Inc. v. United States, 931 F.2d 554 (9th Cir. 1991): Upholds a supplemental assessment after the IRS materially understated employment tax and issued a refund.

• United States v. Frontone, 383 F.3d 656 (7th Cir. 2004): Treats a refund resulting from an understated assessment as part of the original tax liability rather than as a separate refund claim.

• Johnson v. United States, 123 F.3d 700 (2d Cir. 1997): Recognizes the IRS’s authority to make a supplemental assessment after a defective original assessment.

• O’Bryant v. United States, 49 F.3d 340 (7th Cir. 1995): Distinguishes an erroneous refund resulting from a duplicate payment posting from a refund resulting from an incorrect assessment.

• Estate of Wilbanks v. Commissioner, T.C. Memo. 1991-45: Applies §6204 when an earlier assessment omitted a material addition to tax.

• Golsen v. Commissioner, 54 T.C. 742 (1970): Requires the Tax Court to follow controlling precedent from the appellate circuit to which the case is appealable.

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Holding

The U.S. District Court for the Southern District of Florida found that President Trump, the IRS, and the Treasury Department were not truly on opposing sides, which is required for an Article III case. The court said the lawsuit was filed for the wrong reasons, gave nonmonetary sanctions under Rule 11, and allowed for possible monetary sanctions to cover costs caused by the parties’ actions.

Why It Matters

• This is not a routine jurisdictional ruling. The Court concluded that a sitting President cannot establish a genuine federal controversy by suing agencies that remain subject to his supervision and control.

• The order limits the legal value of the purported settlement. The parties may not cite or use the agreement as evidence of a settlement reached in the federal case.

• The Court treated the litigation process itself as sanctionable conduct. The voluntary dismissal ended the merits proceeding but did not eliminate the Court’s authority to examine Rule 11 violations and other abuses of the judicial process.

• The ruling does not decide whether every provision of the private agreement is independently valid. It addresses the absence of a judicial controversy, the improper use of the lawsuit, and the parties’ ability to characterize the agreement as a court-connected settlement.

Key Facts

Charles Littlejohn, an IRS contractor employed by Booz Allen Hamilton, unlawfully disclosed tax information associated with President Trump and thousands of other taxpayers. He pleaded guilty in 2023 and received a five-year prison sentence in January 2024.

President Trump, Donald Trump Jr., Eric Trump, and the Trump Organization sued the IRS and Treasury Department on January 29, 2026. They sought at least $10 billion under IRC §7431, which permits taxpayers to recover damages for unauthorized inspections or disclosures of tax return information.

The complaint arrived more than two years after an attorney representing Trump appeared at Littlejohn’s October 2023 plea hearing and identified Trump as a victim. IRC §7431 generally requires a taxpayer to file suit within two years after discovering the unauthorized inspection or disclosure.

The government never filed an appearance, an answer, a motion to dismiss, or any other substantive response. Instead, the parties requested additional time to discuss settlement.

The Court questioned whether it had subject matter jurisdiction because President Trump headed the executive branch and exercised authority over the defendant agencies. It ordered the parties to brief whether a genuine case or controversy existed.

Neither side submitted the required jurisdictional briefing. Plaintiffs instead voluntarily dismissed the case with prejudice on May 18, 2026.

The Justice Department then announced an agreement that included:

• A formal apology to the plaintiffs.

• A proposed $1.776 billion Anti-Weaponization Fund financed through the Treasury Judgment Fund.

• A separate Justice Department release purporting to protect Trump, his relatives, affiliated businesses, and others from broad categories of existing and potential government claims.

• Restrictions on future IRS audits and investigations involving the plaintiffs.

Acting Attorney General Todd Blanche later told Congress that the Anti-Weaponization Fund would not proceed. He did not provide the Court with the settlement for review before the dismissal.

Thirty-five former federal judges and other nonparty movants asked the Court to reopen the matter or grant related relief. They alleged that the litigation and settlement resulted from collusion and constituted a fraud on the Court.

The Court ordered the plaintiffs to respond to questions regarding collusion, adverse conduct, deception, and possible misuse of the judicial process.

Procedural Framework

Article III limits federal judicial power to genuine cases and controversies. A case must involve parties with adverse legal interests. Nominally placing parties on opposite sides of a caption does not establish adverseness when one party controls both sides of the litigation.

Federal Rule of Civil Procedure 41(a)(1) permits a plaintiff to voluntarily dismiss an action before the opposing party files an answer or motion for summary judgment. The dismissal generally ends the Court’s authority over the merits but does not eliminate jurisdiction over collateral matters such as sanctions, costs, attorney fees, and contempt.

Federal Rule of Civil Procedure 11 requires attorneys and parties to certify that filings serve a proper purpose and have a reasonable legal and factual basis. A Court may impose sanctions when a party files an action to achieve an improper objective rather than obtain a legitimate judicial resolution.

Federal courts also possess inherent authority to sanction bad-faith conduct that abuses the judicial process. Unlike Rule 11, this authority does not depend entirely on the timing and procedural requirements of a sanctions motion.

IRC §7431 authorizes damages for unauthorized inspections or disclosures of return information. The statute generally provides statutory damages of $1,000 for each unauthorized act, plus actual and punitive damages when the statutory requirements apply.

IRC §7217 prohibits specified executive branch officials from requesting that the IRS begin or terminate an audit or investigation of a particular taxpayer.

Arguments

Taxpayer argued:

• The voluntary dismissal automatically ended the Court’s jurisdiction.

• The Court could not continue reviewing the underlying dispute after plaintiffs dismissed the case.

• The lawsuit involved ordinary settlement activity between parties that had the power to resolve their disputes without judicial involvement.

• Donald Trump Jr., Eric Trump, and the Trump Organization held claims distinct from President Trump’s official authority over the executive branch.

• The parties remained sufficiently adverse because plaintiffs sought damages from government agencies.

• Rule 11 restricted the Court’s ability to impose sanctions after the voluntary dismissal.

• The nonparty movants raised political grievances rather than legally cognizable objections.

Government argued:

• The government filed no appearance or substantive position in the litigation.

• Justice Department officials defended the agreement publicly but did not present the agreement or the government’s legal analysis to the Court.

• Acting Attorney General Blanche asserted that the dismissal left no judge or mechanism available to review the agreement.

Nonparty movants argued:

• President Trump controlled the officials of the IRS, the Treasury Department, and the Justice Department who acted for the defendants.

• The parties filed the lawsuit to create legal cover for an agreement they had already decided to reach.

• The government abandoned defenses that it had asserted in similar unauthorized disclosure cases.

• The proposed settlement provided remedies far beyond the relief available under IRC §7431.

• The litigation lacked genuine adverseness and therefore never presented an Article III case or controversy.

• Plaintiffs and government officials used the lawsuit to give apparent judicial legitimacy to an agreement involving taxpayer funds, audit restrictions, and broad governmental releases.

Court’s Reasoning

• President Trump controlled the defendant agencies. The Constitution places executive power in the President. The Treasury Department and IRS operate within the executive branch, and their senior officials remain subject to presidential supervision and removal authority.

• The administration’s executive order reinforced that control. Executive Order 14215 required executive branch employees to follow legal interpretations established by the President and Attorney General, including positions advanced in litigation. The Court concluded that the order restricted the government defendants’ ability to take a litigation position contrary to President Trump.

• The parties’ conduct showed no genuine adverseness. The IRS and Treasury Department never appeared, defended the case, disputed damages, raised the statute of limitations, or challenged whether the government was the proper defendant. The same agencies had vigorously asserted those defenses in similar disclosure litigation brought by private taxpayers.

• The other plaintiffs did not create an independent controversy. Donald Trump Jr., Eric Trump, and the Trump Organization shared counsel, interests, ownership relationships, and settlement objectives with President Trump. They did not present distinct positions that restored a sense of adversity.

• The settlement extended far beyond the pleaded tax disclosure claims. The agreement proposed a $1.776 billion fund for undefined weaponization and lawfare claims involving unidentified third parties. A separate release purported to restrict audits, investigations, and other government actions involving the plaintiffs and their affiliates.

• The timing supported an improper-purpose finding. Plaintiffs filed the case after President Trump returned to office. The government remained silent. The parties dismissed the action shortly after the Court ordered jurisdictional briefing. They then announced the settlement without submitting it for judicial review.

• The Court viewed the lawsuit as a mechanism for legitimizing a predetermined agreement. Because the parties lacked adverse interests, the lawsuit could not provide the judicial foundation the agreement appeared designed to claim.

Article III Adverseness

The Court treated adverseness as a constitutional requirement rather than a discretionary procedural consideration.

A federal Court may decide only disputes between parties with genuinely conflicting legal interests. Courts must examine the parties’ actual relationship and cannot rely solely on labels such as plaintiff and defendant.

The Court applied decisions holding that Article III jurisdiction does not exist when:

• The parties seek the same result.

• One party controls the nominal opposing party.

• The litigation asks a Court to approve or validate an agreed outcome rather than resolve an actual dispute.

• A party effectively operates as the controlling litigant on both sides.

President Trump served as both the lead plaintiff and the official responsible for supervising the executive agencies named as defendants. The Court concluded that this authority prevented the IRS and Treasury Department from functioning as genuinely adverse litigants.

The Court therefore found that the action never presented a case or controversy and that no party could properly obtain judicial approval of the settlement through the proceeding.

Rule 11 Sanctions

The voluntary dismissal did not prevent the Court from considering sanctions. Rule 11 violations occur when a party files the offending pleading. A later dismissal does not erase the violation.

The Court found that plaintiffs used the lawsuit for an improper purpose. It concluded that the action sought to confer judicial legitimacy on a settlement rather than to obtain an adjudication of a genuine dispute.

Rule 11 limited the Court’s ability to impose monetary sanctions on its own initiative because plaintiffs dismissed the case before the Court issued a sanctions show-cause order. The Court therefore imposed nonmonetary sanctions under Rule 11:

• Attorney Alejandro Brito was referred to The Florida Bar for possible disciplinary review.

• Daniel Epstein may not obtain pro hac vice admission in the Southern District of Florida for one year or until further Court order.

• The parties may not describe, introduce, cite, or rely on the purported agreement as evidence of a settlement reached in the federal case.

The final restriction applies to President Trump, Donald Trump Jr., Eric Trump, the Trump Organization, the IRS, the Treasury Department, and related agents, affiliates, representatives, and persons acting under their control.

Inherent-Authority Sanctions

The Court separately invoked its inherent authority, which permits sanctions for subjective bad faith and broader abuses of the judicial process.

The Court found that plaintiffs acted in bad faith by:

• Filing claims that appeared untimely.

• Seeking damages with no demonstrated relationship to the remedies authorized by IRC §7431.

• Using the litigation to obtain benefits unavailable through an ordinary adjudication.

• Dismissing the case after the Court raised jurisdictional questions.

• Announcing a purported settlement without permitting judicial review.

The Court also criticized the government’s failure to defend the public fisc, assert available defenses, or explain its legal position.

The Court concluded that monetary sanctions could include attorneys' fees incurred by amici whose participation became necessary due to the parties’ conduct.

The court-appointed amici declined reimbursement. Other amici, including former federal judges who filed the motion that led to the order, may submit reimbursement requests. Plaintiffs may respond to any such request.

The order also directed the clerk to send copies to:

• The Florida Bar regarding Alejandro Brito.

• The New York disciplinary authorities, where Todd Blanche is admitted.

• The District of Columbia disciplinary authorities, where Stanley Woodward is admitted.

The Court did not impose a final monetary amount in the order.

Limits of the Decision

The order does not adjudicate the underlying merits of the unauthorized disclosure claims. Plaintiffs dismissed those claims with prejudice before the government responded.

The Court did not definitively decide whether the settlement agreement remains enforceable as a purely private executive branch agreement. It instead prohibited the parties from treating it as a settlement reached through the federal lawsuit.

The Court also declined to make a final determination under Rule 60(d)(3), which permits relief for fraud on the Court. It left open the possibility of future proceedings under that rule.

The decision comes from a federal district Court. It does not establish binding precedent outside the case in the same manner as a federal appellate decision.

Result

The Court found no Article III case or controversy, imposed nonmonetary Rule 11 sanctions, permitted possible monetary sanctions, and barred the parties from using the agreement as evidence of a Court settlement.

The Takeaway

Tax professionals should see this order mainly as a decision about constitutional issues and litigation sanctions, not as a detailed interpretation of IRC §7431. The main point is that the court refused to accept a tax settlement when the plaintiff controlled the government agencies being sued and there was no real adversarial review.

List of Citations

• U.S. Constitution, Article III, §2: Limits federal judicial power to genuine cases and controversies.

• U.S. Constitution, Article II, §1: Vests executive power in the President and supported the Court’s control analysis.

• IRC §7431: Authorizes civil damages for unauthorized inspections or disclosures of tax return information.

• IRC §7431(d): Establishes the two-year limitations period for unauthorized disclosure actions.

• IRC §7217: Prohibits executive branch influence over specific IRS audits and investigations.

• IRC §7803(a): Governs appointment and removal authority for the IRS Commissioner.

• Federal Rule of Civil Procedure 11: Authorizes sanctions for filings presented for an improper purpose.

• Federal Rule of Civil Procedure 41(a)(1): Governs voluntary dismissals before a defendant files an answer or summary judgment motion.

• Federal Rule of Civil Procedure 60(d)(3): Preserves judicial authority to address fraud on the Court.

• Lord v. Veazie, 49 U.S. 251 (1850): Rejects jurisdiction where nominally adverse parties share the same interests.

• Muskrat v. United States, 219 U.S. 346 (1911): Requires actual adverse parties for an Article III controversy.

• Aetna Life Insurance Co. v. Haworth, 300 U.S. 227 (1937): Defines a justiciable controversy as concrete and involving adverse legal interests.

• GTE Sylvania Inc. v. Consumers Union, 445 U.S. 375 (1980): Explains that no controversy exists when parties seek the same result.

• South Spring Hill Gold Mining Co. v. Amador Medean Gold Mining Co., 145 U.S. 300 (1892): Rejects litigation when the same persons control both sides.

• Cooter & Gell v. Hartmarx Corp., 496 U.S. 384 (1990): Holds that voluntary dismissal does not eliminate Rule 11 jurisdiction.

• Absolute Activist Value Master Fund Ltd. v. Devine, 998 F.3d 1258 (11th Cir. 2021): Confirms that courts retain jurisdiction over collateral sanctions issues after dismissal.

• Chambers v. NASCO Inc., 501 U.S. 32 (1991): Recognizes the federal courts’ inherent authority to sanction bad-faith litigation conduct.

• Trump v. Clinton, 640 F. Supp. 3d 1329 (S.D. Fla. 2022): Supports sanctions for litigation filed for an improper or performative purpose.

Holding

The DOJ asked for a new hearing after the Seventh Circuit said the claim of right doctrine could be used to exclude certain payments from income. The court sent Hyatt’s loyalty fund case back to the Tax Court.

Why It Matters

• This is consequential because the government frames the panel decision as a threat to the basic definition of gross income under §61.

• The petition argues that the claim-of-right doctrine is a rule of income inclusion, not a taxpayer election to exclude controlled receipts from income.

• The dispute matters beyond Hyatt because many businesses receive and administer funds tied to customer programs, vendor arrangements, rebates, deposits, or restricted-use accounts.

• The government’s concern is administrative. If the panel decision stands, taxpayers may try to avoid income recognition by denying a claim of right while still controlling and benefiting from the funds.

Key Facts

The IRS issued Hyatt a notice of deficiency asserting an additional $70 million in corporate income tax for the years between 2005 and 2012.

The deficiencies arose from payments made into a fund used to administer Hyatt’s Gold Passport customer loyalty program. Most payments came from third-party hotel owners.

Hyatt administered the fund. The IRS determined that Hyatt improperly omitted those payments from income.

The Tax Court addressed three issues:

• whether payments into the fund were income to Hyatt

• whether the IRS could make an accounting adjustment based on Hyatt’s earlier omission of that income

• whether Hyatt could use a Treasury regulation to reduce the amount it had to include in income

The Tax Court ruled for the Commissioner on the income inclusion and regulation issues. It ruled against the Commissioner on the accounting adjustment issue.

Hyatt appealed. The Seventh Circuit did not resolve the Tax Court’s analysis of the trust fund doctrine. It instead held that the claim of right doctrine may provide an independent and broader basis for income exclusion.

The panel remanded the case to the Tax Court to consider whether the fund payments were income to Hyatt under the claim-of-right doctrine.

Statutory or Regulatory Framework

Section 61 defines gross income broadly as all income from whatever source derived. The claim of right doctrine generally requires inclusion of income when a taxpayer receives earnings under a claim of right and without restriction on disposition, even if the taxpayer may later have to repay the money.

The trust fund doctrine can exclude funds from income when a taxpayer merely holds funds for another party and lacks beneficial ownership. The DOJ’s petition treats that doctrine as a narrow exclusion and argues that the panel’s claim-of-right analysis would make it largely unnecessary.

Arguments

Taxpayer argued:

• Hyatt did not have to include the loyalty fund payments in income.

• The claim of right doctrine provided an independent basis for excluding the payments.

• The fund payments should not be treated as Hyatt’s income if Hyatt lacked the required claim of right over the money.

Government argued:

• The claim of right doctrine is a rule of inclusion.

• Failure to satisfy the claim-of-right test does not automatically exclude a receipt from income.

• The panel's decision conflicts with Supreme Court precedent that broadly defines income.

• Indianapolis Power did not convert the claim-of-right doctrine into an exclusionary rule.

• The decision would allow taxpayers to control and benefit from funds while denying income treatment by disclaiming a claim of right.

Court’s Reasoning

The petition challenges the panel’s reasoning. It does not announce a new Court ruling.

The DOJ makes these points:

• The claim-of-right doctrine identifies one situation in which a taxpayer must include disputed receipts in income for the year of receipt.

• The doctrine does not define the outer boundary of income.

• The panel allegedly confused a sufficient condition for income inclusion with a necessary condition for income recognition.

• The DOJ argues that the panel revived the error of Commissioner v. Wilcox, which treated the presence of a claim of right as a condition for taxable income.

• The DOJ argues that James v. United States rejected that approach by overruling Wilcox and holding that unlawful gains can constitute taxable income even absent a bona fide claim of right.

• The DOJ contends that Indianapolis Power turned on dominion and an obligation to repay customer deposits, rather than on an exclusionary version of the claim-of-right doctrine.

• The DOJ argues that the panel's decision could weaken broader income principles grounded in control, dominion, and readily realizable economic value.

Result

The DOJ wants the Seventh Circuit to rehear the case, cancel the panel’s decision, and not allow the claim of right doctrine to be used as a way to exclude income.

The Takeaway

Tax professionals should see this as an important case about gross income, not just a loyalty program issue. The main question is whether the Seventh Circuit will let the claim of right doctrine become a broader way for taxpayers to exclude income when they handle disputed or restricted funds.

List of Citations

• §61: Defines gross income broadly as income from whatever source derived.

• Hyatt Hotels Corp. v. Commissioner, 174 F.4th 535: Seventh Circuit panel decision that the DOJ seeks to rehear.

• James v. United States, 366 U.S. 213: Central Supreme Court authority cited by the DOJ for the broad definition of income and the rejection of Wilcox.

• Commissioner v. Wilcox, 327 U.S. 404: Overruled case that treated claim of right as a condition for taxable income.

• Rutkin v. United States, 343 U.S. 130: Supreme Court case holding that unlawful gains are taxable income when the taxpayer has control and economic value.

• Commissioner v. Glenshaw Glass Co., 348 U.S. 426: Foundational case defining income as undeniable accessions to wealth, clearly realized, over which the taxpayer has complete dominion.

• Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203: Customer deposit case that the panel relied on and that the DOJ argues the panel misread.

• United States v. Skelly Oil Co., 394 U.S. 678: States the classic claim-of-right formulation and ties it to annual accounting.

• North American Oil Consolidated v. Burnet, 286 U.S. 417: Original claim-of-right case requiring inclusion of income in the year of receipt despite ongoing entitlement litigation.

• Healy v. Commissioner, 347 U.S. 278: Applies the claim-of-right doctrine to salary received without restriction, even though a later repayment liability arose.

• Macias v. Commissioner, 255 F.2d 23: Seventh Circuit authority cited by DOJ as rejecting claim of right as an exclusion doctrine.

• Commissioner v. Schleier, 515 U.S. 323: Cited for the sweeping scope of gross income.

Generative AI changes how we work, but it does not change legal responsibility. A tool that quickly creates a polished memo can also make up citations, invent safe harbors, or suggest transaction structures that look right but miss the real requirements. In tax, this is not just a drafting issue—it is a compliance issue.

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People often say AI is risky because it sometimes makes things up. That is true, but it is not the whole story. AI works by guessing what is likely, while tax law relies on clear authority, rules, and checking facts. The system does not care if an answer sounds correct—it cares if you can trace it to a real law, regulation, ruling, case, or record.

The Event

Generative AI is now used to read statutes, draft memos, summarize legal sources, and help with tax analysis. It really does save time and makes complicated material easier to handle.

But this same ability also changes the risks. Large language models do not perform legal reasoning as tax professionals do. They predict what text should come next. When asked about rules like IRC §351 or §199A, the model might give an answer that looks finished but actually makes up a safe harbor, gets a Treasury Regulation wrong, or invents a precedent. The real risk is not messy output—it is a polished answer that is actually wrong.

Courts have already seen what can go wrong. There are examples of AI-generated legal filings that cited fake cases, leading to sanctions, thrown-out memos, and disciplinary actions. In tax, these mistakes are even more serious because the system relies on people following the rules themselves. Fake authority does not just mislead a Court—it also adds misinformation to a system that is already very complex.

This issue became even more important after Loper Bright. Now that Chevron has been overruled, courts must interpret ambiguous laws on their own, without relying on agency explanations. This means the actual text, structure, legislative history, and real records matter even more. AI can quickly find and summarize lots of material, but finding information is not the same as interpreting it. If AI invents a Senate report or Treasury explanation, it is not just harmless background—it can actually distort the record.

The Real Driver

The real reason behind these changes is not technology itself—it is the incentives people face.

Tax professionals are under pressure to work faster, cut costs, and get more done in less time. AI fits these needs well. It makes it seem like you have more help. You can ask for a memo, a transaction outline, or a list of citations and get something that looks professional. Because the output looks smart, people are more likely to trust it without checking.

That is the trap. AI is not a junior associate or a paralegal. It is not someone you can supervise like a regular team member. You give it prompts, but it is not trained in the same way. It lacks loyalty, cannot exercise judgment, and does not understand what happens if it is wrong. Treating AI like a legal assistant is misleading and reduces accountability.

The better model is instrumentality. It is better to think of AI as a tool that helps people do more. But unlike a calculator or a word processor, AI can create legal claims. If a calculator makes a mistake, you can usually see it. If AI makes a mistake, it might look convincing even though it is wrong. Because of this, the human practitioner must check every legal point before it goes out. As drawn from United States v. Boyle, reliance on another actor does not excuse failure to perform a non-delegable duty. The source material applies that principle to AI verification. Checking whether a case exists, whether a quotation is accurate, and whether a cited authority supports the proposition is not the kind of judgment that can be outsourced to a machine. It is ordinary professional diligence.

Circular 230 points in the same direction. Section 10.22 requires due diligence in determining the correctness of representations made to Treasury. A large language model is not a person who can be supervised within the meaning of that framework. The current rules were built to account for human error and misconduct. AI changes scale. One practitioner can make an isolated mistake. One AI workflow can generate thousands of plausible errors.

The Pattern

The recurring pattern is institutional lag.

A new tool is used in professional practice before rules and controls are in place. People start using it because it saves time. Firms allow it because it cuts costs. Regulators and courts react only after problems surface in filings, client advice, or public records. By that point, the issue has grown from a single mistake to a bigger process risk.

Tax is especially at risk because technical details matter a lot. AI is good at getting the form right. For example, it can describe a §351 exchange with property transferred, stock received, and control met. But tax law also considers whether the deal has real economic substance, a business purpose, and an actual economic impact. These questions depend on intent, context, and real facts. AI can replicate the language of these rules, but it cannot determine whether the facts actually fit.

That produces synthetic compliance. A transaction can appear properly assembled yet fail the doctrine that matters. Under IRC §7701(o), economic substance requires meaningful economic change and substantial non-tax purpose. A model can draft business justifications from common patterns, but those justifications are not facts. They are generated language. The same problem appears in step transaction analysis. AI can sequence steps neatly. A Court may collapse them if they were part of a fixed plan. This pattern also shows up in jurisdictional analysis. AI often misses important differences because it learns from the most common patterns in its training data. Federal tax rules might be overrepresented, while state, local, and international rules are less visible. This can cause mistakes, such as using the wrong Court circuit, treating OECD guidance as U.S. law, or mixing up VAT with U.S. sales tax. Tax law needs specific answers, but AI often turns specifics into general responses.

Implication

The responsibility stays with the practitioner, not the tool.

If AI creates a fake authority, the Court does not punish the software. If client data is put into a public model, the privilege problem is not the model’s fault. If an AI-generated structure fails the economic substance test, the machine is not penalized under §6662 or subject to promoter issues under §6700. The person is responsible for the submission, the advice, and any breach of confidentiality.

The privilege issue is especially clear. Most generative AI tools run in the cloud. Putting client facts, return positions, or tax strategies into these tools can send sensitive information to a third-party provider. If that provider logs, stores, or reuses the data, confidentiality can be lost. The Kovel analogy does not fix this. Kovel protects some non-lawyer helpers who work under a confidential relationship. Public AI tools do not fit this model because they lack agency, loyalty, or a clear confidentiality framework.

IRC §7216 brings up a similar concern when tax return information is shared without permission. The source material says this is more than just an ethics issue—it is a structural problem caused by data being stored, hidden, or reused. The main lesson is simple: a public AI prompt box is not a private conference room, no matter how friendly it seems.

Lessons for Practitioners

• When using AI, the real work is in verifying the results. The draft might come from the tool, but responsibility for accuracy lies with the practitioner.

• Just because something sounds fluent does not mean it is reliable. A polished list of citations is risky because it makes it look like someone has already checked it.

• Anti-abuse rules show the limits of drafting based only on form. AI can put steps together, but economic substance and step transaction analysis rely on facts, purpose, and context.

• Confidentiality risks begin as soon as you enter information. Putting client facts into a public or poorly controlled AI system can cause privilege and disclosure problems before you even draft a memo.

• Governance is more than just a policy memo in a folder. Good controls include keeping records of source checks, usage logs, and version histories; using restricted tools; having zero-retention contracts; and ensuring a human reviews everything before it goes to a client, Court, or agency.

Human Element

When people are under pressure, they are more likely to take shortcuts if those shortcuts look professional. AI makes this easier by hiding the rough parts of early drafts. The draft comes out looking finished and confident, which makes people trust it before they have checked it.

Forward View

The continuing pattern is not prohibition. AI will remain in tax practice because the efficiency gains are too large to ignore. The profession will not stop using tools that can summarize material, organize research, and accelerate drafting. The question is whether those tools are placed within a system that makes errors harder to detect. That system must make human review the main checkpoint. Courts might require proof that AI-assisted filings have been checked. Treasury could update Circular 230 to cover generative AI. Firms might limit public tools and require verified databases for legal work. All these steps lead to the same point: AI can help with tax work, but it cannot take on legal responsibility.

The tax system can handle faster tools, but it cannot handle unverified information that appears to be professional judgment.

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Holding

The Tax Court agreed with the IRS and denied the taxpayer’s deductions for travel, meals, entertainment, security, telephone, and duplicate fees. However, it allowed some deductions for bank charges, dues and subscriptions, taxes and licenses, and postage. The final amount owed will be calculated under Rule 155.

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Why It Matters

• This is a routine substantiation case, but it is useful because the taxpayer had receipts, credit card records, and spreadsheets. Those records still failed where they did not prove business purpose.

• The opinion reinforces that travel with friends, romantic partners, or family members invites scrutiny when the taxpayer claims business deductions.

• Post-examination reconstruction had limited value. The Court gave little weight to emails created in 2024 to support travel taken in 2021.

• The Court allowed expenses when the taxpayer tied them directly to the business. It rejected expenses when the evidence showed personal use or no allocation.

Key Facts

Gregory Rodrigues filed a 2021 federal income tax return reporting $575,232 of W-2 wages from Ecologic Brands.

He also reported income and expenses from Western Land Financial, LLC, a real estate investment company he founded in 2003.

Western Land Financial reported:

• $1,999 of gross receipts.

• $52,426 of expenses.

• A Schedule C loss of $50,427.

The disputed deductions included:

• $16,206 for travel.

• $6,218 for meals and entertainment.

• $12,683 for “Other” expenses.

The “Other” expenses included bank charges, dues and subscriptions, fees, postage, security, taxes and licenses, and telephone expenses.

Rodrigues traveled in 2021 to West Palm Beach, Miami, San Jose del Cabo, Carmel, Healdsburg, and California’s Central Valley. He also booked a canceled trip to Austin and a later “Backroads” trip scheduled for 2022.

He claimed the travel was related to real estate investment activity, including efforts to sell land in Anza, California, and interests in land in Holbrook, Arizona.

Some travel involved members of a Harvard Business School friend group called the Loveshack Investors. Some members worked in real estate.

Jennifer George, an attorney employed by PwC, accompanied Rodrigues on several trips. Rodrigues and George shared a residence and had a child together. They did not have a retainer agreement for legal services during 2021.

Rodrigues did not maintain contemporaneous travel logs. He later prepared spreadsheets using receipts, credit card records, and bank statements.

Statutory or Regulatory Framework

§162 allows deductions for ordinary and necessary business expenses. “Ordinary” means common in the taxpayer’s business. “Necessary” means appropriate and helpful to that business.

§262 disallows deductions for personal, living, or family expenses.

§274(d) imposes strict substantiation rules for travel, meals, entertainment, gifts, and listed property. A taxpayer must prove the amount, time, place, business purpose, and, for entertainment or gifts, the business relationship.

§6001 and the regulations require taxpayers to keep records sufficient to establish their deductions.

The Cohan rule allows courts to estimate some business expenses when the taxpayer proves the expense occurred but not the exact amount. The rule does not apply when strict substantiation is required or when the Court lacks a reasonable basis for allocation.

Arguments

Taxpayer argued:

• The travel expenses related to Western Land Financial’s real estate business.

• The trips involved meetings with investors and real estate professionals.

• George accompanied him as his attorney.

• The Loveshack Investors trips had a business purpose because some members were real estate professionals.

• The “Other” expenses were ordinary and necessary expenses of Western Land Financial.

Government argued:

• Rodrigues failed to prove that the disputed expenses were paid or business-related.

• The travel appeared personal.

• The records did not satisfy §274(d).

• Several expenses were personal, duplicative, or inadequately allocated.

Court’s Reasoning

• The Court accepted that Rodrigues paid many of the expenses. Payment alone did not establish deductibility.

• The Court did not find Rodrigues’s spreadsheets reliable as proof of business purpose.

• The Court found his testimony regarding the business purpose of the travel and meals not credible.

• The Court treated the travel as predominantly personal because it involved friends and George, with whom Rodrigues shared a residence and child.

• The Court rejected the claim that George traveled as his attorney because there was no documentary evidence of an attorney-client relationship for the trips.

• The Court gave little weight to 2024 emails sent to Loveshack Investors members because they were not contemporaneous with the 2021 travel and were created after the IRS examination began.

• The Court found that a 2005 concept plan for the Anza property did little to prove that 2021 travel had a business purpose.

• The Court held that Rodrigues failed the §274(d) business-purpose requirement for travel and meals.

• The Court allowed bank charges because Rodrigues substantiated $120 in wire transfer fees associated with real estate loans.

• The Court allowed $4,758 of dues and subscriptions because the record tied the HOA fees, Wall Street Journal subscription, and Ring subscription to Western Land Financial’s business or property security.

• The Court denied a separate $168 fee deduction because it duplicated amounts included in taxes and licenses.

• The Court allowed $577 for substantiated taxes and licenses.

• The Court allowed $336 for postage because the record linked the expense to the shipping and notarization of real estate documents.

• The Court denied the $216 security expense because Rodrigues failed to substantiate its business purpose.

• The Court denied telephone expenses because the charges included personal cable television services and Rodrigues did not provide a reasonable allocation between personal and business use.

Result

Decision will be entered under Rule 155 after allowing limited deductions and sustaining the IRS’s remaining disallowances.

The Takeaway

This decision is a clear reminder that receipts and spreadsheets alone are not enough to prove a deduction unless they show a business purpose. Accountants should treat travel, meals, mixed-use subscriptions, and home-related expenses as high-risk for Schedule C unless the taxpayer has up-to-date records and a solid way to separate business from personal use.

List of Citations

• Welch v. Helvering: burden-and-necessity standard for business expenses.

• INDOPCO, Inc. v. Commissioner, deductions are a matter of legislative grace.

• Cohan v. Commissioner, estimation allowed only when the record provides a basis.

• Vanicek v. Commissioner, estimation requires a reasonable evidentiary foundation.

• Sanford v. Commissioner: strict substantiation limits on §274(d) expenses.

Holding

The Tax Court refused to allow the proposed levy. It denied the IRS’s request for summary judgment, treated the taxpayer’s response as a cross-motion, and ruled in favor of the taxpayer.

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Why It Matters

• The decision limits the IRS's collection discretion when the DOJ has already resolved the same tax liabilities through a settlement agreement.

• The ruling does not invalidate restitution-based assessments, or RBAs. It limits how the IRS may collect them when collection conflicts with a later DOJ compromise.

• The case turns on timing and consistency, not double collection. The Tax Court accepted that payments against RBAs would be credited against civil tax liabilities.

• The practical point is procedural. Appeals must consider whether a levy is more intrusive than necessary when the government has already agreed to installment payment rights.

Key Facts

Joseph White owed federal income tax liabilities for 2000 through 2011.

In 2017, he was convicted under §7201 for willfully attempting to evade payment of those taxes. The sentencing Court ordered $1.2 million in restitution to the IRS. The IRS then made RBAs under §6201(a)(4) for the same $1.2 million.

In 2022, DOJ brought a civil collection action under §6502 to reduce White’s unpaid 2000 through 2011 tax liabilities to judgment. By August 2023, the liabilities had grown to about $1.893 million with interest and additions to tax.

DOJ and White settled that action in September 2023. White agreed to a judgment of about $1.893 million. DOJ agreed to treat the judgment as satisfied and take no further collection action for the 2000 through 2011 income tax liabilities if White paid $1.6 million by July 1, 2027, under a specified payment plan.

White stayed current on the payment plan. By March 2026, he had paid almost $1 million.

While the civil collection case was pending, the IRS issued a levy notice to collect about $1.102 million of unpaid RBAs. Appeals sustained the levy.

Statutory Framework

Section 6201(a)(4) allows the IRS to assess and collect criminal tax restitution as if it were tax. An RBA is a tax collection assessment issued pursuant to a restitution order. Section 6201(a)(4)(C) bars the taxpayer from challenging the amount of restitution by disputing the underlying tax liability in a tax proceeding.

Section 6330 requires Appeals to verify legal requirements, consider issues the taxpayer raises, and decide whether the proposed collection action balances efficient collection with the taxpayer’s legitimate concern that collection be no more intrusive than necessary.

Arguments

Taxpayer argued:

• The RBAs matched the same unpaid income tax liabilities for 2000 through 2011 that were covered by the DOJ settlement.

• The levy conflicted with the settlement because DOJ agreed to accept $1.6 million over time.

• Immediate collection of the levy would disregard his contractual right to pay through July 2027.

• The levy would be more intrusive than necessary.

Government argued:

• The RBAs were separate and distinct from White’s civil income tax liabilities.

• DOJ’s settlement resolved only the civil tax liabilities reduced to judgment.

• Appeals properly sustained the levy because White could not challenge the restitution assessment under §6201(a)(4)(C).

• White did not provide financial information supporting a collection alternative.

Court’s Reasoning

• The Tax Court reviewed the Appeals for abuse of discretion because White could not challenge the underlying RBA liability in the CDP proceeding.

• The Court rejected White’s double collection theory. The IRS could not collect the same tax loss twice, but any RBA collection would be credited against the related tax liabilities.

• The Court found that the RBAs were distinct in assessment procedure, but not separate in economic substance. They represented the same 2000-2011 income tax liabilities.

• DOJ had already agreed to a different collection mechanism for those same liabilities. The settlement gave White until July 1, 2027, to complete payment.

• Appeals sustained a levy that would have collected the remaining balance immediately, and potentially more than the unpaid balance under the settlement.

• The settlement officer failed to account for White’s ongoing compliance with the DOJ payment plan.

• The levy conflicted with the government’s settlement and was more intrusive than necessary under §6330(c)(3).

Result

Decision entered for White, and the proposed levy was not sustained.

The Takeaway

This case is not a sweeping victory for taxpayers against restitution assessments. Instead, it says the IRS cannot use an RBA levy to get around a DOJ settlement that covers the same tax debts and payment plan.

Practitioners should pay attention to how the tax debts, the settlement terms, and the taxpayer’s payment plan fit together. This is the important part of the case, since it shows that different parts of the government may not always coordinate their actions.

List of Citations

• Klein v. Commissioner, 149 T.C. 341, supports the treatment of RBAs and limits on interest or additions assessed on restitution.

• Carpenter v. Commissioner, 152 T.C. 202, addresses RBA procedures and limitations.

• Zuch v. Commissioner, 145 S. Ct. 1707, cited for mootness after liabilities were fully paid.

Holding

The Tax Court ruled in favor of the IRS and agreed with Appeals’ decision to let the IRS collect Frederick Whigham’s unpaid federal income taxes for 2011, 2014, 2015, and 2017 through a levy.

Why It Matters

• This is a routine application of settled collection due process rules, not a new legal standard.

• The decision reinforces that inability to pay requires proof, not general claims of financial distress.

• Real estate equity can defeat a request for currently not collectible status, even when the taxpayer reports a limited monthly cash flow.

• Appeals may close the record after giving the taxpayer a reasonable opportunity to provide documents.

• Taxpayers who omit sources of income or bank accounts weaken hardship claims. The system, astonishingly, still expects numbers to match reality.

Key Facts

Frederick Whigham owed federal income tax liabilities for 2011, 2014, 2015, and 2017. The IRS prepared substitutes for returns for 2011, 2014, and 2015 after he failed to file his returns on time. A substitute for return is an IRS-prepared return used to assess tax when a taxpayer does not file.

The IRS issued a Notice CP90, Notice of Intent to Seize Your Assets and of Your Right to a Hearing, dated August 30, 2021. The notice showed a total balance due of $157,682.18 for the four tax years.

Whigham requested a collection due process hearing. His Form 12153 checked “I Cannot Pay Balance” and did not request a specific collection alternative. He stated that he had financial hardship, that his wife had suffered a brain aneurysm, that her Social Security income would be used for nursing home care, that his residence had been foreclosed, and that he lacked money to pay the IRS notice.

Appeals requested financial information, including Form 433-A, bank statements, documentation for income sources, rental income information, and tax returns for 2020 and 2021.

Whigham submitted Form 433-F instead of Form 433-A. He reported one bank account, four real properties with a combined reported value of $257,691, a monthly income of $1,991, and monthly expenses of $2,257. He reported liens on the properties but provided incomplete documentation.

His 2020 return reported $24,632 in rent received and $2,830 in net rental income from four properties. His 2021 return reported $87,223 in rent received and $8,669 in net rental income from the same properties.

During the CDP hearing, Whigham acknowledged that he received rental income from at least one property that he had not disclosed on Form 433-F. Appeals asked for verification of rental income and statements for all open bank accounts. Whigham did not timely provide the requested records.

Collection later reported that IRS records showed more than $61,000 of rental income in 2021, including $51,000 from the Missouri Housing Development Commission. The collection also calculated at least $197,023 in equity in two properties, excluding the other two.

Whigham later submitted Form 433-A showing $625 of monthly net rental income and a total monthly income of $2,725. He still had not provided bank statements for the account into which the rental income was deposited.

Appeals determined that Whigham could pay the liabilities through property equity and monthly payments. Appeals sustained the proposed levy.

Statutory or Regulatory Framework

Section 6330 gives taxpayers the right to a collection due process hearing before levy action proceeds. Appeals must verify legal and procedural compliance, consider relevant issues raised by the taxpayer, and balance efficient tax collection against the taxpayer’s interest in avoiding unnecessarily intrusive collection action.

Currently not collectible status may apply when a taxpayer cannot pay because income and assets are insufficient to cover tax liabilities while meeting reasonable basic living expenses. A taxpayer generally must provide complete financial information demonstrating a lack of income, a lack of equity in assets, and hardship.

When the taxpayer does not challenge the underlying liability during the CDP hearing, the Tax Court reviews the Appeals’ determination for abuse of discretion. Abuse of discretion means the decision was arbitrary, capricious, or lacked a sound factual or legal basis.

Arguments

Taxpayer argued:

• He lacked the money to pay the tax liabilities.

• His properties required substantial repairs before they could be habitable or sold.

• H&R Block had prepared his prior returns.

• Appeals should have treated him as unable to pay.

Government argued:

• Appeals properly verified all legal and procedural requirements.

• Whigham did not dispute the underlying liabilities during the CDP hearing.

• Whigham failed to provide complete financial documentation.

• His rental income and real estate equity showed an ability to pay.

• Appeals did not abuse its discretion by sustaining the levy.

Court’s Reasoning

• Whigham did not respond to the IRS motion for summary judgment, but the Court still reviewed the merits.

• The Court treated the underlying liabilities as outside the case because Whigham did not properly raise them during the CDP hearing.

• Appeals verified that required assessments, notices, and procedures were properly completed.

• Whigham raised only one issue during the CDP hearing: inability to pay.

• Appeals reasonably requested financial records, including income verification, bank statements, and property information.

• Whigham did not provide complete records for rental income or all bank accounts, even after multiple requests.

• Appeals reasonably relied on Collection’s rental income analysis because it matched information reported on Whigham’s own tax return.

• Whigham’s own financial disclosures showed that he could cover basic living expenses, especially when rental income was included.

• His reported real estate values and mortgage information showed substantial property equity. The Court calculated $225,478 of equity based on his own reporting and noted that Collection identified $197,023 of equity even without including two properties.

• Whigham provided no evidence that he could not borrow against or sell the properties.

• Appeals gave Whigham enough time to provide additional records. The settlement officer did not abuse discretion by refusing to reopen the issue after months of incomplete submissions.

• Appeals properly balanced collection needs against intrusiveness because Whigham did not offer or agree to an alternative collection method.

Result

The Tax Court granted the IRS's motion for summary judgment and sustained the levy for Whigham’s 2011, 2014, 2015, and 2017 liabilities.

The Takeaway

This decision matters most for practitioners handling CDP cases where the taxpayer claims hardship but owns real estate or receives rental income. Appeals can reject the currently not collectible status when the taxpayer fails to document income and asset equity, and when the taxpayer is unable to access property value.

List of Citations

• §6330: Governs collection due process hearings before levy action.

• §6020(b): Authorizes the IRS to prepare substitutes for returns when taxpayers fail to file.

• §6651(a)(1): Imposes additions to tax for failure to file.

• §6651(a)(2): Imposes additions to tax for failure to pay.

• §6654: Imposes additions to tax for failure to pay estimated tax.

• Tax Court Rule 121: Governs summary judgment.

• Goza v. Commissioner, 114 T.C. 176: Establishes abuse-of-discretion review when the underlying liability is not at issue.

• Thompson v. Commissioner, 140 T.C. 173: Holds that a taxpayer must raise the underlying liability at the CDP hearing to place it before the Court.

• Giamelli v. Commissioner, 129 T.C. 107: Bars issues not properly raised during the CDP hearing.

• Murphy v. Commissioner, 125 T.C. 301: Defines abuse of discretion in CDP review.

• Hoyle v. Commissioner, 131 T.C. 197: Requires the Court to review verification compliance.

• Pough v. Commissioner, 135 T.C. 344: Allows Appeals to proceed when the taxpayer fails to submit requested records after an adequate time.

• Orum v. Commissioner, 123 T.C. 1: Supports rejection of collection alternatives when the taxpayer fails to provide financial information.

• Mackland v. Commissioner, T.C. Memo. 2025-69: Supports denial of relief where the taxpayer provides no evidence of inability to access real estate equity.

• Margolis-Sellers v. Commissioner, T.C. Memo. 2019-165: Supports denial of currently not collectible status when the taxpayer can make some payment.

• IRM 5.16.1.2.9: Describes the currently not collectible status based on hardship and inability to pay.

• IRM 5.15.1.18: Addresses financial analysis concepts relevant to collection potential.

Holding

The Tax Court agreed with the IRS and dismissed Meta’s claims about how the IRS calculated interest, penalties, and other amounts related to the COVID-19 disaster period, saying it did not have the authority to decide those issues.

Why It Matters

• The order applies settled jurisdictional limits. The Tax Court does not have general authority to decide disputes over interest computation during a deficiency proceeding.

• The decision separates tax liability from statutory interest. Interest on an underpayment under §6601 is not treated as tax for deficiency jurisdiction purposes.

• The procedural point matters for large refund and deficiency cases. A taxpayer must usually wait until after a final Tax Court decision, assessment, payment, or refund before asking the Tax Court to redetermine interest under §7481(c).

• The ruling does not decide whether COVID-19 disaster relief under §7508A affects any interest computation. It decides only that Meta raised the issue too early and in the wrong procedural posture.

Key Facts

Meta filed a Tax Court petition challenging IRS determinations for the years at issue.

The petition included allegations under the heading “Interest Computation.” Meta alleged that the IRS failed to follow §7508A by disregarding the federally declared disaster period beginning January 20, 2020, and continuing through July 10, 2023.

Meta claimed that the IRS erred in determining “any interest, penalty, additional amount, or addition to tax” because it did not account for that disaster period.

The IRS moved to dismiss those allegations for lack of jurisdiction and to strike the related paragraphs from the petition.

Meta opposed the motion. It argued that it had invoked the Tax Court’s overpayment jurisdiction under §6512(b) because it alleged that the IRS wrongly denied a refund claim. Meta reasoned that any resulting overpayment could bear interest and that its allegations of interest should remain in the case.

Statutory or Regulatory Framework

The Tax Court may exercise only the jurisdiction Congress gives it by statute.

Section 6601 imposes interest on tax underpayments. Section 6601(e)(1) states that interest on an underpayment is not treated as tax for purposes of deficiency proceedings.

Section 6512(b) gives the Tax Court jurisdiction to determine an overpayment in a deficiency case.

Section 7481(c) gives the Tax Court limited post-decision jurisdiction to redetermine interest. The taxpayer must file a motion within one year after the Tax Court decision becomes final, and the statutory conditions must be met.

Section 7508A allows the IRS to postpone certain tax-related deadlines for taxpayers affected by federally declared disasters.

Arguments

Taxpayer argued:

• The IRS failed to apply §7508A to the COVID-19 federally declared disaster period.

• The disaster period ran from January 20, 2020, through July 10, 2023.

• The alleged error affected interest, penalties, additions to tax, or additional amounts.

• The Tax Court had overpayment jurisdiction under §6512(b).

• Overpayment interest was not excluded from the definition of tax by §6601(e)(1).The

• Estate of Baumgardner supported keeping the interest claim in the case.

The government argued:

• The challenged allegations concerned interest computation.

• The Tax Court lacks jurisdiction over statutory interest in a pending deficiency case.

• Interest disputes must proceed, if at all, under §7481(c) after a final decision and satisfaction of the statutory prerequisites.

• The interest-related allegations should be dismissed and struck from the petition.

Court’s Reasoning

• The Tax Court started with the jurisdictional rule. It may act only where a statute expressly authorizes jurisdiction.

• The Court treated Meta’s allegations as directed at statutory interest under §6601(a) on potential underpayments of tax.

• Statutory interest on a deficiency accrues from the original return due date until payment, but §6601(e)(1) prevents that interest from being treated as tax for deficiency proceeding purposes.

• The Court relied on Pen Coal and related authority to confirm that taxpayers cannot challenge statutory interest computations before the Tax Court determines a deficiency.

• Section 7481(c) supplies the relevant procedure. The Tax Court may reopen a case after its decision becomes final only to determine whether the taxpayer overpaid interest or the IRS underpaid interest.

• Meta’s reliance on Estate of Baumgardner did not carry the argument. That case distinguished interest that becomes part of an overpayment from ordinary jurisdiction over overpayment interest, and it did not give the Tax Court general authority over interest computations in a pending deficiency case.

• The required procedural steps had not been completed. The Court had not determined a deficiency or overpayment; the IRS had not assessed a deficiency resulting from a Tax Court decision; Meta had not paid a deficiency with disputed interest; and the IRS had not refunded an overpayment with interest.

Result

The Tax Court agreed with the IRS and removed Meta’s claims about interest calculations from the case.

The Takeaway

Taxpayers should not treat interest calculation disputes as regular deficiency issues. The Tax Court can only handle these disputes after a final decision, using the specific process in §7481(c), not through general claims in the first petition.

List of Citations

• §6601, Interest on underpayments, establishes statutory interest on unpaid tax.

• §6601(e)(1), Treatment of interest, provides that underpayment interest is not treated as tax for deficiency proceeding purposes.

• §6512(b), Overpayment jurisdiction, allows the Tax Court to determine overpayments in deficiency cases.

• §7481(c), Interest redetermination jurisdiction, allows limited post-final-decision review of interest computations.

• §7508A, Disaster postponement authority, allows postponement of certain tax deadlines for federally declared disasters.

• §7442, Tax Court jurisdiction, confirms that the Tax Court’s jurisdiction depends on statutory authorization.

• Rule 261, Tax Court Rules of Practice and Procedure, governs motions to redetermine interest under §7481(c).

• Pen Coal Corp. v. Commissioner, 107 T.C. 249 (1996), confirms that the Tax Court lacks jurisdiction over statutory interest in ordinary deficiency proceedings before the statutory prerequisites are met.

• United States v. Beane, 841 F.3d 1273 (11th Cir. 2016), supports the rule that statutory interest is not treated as tax for deficiency jurisdiction purposes.

• Estate of Baumgardner v. Commissioner, 85 T.C. 445 (1985), distinguishes interest that becomes part of an overpayment from general jurisdiction over overpayment interest.

• Sunoco, Inc. v. Commissioner, 663 F.3d 181 (3d Cir. 2011), confirms the limited reach of the Tax Court’s overpayment interest jurisdiction.

Holding

The U.S. District Court for the Southern District of Mississippi denied Plastic Film LLC’s request for judgment on the pleadings. The court decided that §7405 still lets the United States recover Employee Retention Credit refunds it claims were paid by mistake. The court also let the government revise its counterclaim because it had used the wrong statute and only made broad statements about ERC ineligibility without enough detail.

Why It Matters

• The ruling preserves civil erroneous refund suits as an IRS recovery tool for ERC refunds. The 2023 ERC recapture regulations do not make administrative assessment the government’s exclusive remedy.

• The decision matters for ERC litigation because refund suits can expose taxpayers to counterclaims for quarters in which the IRS has already paid ERC amounts.

• The ruling does not decide whether Plastic Film qualified for the ERC. It only addresses the government’s authority to sue and the sufficiency of its pleading.

• The pleading issue cuts both ways. The government can bring the counterclaim, but it must allege facts showing why the taxpayer failed ERC eligibility requirements. Bare statutory conclusions are not enough. Humanity survives another day because Rule 8 still requires facts.

Key Facts

Plastic Film LLC sued the United States and the IRS on April 1, 2025.

The complaint asserted:

• A payroll tax refund claim under §7422(a).

• Administrative Procedure Act claims.

The dispute involved ERC claims for multiple calendar quarters.

On January 20, 2026, the Court dismissed as moot Plastic Film’s refund claims for the second and fourth quarters of 2020 and the second quarter of 2021 because the IRS had already issued refunds for those periods.

The Court allowed Plastic Film’s refund claim for the third quarter of 2020 to proceed.

The Court dismissed the APA claims for lack of standing, lack of waiver of sovereign immunity, and failure to state a claim.

On February 3, 2026, the government filed an answer and counterclaim. It sought recovery of alleged erroneous tax refunds under §§7401 and 7405.

Plastic Film moved for judgment on the pleadings against the counterclaim.

Plastic Film argued that improper ERC refunds must be treated as payroll tax underpayments and recovered through administrative procedures under §6205.

Plastic Film also argued that the counterclaim failed federal pleading standards because it recited statutory language without alleging facts showing that the refunds were erroneous.

The government responded that §7405 authorized a civil action to recover erroneous ERC refunds and that the 2023 ERC recapture regulations did not eliminate that remedy.

Statutory or Regulatory Framework

Section 7405(b) authorizes the United States to bring a civil action to recover any portion of a tax that has been erroneously refunded.

Section 7401 authorizes civil actions by the United States to recover taxes, subject to authorization requirements.

Section 6532 generally supplies the limitations period for erroneous refund suits.

Section 6205 allows administrative correction of certain employment tax underpayments.

The ERC, or Employee Retention Credit, is a refundable payroll tax credit enacted during the COVID-19 period for eligible employers that met specified suspension or gross receipts tests.

The 2023 ERC recapture regulations treat some erroneous ERC refunds as underpayments of employment taxes that may be assessed and collected administratively.

Arguments

Taxpayer argued:

• The ERC recapture regulations required improper ERC refunds to be treated as underpayments of payroll taxes.

• The government had to use the administrative assessment process under §6205.

• Section 7405 did not apply because the regulations supplied the required recovery method.

• The regulation’s use of “shall” made the administrative method mandatory.

• The government’s counterclaim failed because it did not allege specific facts showing that Plastic Film was ineligible for the ERC.

• The counterclaim relied on conclusory assertions rather than factual allegations that satisfied Twombly and Iqbal.

Government argued:

• Section 7405 expressly allows the United States to sue to recover erroneous refunds.

• The 2023 ERC recapture regulations did not repeal or limit §7405.

• The regulatory preamble stated that assessment and administrative collection procedures were not exclusive.

• Administrative recapture is an additional method, not a replacement for civil erroneous refund suits.

• The counterclaim plausibly alleged that Plastic Film was not entitled to the refunds.

• The government should be granted leave to amend if the Court finds the statutory citation incorrect or the pleading deficient.

Court’s Reasoning

• Section 7405(b) expressly authorizes the United States to sue to recover erroneously refunded taxes.

• Longstanding Supreme Court precedent recognizes the government’s right to recover money wrongfully or erroneously paid.

• The 2023 ERC recapture regulations did not eliminate the government’s statutory authority under §7405.

• The regulatory preamble stated that administrative assessment and collection procedures were not exclusive to, nor did they replace, existing recapture methods.

• The regulation’s use of “shall” did not override Congress’s express grant of authority under §7405.

• The government therefore may pursue recovery of allegedly erroneous ERC refunds through a civil action.

• The government’s counterclaim still had pleading defects. It cited §3134, which applies to ERC claims for the third quarter of 2021, even though the relevant quarters were earlier.

• The government also alleged Plastic Film’s ineligibility for ERC without sufficient factual detail.

• The Court compared the counterclaim with Plastic Film’s refund pleading. Plastic Film had alleged business divisions, COVID-19 restrictions, operational suspensions, and gross-receipt declines. The government’s counterclaim did not provide comparable factual content.

• The Court granted leave to amend because correcting the citation and adding factual allegations could cure the defects.

Result

The Court denied Plastic Film’s request for judgment on the pleadings, but without prejudice, and gave the government 14 days to revise its counterclaim.

The Takeaway

ERC refund lawsuits can create risks for both sides. If a taxpayer sues for more ERC money, the government may respond with a counterclaim to get back refunds it already paid.

This ruling matters more for choosing the right legal remedy than for deciding ERC eligibility. It confirms the IRS can use both civil lawsuits and administrative ERC recapture, but still requires strong factual claims.

List of Citations

• CARES Act §2301(c)(2)(A): Supplies the relevant ERC eligible employer definition for earlier ERC quarters.

• 26 C.F.R. §31.3111-6(b): Addresses ERC recapture for certain employment tax credits.

• 26 C.F.R. §31.3221-5(b): Addresses ERC recapture in the railroad employment tax context.

• United States v. Wurts, 303 U.S. 414 (1938): Recognizes the government’s authority to recover funds erroneously or illegally paid.

• Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007): Requires factual allegations sufficient to make a claim plausible.

• Ashcroft v. Iqbal, 556 U.S. 662 (2009): Rejects threadbare legal conclusions as insufficient pleading.

• In re Great Lakes Dredge & Dock Co., 624 F.3d 201 (5th Cir. 2010): Applies the Rule 12(b)(6) plausibility standard to Rule 12(c) motions.

• Doe v. MySpace, Inc., 528 F.3d 413 (5th Cir. 2008): Addresses the standard for judgment on the pleadings.

• United States ex rel. Marcy v. Rowan Cos., Inc., 520 F.3d 384 (5th Cir. 2008): Supports liberal leave to amend when amendment is not futile.

Holding

The Eleventh Circuit agreed with the lower court’s decision in favor of the United States. The court found there was no real dispute about the facts, so the government could collect James Reeves’s unpaid federal income taxes, interest, and penalties through a court judgment.

Why It Matters

• The decision is a routine application of settled law governing tax collection suits. A taxpayer must produce evidence disputing the validity or amount of the assessment, not broad attacks on the legitimacy of the federal income tax system.

• The Court treated Reeves’s arguments as frivolous. Challenges to the existence of the IRS, the validity of the Internal Revenue Code, or the legal duty to file returns do not create a triable issue.

• The case reinforces the evidentiary force of IRS assessments in collection litigation. Once the government supports the assessment, the taxpayer must identify a genuine factual dispute.

• The opinion has limited precedential value because it is unpublished and designated not for publication. Its practical value lies in confirming how courts handle tax-protester arguments at the summary judgment stage.

Key Facts

James Reeves was a partner in Envision Software LLC from 2009 through 2012.

He received income from that role.

Reeves did not make estimated tax payments, file federal income tax returns, or pay federal income tax liabilities for those years.

The IRS audited Reeves’s liabilities and issued a statutory notice of deficiency in 2014. A statutory notice of deficiency is the IRS notice that allows a taxpayer to petition the Tax Court before assessment.

Reeves petitioned the Tax Court but failed to pay the filing fee. The Tax Court dismissed the case.

In December 2015, the IRS assessed income taxes, interest, and penalties against Reeves for 2009 through 2012. The assessed balance totaled $157,025.77.

The IRS issued notices and demands for payment. Reeves did not pay.

In May 2024, the United States sued in the U.S. District Court for the Middle District of Georgia to reduce the unpaid assessments to judgment. At that time, the government alleged that Reeves owed $261,377.04.

The government later moved for summary judgment and stated that Reeves owed $275,289.58.

Reeves denied that a proper assessment existed. He also denied that federal law required him to file returns, authorized the IRS to file or process returns, or imposed tax liability on him.

The district Court granted summary judgment for the government, denied Reeves’s motion to dismiss, and denied his motion for reconsideration.

Reeves appealed only the grant of summary judgment.

Statutory or Regulatory Framework

A federal tax assessment records the taxpayer’s liability on the IRS’s books and supports collection action. After assessment and notice and demand for payment, the United States may sue to reduce the liability to judgment. Summary judgment is proper when no genuine dispute of material fact exists, and the moving party is entitled to judgment as a matter of law.

Arguments

Taxpayer argued:

• Congress did not create the IRS.

• The IRS is not a department or agency of the United States.

• The IRS lacks authority to process Form 1040.

• The IRS lacks authority to perfect liens or prosecute seizures.

• No statute establishes income tax liability.

• The Internal Revenue Code was never enacted.

• The Internal Revenue Code has no implementing regulations.

• The Internal Revenue Code does not apply to him.

• The government did not show that he had been notified to keep books or records.

• The government did not prove a contract creating liability.

• The case fell under admiralty or maritime jurisdiction.

• Tax Court decisions apply only to the parties involved and only for one year.

• The Sixteenth Amendment was not properly invoked.

• The federal income tax is an invalid direct, unapportioned tax on American citizens.

Government argued:

• The IRS made valid assessments for Reeves’s unpaid federal income taxes, interest, and penalties.

• Reeves failed to produce evidence disputing the assessments.

• Reeves relied on legally baseless arguments rather than facts.

• No genuine dispute of material fact existed.

• The government was entitled to judgment as a matter of law.

Court’s Reasoning

• The Eleventh Circuit reviewed the district Court’s summary judgment ruling de novo, meaning it reviewed the issue without deferring to the district Court’s legal conclusion.

• The Court applied Federal Rule of Civil Procedure 56(a), which allows summary judgment when no genuine dispute of material fact exists and the movant is entitled to judgment as a matter of law.

• Reeves did not identify evidence showing that the assessments were invalid or that the amounts were wrong.

• Reeves instead challenged the authority of the IRS, the validity of the federal income tax system, and the applicability of the Internal Revenue Code.

• The Court rejected those arguments as meritless and cited Cain v. Commissioner, where the Fifth Circuit refused to treat similar tax-protester arguments as colorable legal claims.

• The Court concluded that Reeves’s assertions did not create a genuine factual dispute.

• Because the government supported its claim and Reeves offered no legally relevant defense, the government was entitled to judgment.

Result

The Eleventh Circuit affirmed the district Court’s grant of summary judgment for the United States.

The Takeaway

Taxpayers cannot avoid a collection judgment just by denying the federal tax system’s existence or authority. For practitioners, this case is a clear reminder that collection lawsuits depend on evidence, whether the assessment is valid, time limits, payment records, and any procedural mistakes—not on repeated tax-protester arguments.

List of Citations

• Fed. R. Civ. P. 56(a): Sets the standard for summary judgment when no genuine dispute of material fact exists.

• United States v. White, 466 F.3d 1241 (11th Cir. 2006): Provides the Eleventh Circuit’s de novo standard of review for summary judgment.

• Information Systems & Networks Corp. v. City of Atlanta, 281 F.3d 1220 (11th Cir. 2002): Cited for the summary judgment standard.

• Cain v. Commissioner, 737 F.2d 1417 (5th Cir. 1984): Rejects frivolous challenges to the constitutionality and administration of the federal income tax system.

• Access Now, Inc. v. Southwest Airlines Co., 385 F.3d 1324 (11th Cir. 2004): Supports the rule that arguments not raised below generally are not preserved for appeal.

Holding

The Tax Court held that Keith and Rhonda Schumacher did not operate Schumacher Quarter Horses for profit under § 183 during 2017, 2018, and 2019. The Court sustained the IRS’s disallowance of their horse-related loss deductions, subject to Rule 155 computations. Still, it held that they were not liable for § 6662(a) accuracy-related penalties because they reasonably relied on their longtime accountant and enrolled agent.

Why It Matters

• This is a typical but helpful § 183 case. The court used the standard nine-factor profit-motive test and decided that ongoing losses, weak records, no business plan, and personal enjoyment were more important than the Schumachers’ horse expertise and time spent.

• The decision reinforces that equine activities receive a special statutory safe harbor, but taxpayers must actually meet the safe harbor. Horse breeding, training, showing, or racing is presumed profit-motivated only if it produces profits in at least two of seven consecutive years. SQH never made a profit.

• The penalty holding matters separately. The taxpayers lost the deduction issue but avoided penalties because they disclosed information to a competent adviser, discussed § 183 compliance annually, and relied on his judgment.

• The case distinguishes care and effort from profit motive. The Court accepted that the Schumachers took substantial care of the horses and spent significant time on the activity, but those facts did not establish a business objective.

Key Facts

Keith and Rhonda Schumacher operated Schumacher Quarter Horses, or SQH, as a sole proprietorship beginning in 2001. SQH bred, raised, trained, and showed quarter horses.

Dr. Schumacher was a veterinarian and shareholder in Northeast Nebraska Veterinary Services, PC. During the years at issue, he worked full time, often 60 or more hours per week. Mrs. Schumacher worked full time in education. Their son also helped with horse-related chores.

The Schumachers had extensive personal experience with horses. Dr. Schumacher had owned horses for most of his adult life, completed a 12-week horse training course in 2019, and regularly discussed breeding with AQHA members. Mrs. Schumacher had experience in barrel racing, roping, showing, and training.

SQH achieved competitive success. Schumacher horses placed highly at AQHA World Championship Shows. One mare was a two-time reserve world champion and three-time top ten contender.

The activity did not achieve financial success. SQH had no profitable year from its founding in 2001 through the years leading up to the Court. From 2010 through 2019, it reported annual Schedule F losses ranging from $51,028 to $210,148.

For the years at issue, the Schumachers reported Schedule F losses of:

• 2017: $161,321

• 2018: $165,149

• 2019: $129,908

Those losses offset substantial income from other sources, including wages and passthrough income from Northeast.

The Schumachers maintained a separate SQH bank account, but they frequently paid horse expenses from their personal account. Their personal account also served as overdraft protection for SQH. They tracked income and expenses mainly through bank statements, handwritten notes, and receipts. They did not maintain per-horse expense records.

They had no written business plan. The Court also found no unwritten plan supported by their conduct.

Robert Cruise, an accountant and enrolled agent, prepared their returns for approximately 20 years. He also prepared tax returns and bookkeeping for Northeast. The Schumachers discussed § 183 compliance with him each year. He advised them that SQH qualified as a for-profit activity despite its history of losses.

The IRS examined the Schumachers’ 2017 through 2019 returns and determined deficiencies of $62,266, $61,466, and $67,447. The IRS also asserted § 6662(a) penalties of $11,458, $11,697, and $10,365.

Statutory or Regulatory Framework

Section 183 limits deductions for activities not engaged in for profit. A taxpayer may generally deduct ordinary and necessary business expenses under § 162, but expenses from a hobby or recreational activity are deductible only to the extent allowed by § 183.

For horse activities, § 183(d) provides a favorable presumption. An activity consisting in major part of breeding, training, showing, or racing horses is presumed profit-motivated if gross income exceeds deductions in at least two of the seven consecutive years ending with the taxable year.

SQH did not qualify for that presumption because it had never produced a profit.

The Court therefore applied the nine-factor test under Treas. Reg. § 1.183-2(b). The taxpayer’s profit expectation need not be reasonable, but it must be actual, honest, and held in good faith.

Section 6662(a) imposes a 20% penalty on underpayments attributable to negligence or substantial understatement of income tax. Section 6664(c)(1) removes the penalty when the taxpayer shows reasonable cause and good faith. Reliance on professional advice can establish reasonable cause if the adviser was competent, the taxpayer provided necessary and accurate information, and the taxpayer actually relied in good faith.

Arguments

Taxpayer argued:

• SQH was operated with a profit objective.

• Their horse knowledge, training experience, and AQHA involvement showed expertise.

• They devoted substantial time to the activity despite full-time employment.

• Their changes in breeding and training strategy reflected attempts to improve profitability.

• They relied on their longtime accountant and enrolled agent for § 183 advice.

Government argued:

• SQH lacked a profit motive under § 183.

• The Schumachers did not keep complete and accurate books and records.

• The separate SQH account functioned as an extension of their personal account.

• SQH had no business plan and no meaningful cost-control strategy.

• The activity produced uninterrupted losses for at least 18 years.

• The taxpayers had substantial income from other sources and used SQH losses to offset that income.

• The taxpayers personally and recreationally enjoyed horse activities.

Court’s Reasoning

• The Court found that SQH was not operated in a businesslike manner. The Schumachers kept handwritten notes and receipts, but the Court viewed those records as tax-reporting records rather than tools for reducing costs, increasing profit, or evaluating performance.

• The Court gave weight to the commingling of personal and business funds. Although SQH had a separate bank account, the taxpayers often paid horse expenses from their personal account and replenished SQH with personal funds.

• The absence of a business plan weighed against the taxpayers. A written plan was not mandatory, but the Court found no conduct showing an unwritten financial plan.

• The Court rejected the taxpayers’ claim that operational changes showed a profit objective. Their changes in breeding and training produced competitive success but not profitability. The Court found no evidence that they tried to reduce expenses.

• The Court credited the taxpayers’ horse expertise. Their experience, AQHA involvement, and Dr. Schumacher’s training course supported them on the expertise factor.

• The Court also credited their time and effort. Dr. Schumacher spent two to four hours per day with the horses; Mrs. Schumacher spent substantial time; and the family maintained the activity year-round.

• The appreciation factor favored the IRS. The taxpayers did not provide adequate horse inventory records or valuation evidence, so the Court could not determine whether the herd could appreciate enough to offset prior losses.

• The history of losses strongly favored the IRS. SQH had operated since 2001 and had never turned a profit. The Court found no credible explanation for the startup period.

• The taxpayers’ financial status favored the IRS. They had substantial non-SQH income and could absorb the losses.

• Personal pleasure favored the IRS. The Court found that the Schumachers derived substantial enjoyment from breeding, raising, training, racing, and showing horses.

• The Court concluded that six factors favored the IRS, two favored the taxpayers, and one was neutral. It held that the Schumachers lacked an actual and honest profit objective.

Penalty Analysis

The IRS met its burden of production for the § 6662(a) penalties. The Court found that the understatements likely exceeded the statutory threshold for substantial understatement, as measured by Rule 155 computations.

The IRS also satisfied § 6751(b)(1). The revenue agent prepared a penalty approval form on October 16, 2020, and her immediate supervisor approved it that same day. The penalties were first formally communicated to the Schumachers on January 5, 2021.

The taxpayers still avoided penalties. The Court found reasonable cause and good faith because:

• The taxpayers had little tax-law expertise.

• Mr. Cruise was an experienced accountant and enrolled agent.

• He had prepared their returns for about 20 years.

• He also handled bookkeeping and returns for Dr. Schumacher’s veterinary practice.

• The taxpayers discussed § 183 with him each year.

• Mr. Cruise advised that SQH satisfied § 183.

• Dr. Schumacher responded to information requests.

• The record did not show that the taxpayers withheld information.

The result is irritatingly human but legally clean: the taxpayers were wrong, but not careless enough to be penalized.

Result

Decision will be entered under Rule 155 disallowing the SQH loss deductions but rejecting the § 6662(a) accuracy-related penalties.

The Takeaway

Horse, farming, ranching, and similar activities need business records that track profitability, not just records for tax returns. Practitioners should see the penalty outcome as a separate lesson: even if § 183 is a risk, getting yearly written advice from a qualified adviser can help support a reasonable-cause defense.

List of Citations

• IRC § 183: Limits deductions for activities not engaged in for profit.

• IRC § 183(d): Provides the horse-activity presumption requiring profits in two of seven consecutive years.

• IRC § 162: Allows deductions for ordinary and necessary business expenses.

• IRC § 212: Allows deductions for expenses incurred for production or collection of income.

• Treas. Reg. § 1.183-2(b): Provides the nine-factor profit-motive framework.

• IRC § 6662(a): Imposes a 20% accuracy-related penalty.

• IRC § 6662(d): Defines substantial understatement of income tax.

• IRC § 6664(c)(1): Provides the reasonable-cause and good-faith exception to penalties.

• IRC § 6751(b)(1): Requires written supervisory approval of penalties before assessment.

• Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002): Sets the professional-reliance standard for reasonable cause.

• Graev v. Commissioner, 149 T.C. 485 (2017): Addresses the IRS burden to show supervisory approval of penalties.

• Engdahl v. Commissioner, 72 T.C. 659 (1979): Explains profit motive and startup losses in horse-related activities.

• Dunn v. Commissioner, 70 T.C. 715 (1978), aff’d, 615 F.2d 578 (2d Cir. 1980): Confirms that no single § 183 factor controls.

Holding

The Tax Court denied William P. Wells and Ruth E. Wells’s charitable contribution carryover deductions for 2019, 2020, and 2021 because the written acknowledgment for their 2016 real property donation did not meet § 170(f)(8) requirements. However, the court did not apply the IRS’s § 6662 accuracy-related penalties because the taxpayers reasonably relied on their longtime CPA in good faith.

Why It Matters

• This is a strict substantiation case. The Court did not question whether the property was donated. It disallowed the deductions because the acknowledgment omitted required language.

• The ruling reinforces that Form 8283 and an appraisal do not cure a defective contemporaneous written acknowledgment.

• The case matters for closely controlled charitable transactions. The taxpayer had roles on both sides of the transaction, but the Court still required a valid acknowledgment from the donee organization.

• The penalty holding is taxpayer-favorable but limited. The taxpayers avoided penalties because they relied on a competent CPA, asked questions, and followed the advice they received.

Key Facts

Chamberlain, LLC owned real property in Claiborne County, Mississippi, consisting of 104 acres and 110,622 square feet of buildings. William Wells owned 50% of Chamberlain.

On December 30, 2016, Chamberlain transferred the property to Chamberlain-Hunt Academy by quitclaim deed. Chamberlain claimed a $4.42 million noncash charitable contribution deduction on its 2016 partnership return. A proportionate share flowed through to Wells.

The Wellses claimed a $2.21 million charitable contribution deduction on their 2016 joint return. They carried forward unused amounts and deducted $168,936 for 2019, $620,192 for 2020, and $374,561 for 2021.

The IRS issued a notice of deficiency disallowing the carryover deductions. It also determined § 6662 accuracy-related penalties of $9,091.60 for 2019, $44,873.60 for 2020, and $26,576.40 for 2021.

The taxpayers relied on four documents to satisfy the contemporaneous written acknowledgment requirement:

• Donation letter.

• Quitclaim deed.

• Form 8283.

• Acknowledgment letter from the donee.

The acknowledgment letter thanked the donors for their gift and stated that its value was $4.42 million. It did not describe the property. It also did not state whether Chamberlain-Hunt Academy provided goods or services in exchange for the contribution.

Statutory or Regulatory Framework

Section 170 allows a deduction for charitable contributions, but only if the taxpayer satisfies the substantiation rules. For contributions of $250 or more, § 170(f)(8) requires a contemporaneous written acknowledgment, meaning a written statement from the donee organization received by the taxpayer by the earlier of the return filing date or the return due date.

The acknowledgment must state:

• The amount of cash and a description of any noncash property contributed.

• Whether the donee provided goods or services in exchange.

• A description and good-faith estimate of the value of any goods or services provided.

For noncash contributions above $5,000, § 170(f)(11) also requires additional substantiation, including a qualified appraisal.

Arguments

Taxpayers argued:

• The donation letter, quitclaim deed, Form 8283, and acknowledgment letter should be read together.

• The documents showed the claimed deduction equaled the claimed value of the donated property.

• That equality showed no goods or services were provided in exchange.

• The Court should take into account that Wells was involved with both the donor and the donee.

Government argued:

• The documents did not include a valid acknowledgment from the donee.

• The quitclaim deed was not signed or acknowledged by the donee.

• The documents signed by the donee did not state whether goods or services were provided.

• The deduction must be disallowed as a matter of law.

Court’s Reasoning

• The Court accepted that multiple documents can collectively satisfy the contemporaneous written acknowledgment requirement.

• The Court limited that rule to documents acknowledged by the donee organization.

• The donation letter and quitclaim deed did not qualify because Wells created and signed them on behalf of the donor-side entity, not the donee.

• The only documents acknowledged by the donee were the acknowledgment letter and Form 8283.

• Form 8283 provided a property description but did not state whether the donee provided goods or services.

• The acknowledgment letter thanked the donor and stated the property’s value, but it did not describe the property or address goods or services.

• The Court rejected the taxpayers’ inference argument. Even if the surrounding facts suggested no consideration was provided, § 170(f)(8) requires the acknowledgment itself to say whether goods or services were provided.

Penalties

The IRS sought § 6662 accuracy-related penalties for substantial understatement and, alternatively, negligence or disregard of rules or regulations.

The Court rejected the penalties. The taxpayers showed reasonable cause and good faith because they retained a CPA, relied on him for the charitable contribution substantiation requirements, asked for clarification, obtained the records he requested, and followed the acknowledgment language he provided. The CPA had worked with Wells for about 30 years and had sufficient experience to justify reliance on the CPA.

Result

The Tax Court sustained the IRS’s disallowance of the charitable contribution carryover deductions for 2019, 2020, and 2021, but rejected the § 6662 penalties.

The Takeaway

Practitioners should treat the goods-or-services statement as required, not just implied. A large noncash charitable deduction can be denied even if the transfer happened, the appraisal was done, Form 8283 was filed, and the taxpayer acted in good faith.

List of Citations

• § 170(a)(1), allows charitable contribution deductions only when verified under Treasury regulations.

• § 170(f)(8), requires a contemporaneous written acknowledgment for contributions of $250 or more.

• § 170(f)(11), imposes additional substantiation rules for larger noncash contributions.

• § 6662 imposes accuracy-related penalties for negligence, disregard, or substantial understatement.

• § 6664(c) provides the reasonable cause and good faith defense to penalties.

• Treas. Reg. § 1.170A-13(f), explains the written acknowledgment requirements.

• Treas. Reg. § 1.6664-4, governs reasonable cause and good faith.

• Irby v. Commissioner, 139 T.C. 371, supports using multiple documents to satisfy the acknowledgment requirement when the donee acknowledges them.

IRS Action

The IRS released Rev. Rul. 2026-12 to announce the federal tax rates for July 2026. These include the applicable federal rates, adjusted federal rates, the §382 long-term tax-exempt rate, §42 credit percentages, the §7520 valuation rate, and the 2026 blended annual rate under §7872.

Why It Matters

• This is routine monthly guidance, but it has immediate transactional use. AFRs affect loans, installment sales, deferred compensation, private annuities, and other arrangements that depend on imputed interest rules.

• The July 2026 short-term AFR is 4.00%, the mid-term AFR is 4.35%, and the long-term AFR is 4.98%, each stated on an annual compounding basis.

• The §7520 rate is 5.20% for July 2026. Practitioners use this rate to value annuities, life interests, term interests, remainders, and reversions.

• The §7872 blended annual rate for 2026 is 3.82%. That rate matters for demand loans with below-market interest, because §7872 can treat forgone interest as transferred between the parties.

Key Facts

Rev. Rul. 2026-12 applies to July 2026.

The ruling provides:

• AFRs under §1274(d).

• Adjusted AFRs under §1288(b).

• The adjusted federal long-term rate and the long-term tax-exempt rate under §382(f).

• The appropriate percentages for the low-income housing credit under §42(b)(1).

• The §7520 rate for present-value calculations.

• The 2026 blended annual rate under §7872(e)(2).

Statutory Framework

§1274 uses AFRs to determine interest and issue price for certain debt instruments issued for property. §1288 uses adjusted AFRs for tax-exempt obligations. §382 uses a long-term tax-exempt rate to limit use of net operating losses after an ownership change. §42 uses monthly credit percentages for low-income housing credit calculations. §7520 supplies a rate for valuing split interests. §7872 applies to below-market loans and uses a blended annual rate for certain demand loans.

July 2026 Rates

The annual AFRs for July 2026 are:

• Short-term AFR: 4.00%.

• Mid-term AFR: 4.35%.

• Long-term AFR: 4.98%.

The annual adjusted AFRs for July 2026 are:

• Short-term adjusted AFR: 3.03%.

• Mid-term adjusted AFR: 3.29%.

• Long-term adjusted AFR: 3.77%.

The §382 rates for July 2026 are:

• Adjusted federal long-term rate: 3.77%.

• Long-term tax-exempt rate for ownership changes during July 2026: 3.77%.

The §42 low-income housing credit percentages for July 2026 are:

• 70% present value credit: 8.09%.

• 30% present value credit: 3.47%.

The ruling also notes that §42(b)(2) preserves a minimum 9% applicable percentage for non-federally subsidized new buildings placed in service after July 30, 2008.

The §7520 rate for July 2026 is 5.20%. The §7872(e)(2) blended annual rate for 2026 is 3.82%.

Practical Effect

Practitioners should use the July 2026 rates for any transactions and valuations that need the applicable monthly federal rate. The ruling does not change the rules, but simply provides the numbers required for compliance. In a way, it is like a monthly weather report for tax law.

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IRS Action

The IRS said that Treasury and the IRS plan to issue proposed regulations under §4960, which places an excise tax on excess executive pay by certain tax-exempt organizations. These new rules will cover the expanded definition of “covered employee” from the One, Big, Beautiful Bill Act and will offer limited exceptions for employees who work few hours or are paid from nonexempt funds.

Why It Matters

• This is consequential guidance for tax-exempt organizations because §4960 will no longer apply only with respect to the five highest-compensated employees after 2025.

• The IRS gives transition clarity. Pre-2026 employee status will continue to be tested under the old five-highest-compensated framework.

• The notice preserves practical relief for employees who perform limited services for a related tax-exempt organization.

• The IRS does not plan to preserve the limited services exception because it depended on the old five-highest-compensated-employee structure.

Key Facts

§4960 imposes an excise tax on an applicable tax-exempt organization, related person, or governmental entity that pays a covered employee remuneration over $1 million in a taxable year or makes an excess parachute payment.

Before the OBBBA amendment, a covered employee was limited to either:

• One of the five highest-compensated employees of the applicable tax-exempt organization for the taxable year.

• A person who was a covered employee of that organization, or its predecessor, for a prior taxable year beginning after December 31, 2016.

The OBBBA changed the definition for taxable years beginning after December 31, 2025. After that date, the definition of covered employee generally includes any employee of an applicable tax-exempt organization and certain former employees.

Statutory Framework

§4960 applies to “covered employees” of an applicable tax-exempt organization. An applicable tax-exempt organization means an organization exempt from tax under §501(a), a farmers’ cooperative under §521(b)(1), a political organization under §527(e)(1), or certain entities with income excluded under §115(1).

The existing regulations include three exceptions tied to the old five-highest-compensated employee test:

• Limited hours exception.

• Nonexempt funds exception.

• Limited services exception.

The IRS expects the forthcoming proposed regulations to retain only the limited hours and nonexempt funds concepts under the expanded post-2025 rule.

IRS Interpretation

The IRS interprets the OBBBA effective date as broadening the definition of covered employee only for taxable years of an applicable tax-exempt organization beginning after December 31, 2025.

That means the old definition still applies to taxable years beginning on or before December 31, 2025, including when determining, after 2025, whether a former employee became a covered employee before 2026.

Under the IRS interpretation, the amended definition includes only:

• Individuals who were employees in taxable years beginning after December 31, 2016, and on or before December 31, 2025, if they were covered employees under prior law.

• Individuals who are employees in taxable years beginning after December 31, 2025, subject to exceptions in future guidance.

Forthcoming Regulations

The IRS expects the proposed regulations to:

• Remove references to an applicable tax-exempt organization’s five highest-compensated employees.

• Make conforming changes to the existing §4960 regulations.

• Adopt the notice’s effective-date interpretation.

• Provide covered employee exceptions similar to the current limited hours and nonexempt funds exceptions.

• Omit the limited services exception because the old displacement concern no longer applies.

The IRS also expects the forthcoming proposed regulations to apply prospectively and not to taxable years beginning before final regulations are issued.

Reliance

Applicable tax-exempt organizations may rely on the rules described in the notice until the forthcoming proposed regulations are issued.

The reliance rule covers:

• TheIRS'sS interpretation of the post-OBBBA covered-employee definition.

• The anticipated limited hours exception.

• The anticipated nonexempt funds exception.

Example

The notice gives a calendar-year example involving an applicable tax-exempt organization and a taxable related corporation.

Employee A was one of the tax-exempt organization’s five highest-compensated employees in 2025 and did not qualify for an exception. Employee A remains a covered employee in 2026 because covered employee status, once obtained, is permanent.

Employee B was never one of the five highest-compensated employees and qualifies for the limited hours exception in 2026. The organization may rely on the notice to treat Employee B as not covered for 2026.

Employee C worked for the tax-exempt organization only in 2020 and was not one of its five highest-compensated employees. The organization may treat Employee C as not covered for 2026 solely because of that prior 2020 employment. If Employee C works for the organization again after 2025 and does not qualify for an exception, Employee C becomes covered for that year and all future years.

Comments

The IRS requested comments on how to adapt the limited hours and nonexempt funds exceptions to the amended definition of covered employee. The IRS also asked whether those exceptions should apply to officers of applicable tax-exempt organizations.

Comments are due August 4, 2026. Commenters should reference Notice 2026-36.

The Takeaway

The notice helps prevent retroactive disruption and confirms that §4960 will become a much broader compliance issue for tax-exempt organizations after 2025. Practitioners should review their employee lists, service arrangements with related organizations, and officer pay structures before the new definition takes effect.

List of Citations

• Notice 2026-36, 2026-26 IRB 1: Announces forthcoming proposed regulations under §4960 and provides interim reliance guidance.

• §4960: Imposes an excise tax on excess remuneration and excess parachute payments paid to covered employees of applicable tax-exempt organizations.

• §4960(c)(2): Defines “covered employee.”

• OBBBA §70416: Expands the §4960 covered employee definition for taxable years beginning after December 31, 2025.

• Treas. Reg. §53.4960-1(d)(2): Provides existing rules and exceptions for identifying five highest-compensated employees under prior law.

Holding

The Court of Federal Claims dismissed a taxpayer’s refund lawsuit for the §1202 qualified small business stock (QSBS) exclusion. The Court found the refund was tied to partnership items, so former IRC §7422(h) prevented the Court from hearing the case.

Why It Matters

• This is primarily a jurisdictional case, not a substantive QSBS decision.

• The Court never addressed whether the taxpayer actually qualified for the §1202 exclusion.

• The decision reinforces the broad reach of the former TEFRA partnership audit regime for pre-2018 tax years.

• Taxpayers cannot bypass partnership-level procedures by reframing partnership determinations as individual refund claims.

• The ruling highlights a procedural trap: even potentially meritorious tax positions may be unavailable if raised in the wrong forum.

Key Facts

Peter Seed co-founded the online brokerage business TradeKing.

Following several corporate restructurings, Seed became a member of TradeKing Holdings, LLC, which elected partnership tax treatment and owned stock in TradeKing Group, Inc.

In 2016, Ally Financial acquired TradeKing Group. The sale generated capital gain at the partnership level, which flowed through to TradeKing Holdings’ members, including Seed.

Seed paid tax on his share of the gain but later concluded that the gain should have qualified for the §1202 QSBS exclusion. He filed a refund claim with the IRS, which the agency denied. He then sued in the Court of Federal Claims seeking a refund.

Statutory or Regulatory Framework

• Former IRC §7422(h) barred refund suits attributable to partnership items under TEFRA.

• IRC §6231(a)(3) defined a “partnership item” as an item more appropriately determined at the partnership level.

• Treasury regulations treated partnership income, gain, loss, deduction, and related legal and factual determinations as partnership items.

• IRC §1202 allows exclusion of gain from qualified small business stock if statutory requirements are met.

• For the 2016 tax year, TEFRA’s partnership procedures still applied because the repeal of §7422(h) did not become effective until later years.

Arguments

Taxpayer argued:

• TradeKing’s business qualified for the §1202 exclusion.

• The company operated a technology-driven self-directed trading platform rather than a disqualified brokerage business.

• Corporate reorganizations did not restart the required five-year holding period.

• The jurisdictional bar should not apply absent a formal TEFRA proceeding initiated by the IRS.

Government argued:

• The refund claim was attributable to partnership items.

• The legal and factual issues underlying the §1202 claim had to be determined at the partnership level.

• Former IRC §7422(h) therefore deprived the Court of jurisdiction.

Court’s Reasoning

• TradeKing Holdings elected partnership tax treatment and qualified as a partnership under the TEFRA rules.

• The gain from the sale of TradeKing Group stock was an item required to be reported on the partnership’s tax return.

• Treasury regulations classify partnership income and gain, along with the legal and factual determinations affecting their characterization, as partnership items.

• Seed’s refund claim depended on determining whether TradeKing was a qualified business under §1202 and whether the stock satisfied the holding-period requirements.

• Those determinations concerned the characterization of partnership-level gain and therefore constituted partnership items.

• Former IRC §7422(h) expressly prohibited refund suits attributable to partnership items.

• The Court rejected the argument that the IRS had to initiate a TEFRA proceeding before the jurisdictional bar could apply. The statute operated automatically when its requirements were met.

Result

The Court of Federal Claims dismissed the refund case for lack of jurisdiction and did not consider the details of the taxpayer’s §1202 claim.

The Takeaway

The main point in this case is not the taxpayer’s QSBS argument, but the procedural rule that stopped the court from hearing it. For partnership years before 2018 under TEFRA, taxpayers usually could not bring partnership-level issues in individual refund lawsuits, even if those issues affected their own taxes.

List of Citations

• Seed v. United States (Ct. Fed. Cl. 2026) – Refund claim dismissed because it was attributable to partnership items.

• IRC §7422(h) – Barred refund suits attributable to partnership items under TEFRA.

• IRC §6231(a)(3) – Defined partnership items for TEFRA purposes.

• Treas. Reg. §301.6231(a)(3)-1 – Classified partnership income and related factual and legal determinations as partnership items.

• IRC §1202 – Qualified small business stock exclusion at the center of the taxpayer’s refund theory.

• Keener v. United States, 551 F.3d 1358 (Fed. Cir. 2009) – Interpreted the phrase “attributable to” in the TEFRA context.

• Schell v. United States, 589 F.3d 1378 (Fed. Cir. 2009) – Applied the jurisdictional bar for partnership-item refund claims.

Holding

There is no decision yet. Texas Instruments has filed a Tax Court petition to challenge the IRS notice of deficiency. The company is seeking to eliminate the claimed deficiencies and to have tax overpayments for 2018 and 2019 recognized.

Why It Matters

• This is one of the first significant Tax Court disputes involving how expenses should be allocated when computing the §250 FDII deduction.

• The case focuses on whether deductions tied to services performed before FDII existed can reduce FDII benefits in later years.

• A favorable taxpayer result could affect many multinational corporations with large stock-based compensation deductions and historic accounting method adjustments.

• The dispute also highlights continuing uncertainty surrounding IRS administrative guidance on FDII expense allocation.

Key Facts

Congress created the FDII regime under the Tax Cuts and Jobs Act, effective for tax years beginning after December 31, 2017. FDII provides a reduced effective tax rate on certain foreign-derived income earned by U.S. corporations.

Texas Instruments received a Notice of Deficiency dated May 18, 2026. The IRS asserted deficiencies of:

• $9.6 million for 2018

• $38.3 million for 2019

The adjustments stem from a dispute over the company’s §250 deduction and the treatment of certain expenses incurred before FDII became effective.

The disputed expenses fall into two categories:

• Deferred compensation expense from restricted stock units and stock options.

• A §481(a) accounting method adjustment related to depreciation and amortization deductions previously affected by the now-repealed Foreign Sales Corporation (FSC) regime.

Texas Instruments argues that much of these expenses relate to periods before FDII existed and therefore should not reduce deduction-eligible income (DEI) for FDII purposes.

The company also seeks overpayment determinations of:

• $11.8 million for 2018

• $289,134 for 2019

based on separate adjustments previously agreed to with the IRS.

Statutory Framework

• §250 allows a deduction for foreign-derived intangible income (FDII).

• FDII is determined by measuring the foreign-derived portion of a corporation’s deemed intangible income (DII).

• DII depends on the relationship between foreign-derived deduction-eligible income (FDDEI) and deduction-eligible income (DEI).

• DEI equals qualifying gross income reduced by deductions properly allocable to that income.

• FDII applies only to income arising in tax years beginning after December 31, 2017.

Taxpayer’s Arguments

Texas Instruments argues:

• Deferred compensation deductions tied to stock awards and options granted or earned in earlier years were not properly allocable to post-2017 DEI.

• The IRS improperly reduced DEI and FDDEI by including those deferred compensation amounts in the FDII calculation.

• The §481(a) adjustment represented depreciation and amortization deductions attributable largely to pre-2007 periods and had no factual relationship to post-2017 income generation.

• Because the underlying FDII adjustments were incorrect, related foreign tax credit adjustments are also incorrect.

• The company is entitled to overpayment determinations based on previously agreed audit adjustments.

Government’s Position

Based on the notice described in the petition, the IRS appears to take the position that:

• Deferred compensation expenses and the §481(a) adjustment must reduce DEI when computing the §250 deduction.

• Those allocations materially reduce FDII and, therefore, the allowable §250 deduction.

• The resulting reductions produce deficiencies for both 2018 and 2019.

Issues Before the Court

The case centers on a narrow but important question:

When an expense is deducted in a post-2017 year but economically relates to services or activities performed before FDII existed, must that expense still reduce DEI for purposes of calculating the §250 deduction?

The answer will determine whether taxpayers must use the deduction's timing or the economic activity underlying it when allocating expenses in the FDII formula.

Why This Case Is Significant

Most large multinational corporations have substantial stock-based compensation programs. Many also implemented accounting method changes that generated §481(a) adjustments after the TCJA became effective.

Texas Instruments alleges that:

• More than $757 million of deferred compensation deductions were involved in 2018.

• Nearly $986 million of deferred compensation deductions were involved in 2019.

• More than 98% of the disputed §481(a) adjustment related to periods before 2007.

Because FDII calculations can produce significant tax benefits, the treatment of these expenses can have a large effect on tax liability across the corporate sector.

The petition also references IRS Advice Memorandum 2022-001, which reconsidered prior IRS views regarding deferred compensation allocation for FDII purposes. That suggests the litigation may test the strength and reach of the IRS’s administrative position in this area.

Request

Texas Instruments is asking the Tax Court to remove the claimed deficiencies, recognize the agreed adjustments, determine overpayments for 2018 and 2019, and order any refunds. The case is still at the pleading stage.

The Takeaway

This is not a typical deficiency dispute. The petition brings up a key FDII allocation issue that could change how companies handle large deferred compensation deductions and past accounting adjustments in the §250 calculation. Tax departments with big stock-based compensation programs should pay close attention, since the outcome could affect FDII calculations for many companies, not just Texas Instruments.

List of Citations

• IRC §250, Foreign-Derived Intangible Income deduction. Central provision governing the disputed deduction.

• IRC §481(a), accounting method adjustment rules. Source of the disputed depreciation and amortization adjustment.

• IRC §83, taxation of restricted stock units and nonqualified stock options. Governs timing of deferred compensation deductions.The The

• Tax Cuts and Jobs Act of 2017 created the FDII regime, effective after 2017.

• CBS Corp. v. United States, 105 Fed. Cl. 74 (2012). Basis for the accounting method change involving FSC assets.

• IRS Advice Memorandum 2022-001. Addresses deferred compensation allocation in FDII calculations and is likely relevant to the dispute.

Holding

The Eleventh Circuit affirmed that Eugene Niksich intentionally did not file accurate FBARs from 2006 to 2012 and dismissed his settlement defenses. Nonetheless, the Court ruled that FBAR penalties could be challenged under the Excessive Fines Clause, sending the case back to the district Court to assess whether the $2.29 million penalty is constitutionally excessive.

Why It Matters

• This is one of the first appellate decisions applying the Eleventh Circuit’s recent holding that FBAR penalties are subject to Eighth Amendment scrutiny.

• The Court reaffirmed that FBAR willfulness includes reckless conduct and is evaluated under an objective standard.

• Taxpayers cannot avoid willful penalties by claiming ignorance when tax returns and surrounding facts clearly point to foreign account reporting obligations.

• Informal settlement discussions with IRS personnel do not bind the government unless officials with actual delegated authority approve the agreement.

• The decision strengthens the government’s position on FBAR willfulness while creating a potential avenue for taxpayers to challenge the size of penalties.

Key Facts

Eugene Niksich was the founder and CEO of a sporting products company and held foreign accounts in Switzerland and Panama.

His foreign assets reached several million dollars during the years at issue. The accounts included:

• Swiss accounts at AKB Privatbank Zurich AG.

• Swiss accounts at DZ Bank.

• Panamanian accounts at Ban Vivenda Banca Privada.

Several facts attracted the Court’s attention:

• He opened the Swiss account after being advised it could help shield assets from potential creditors.

• One account was maintained under the alias “Misty,” the name of his dog.

• He intentionally concealed the account from his then-wife.

• He used foreign banking arrangements that included mail-hold services.

• He self-prepared his tax returns.

• He answered “No” to Schedule B’s foreign account question in 2006 and left the question blank from 2007 through 2012.

Niksich later entered the IRS Offshore Voluntary Disclosure Program (OVDP) and filed delinquent FBARs disclosing the accounts. After opting out of OVDP, he negotiated with the IRS regarding a proposed settlement that would have imposed a penalty of approximately $419,000.

The IRS later declined to finalize the settlement and instead assessed willful FBAR penalties totaling approximately $2.29 million.

Statutory and Regulatory Framework

• 31 U.S.C. §5314 requires certain U.S. persons to report foreign financial accounts.

• FBARs are filed to disclose foreign bank and financial accounts exceeding applicable thresholds.

• 31 U.S.C. §5321(a)(5) authorizes civil penalties for FBAR violations.

• Under Eleventh Circuit precedent, willfulness includes reckless conduct.

• Recklessness exists when a taxpayer should have known there was a grave risk that an accurate FBAR was not being filed and could have easily confirmed the reporting obligation.

• The Eighth Amendment’s Excessive Fines Clause limits certain punitive government penalties.

Arguments

Taxpayer argued:

• He did not know about FBAR filing requirements during the years at issue.

• He mistakenly believed certain foreign assets did not require reporting.

• His later voluntary disclosure showed good-faith compliance rather than willful misconduct.

• The IRS had effectively settled the matter through a closing agreement and payment.

• The government should be estopped from seeking larger penalties after accepting the settlement payment.

• The FBAR penalties violated the Excessive Fines Clause.

Government argued:

• The undisputed facts established willfulness or recklessness.

• Schedule B provided clear notice of foreign account reporting obligations.

• The purported settlement never became binding because the relevant IRS personnel lacked authority to finalize it.

• Equitable estoppel could not apply against the government under these circumstances.

• The penalties were collectible in full.

Court’s Reasoning

• The Court applied the Eleventh Circuit’s objective recklessness standard for FBAR willfulness.

• Niksich self-prepared and signed returns that specifically asked about foreign accounts, under penalty of perjury.

• Schedule B plainly disclosed the existence of foreign account reporting obligations.

• His “No” response in 2006 and subsequent blank responses supported a finding of recklessness.

• His use of foreign accounts to protect assets, conceal funds from his spouse, maintain an alias account, and utilize mail-hold arrangements reinforced the conclusion that he should have known reporting obligations existed.

• His education, business experience, and discussions regarding FATCA further undermined claims of ignorance.

• Subjective claims that he misunderstood the law could not overcome the objective evidence.

• The proposed settlement failed because the IRS employees involved lacked actual delegated authority to bind the government.

• Equitable estoppel failed because the taxpayer could not show the type of affirmative government misconduct required to estop the United States.

• The district Court’s conclusion that FBAR penalties were categorically outside the Eighth Amendment was incorrect in light of the Eleventh Circuit’s earlier decision in Schwarzbaum.

• Because the parties had not developed a factual record regarding excessiveness, remand was necessary.

Result

The Eleventh Circuit affirmed the finding of willful FBAR violations and rejection of the taxpayer’s defenses, but reversed on the Eighth Amendment issue and remanded for further proceedings.

The Takeaway

The significant development is the Court’s acknowledgment that FBAR penalties can be contested under the Excessive Fines Clause. Taxpayers facing substantial willful FBAR penalties now have a more transparent route to challenge their constitutionality, especially when penalties are close to or surpass the value of the misconduct. Simultaneously, the decision indicates that courts remain prepared to determine willfulness on summary judgment when taxpayers overlook clear reporting warnings directly included in their tax returns.

List of Citations

• United States v. Schwarzbaum - Held that FBAR penalties are subject to the Excessive Fines Clause.

• United States v. Rum - Established the objective recklessness standard for FBAR willfulness.

• 31 U.S.C. §5314 - Foreign account reporting requirement.

• 31 U.S.C. §5321(a)(5) - Civil FBAR penalty provision.

• 26 U.S.C. §7121 - Closing agreement authority.

• Eighth Amendment to the U.S. Constitution - Excessive Fines Clause.

Holding

The Tax Court ruled that $33,354 in Cardano staking rewards, earned via a proof-of-stake cryptocurrency platform, were taxable income in 2021 when the taxpayer obtained dominion and control over the tokens. The Court supported the IRS’s stance that these rewards should be included in gross income at the time of receipt.

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Why It Matters

• This is the first Tax Court opinion directly addressing the taxation of proof-of-stake staking rewards.

• The decision strongly supports the IRS position that staking rewards are taxable upon receipt rather than only upon sale.

• The Court reached its conclusion under longstanding §61 income principles, not by relying on IRS administrative guidance.

• Taxpayers advancing “new property” or “self-created property” theories now face unfavorable judicial precedent.

• The ruling is especially important for retail investors using custodial staking platforms such as eToro, Coinbase, Kraken, and similar services.

Key Facts

• Alvie Paschall held Cardano cryptocurrency through the eToro platform.

• eToro automatically staked customers’ Cardano holdings unless customers opted out.

• Staking rewards were distributed monthly in additional Cardano tokens.

• Paschall remained enrolled in the staking program throughout 2021 and never opted out.

• He received staking rewards valued at $33,354 during the year.

• eToro issued Form 1099-MISC reporting the rewards as other income.

• The taxpayers did not report the staking rewards on their return.

Statutory Framework

• §61 defines gross income broadly as “all income from whatever source derived.”

• Cash-method taxpayers generally recognize income when actually or constructively received.

• Property received as compensation or rewards is generally taxable when the taxpayer obtains dominion and control over it.

• The IRS has previously stated in Notice 2014-21 that cryptocurrency is treated as property for federal tax purposes.

• Revenue Ruling 2023-14 similarly concluded that proof-of-stake validation rewards are taxable when the taxpayer gains dominion and control over them.

Taxpayer Arguments

Taxpayer argued:

• Staking rewards should not be taxable until sold or otherwise disposed of.

• The rewards were analogous to nontaxable stock dividends under Eisner v. Macomber.

• The rewards represented self-created property similar to products created by a baker or author.

• eToro’s transfer restrictions prevented full dominion and control.

• Revenue Ruling 2023-14 could not support taxation of rewards received before the ruling was issued.

Government Arguments

Government argued:

• The taxpayer received additional cryptocurrency with measurable fair market value.

• The taxpayer had dominion and control because the tokens could be sold at any time.

• The staking rewards constituted an accession to wealth under established income tax principles.

• The rewards were taxable upon receipt regardless of whether they were later sold.

Court’s Reasoning

• Cryptocurrency is property for federal income tax purposes.

• Gross income includes undeniable accessions to wealth over which a taxpayer has complete dominion and control.

• The staking rewards were credited directly to Paschall’s account and were immediately available for sale.

• Restrictions on transferring tokens to another wallet did not matter because Paschall retained the ability to convert the tokens to cash at any time.

• The rewards were not analogous to stock dividends because they increased both the taxpayer’s holdings and the value of his position.

• Staking rewards were not self-created property because the blockchain protocol, not the taxpayer, generated the additional tokens.

• The Court did not rely on Revenue Ruling 2023-14 and instead grounded its decision in §61 and longstanding income tax principles.

Result

The Tax Court determined that the taxpayer's taxable income from cryptocurrency staking rewards for 2021 was $33,354, dismissing the taxpayer’s claim that taxes should be postponed until sale.

The Takeaway

This is the most significant judicial endorsement of the IRS’s staking-reward position. The case's importance isn't just in the taxpayer losing. The Court used a broad income-recognition analysis, based on traditional tax doctrine, and ruled that staking rewards are taxable when the taxpayer can freely use or sell them.

Tax practitioners should note that the Court did not rely on Revenue Ruling 2023-14. Even if taxpayers question the authority of IRS guidance after Loper Bright, this decision suggests that courts might still reach the same conclusion under established §61 principles.

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List of Citations

• IRC §61 – Defines gross income broadly and served as the primary basis for the decision.

• Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) – Defines taxable income as an accession to wealth under the taxpayer’s dominion and control.

• Corliss v. Bowers, 281 U.S. 376 (1930) – Income subject to a taxpayer’s unfettered command may be taxed.

• Helvering v. Horst, 311 U.S. 112 (1940) – Power to dispose of income is equivalent to ownership.

• Eisner v. Macomber, 252 U.S. 189 (1920) – Distinguished by the Court because staking rewards increased the taxpayer’s economic interest.

• Revenue Ruling 2023-14 – IRS guidance concluding that proof-of-stake rewards are taxable upon receipt, although the Court expressly stated it did not rely on the ruling.

• Notice 2014-21 – IRS guidance treating cryptocurrency as property for federal tax purposes.

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Overview

Notice 2026-17 describes proposed rules that would make it much easier to follow the §987 foreign currency rules. The IRS is responding to ongoing complaints that the current rules are too complicated, costly, and require too much tracking.

The biggest change is a new optional “equity and basis pool” method, based on the 1991 proposed rules that were later withdrawn. Treasury and the IRS also want to limit loss suspension rules, make recognition requirements simpler, expand hedging relief, and create an option that would mostly remove §987(3) gain and loss recognition for CFCs.

What §987 Does

Section 987 applies when a taxpayer owns a qualified business unit (QBU), such as a foreign branch, that uses a different functional currency than its owner. The rules govern:

• Translation of branch income and loss.

• Recognition of foreign currency gains and losses.

• Currency effects when funds move between the branch and its owner.

The 2024 final regulations generally became applicable to tax years beginning after December 31, 2024, and introduced detailed computational and loss-limitation rules.

Proposal

The IRS announced its intent to issue proposed regulations that would:

• Create an elective, simplified equity-and-basis pool method.

• Narrow the scope of §987 loss suspension rules.

• Simplify suspended loss recognition.

• Expand eligible §987 hedging transactions.

• Develop a separate election under which CFCs generally would not recognize §987(3) foreign currency gains and losses.

Why It Matters

• This is one of the most significant taxpayer-friendly developments under §987 since the 2024 regulations were finalized.

• The proposed equity and basis pool method revives concepts many multinational taxpayers already understand from the 1991 proposed regulations.

• The loss suspension changes would allow more ordinary-course remittances to generate currently recognized losses.

• The planned CFC election could dramatically reduce compliance burdens for multinational groups with foreign branches.

• Treasury is signaling a willingness to prioritize administrability over technical precision in certain areas of the §987 regime.

Key Changes

1. New elective equity and basis pool method

Treasury and the IRS intend to permit taxpayers to elect a simplified method based on the framework used in the 1991 proposed regulations.

Under the proposed method:

• Taxable income or loss would generally be translated using the average exchange rate for the year.

• Taxpayers would maintain:

  • an equity pool in the QBU’s currency, and

  • a basis pool in the owner’s currency.

• §987 gain or loss would be computed by comparing the translated equity pool to the basis pool.

• Taxpayers would perform a single annual remittance calculation instead of tracking remittances daily.

The annual remittance calculation is particularly important because it eliminates one of the more administratively difficult features of the 1991 regulations, which required daily remittance tracking.

The election would only be available when a current rate election is already in effect.

2. Loss suspension rules become much narrower

The current regulations generally suspend many §987 losses recognized under a current rate election. Treasury received substantial criticism that these rules are overly broad.

The planned regulations would apply the loss suspension rules only if either:

• The remittance proportion exceeds 5%; or

• The amount that would become suspended exceeds $5 million.

This is a substantial relaxation compared with the current framework and should permit recognition of many losses arising from routine branch operations.

3. Recognition grouping rules become much simpler

Current regulations require taxpayers to track gains and losses across multiple recognition groupings, creating significant complexity.

Treasury intends to simplify the rules by treating all §987 gains and losses as belonging to a single recognition grouping for most taxpayers.

For CFCs, four broader groupings would remain:

• Tentative tested income.

• Subpart F income.

• Effectively connected income excluded under §952(b).

• Other income.

This change would make it easier to use recognized gains to unlock previously suspended losses.

4. Expanded hedging relief

Current §987 hedging rules require compliance with a GAAP-based hedging standard. Treasury received comments that the rule excludes many legitimate economic hedges.

The planned regulations would allow additional hedges to qualify as §987 hedging transactions even when the GAAP hedging requirement is not satisfied, provided the hedge is primarily used to manage exchange-rate risk relating to the QBU investment.

This expansion could significantly increase the number of hedges eligible for favorable §987 treatment.

5. Proposed CFC election

The most consequential proposal may be Treasury’s planned election for controlled foreign corporations.

If elected:

• CFCs generally would not compute or recognize foreign currency gain or loss under §987(3).

• §987(1) and §987(2) would continue to apply for taxable income and earnings and profits calculations.

• Special rules would apply to certain inbound reorganizations and liquidations.

Treasury specifically stated that it intends to issue additional guidance soon enough to allow taxpayers to evaluate the election for 2025 returns filed on extension.

Scope and Limitations

The notice does not change the current law by itself.

Instead, it explains rules that Treasury expects to include in future proposed regulations. Taxpayers can rely on the rules in Sections 3 and 4 of the notice before the proposed regulations come out, as long as everyone in the taxpayer’s §987 electing group uses the rules fully and consistently. The planned CFC election rules are not yet available to rely on.

What Practitioners Should Watch

• Multinationals with foreign branch structures should evaluate whether the equity-and-basis-pool method would reduce compliance costs.

• Taxpayers currently affected by suspended §987 losses may find substantially greater flexibility under the proposed rules.

• Groups with significant CFC operations should closely monitor forthcoming guidance on the proposed CFC election.

• Existing hedging programs may warrant review because more transactions could qualify for §987 hedge treatment.

The Takeaway

Notice 2026-17 marks a clear change in how Treasury is handling §987. Instead of adding more complex rules, the government is aiming for simplification. For many multinational taxpayers, especially those with foreign branches through CFCs, these changes could significantly reduce compliance costs and simplify administration.

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Overview of the Proposal

The IRS and Treasury have proposed new regulations to change when the pending §892 rules for foreign government investments in the U.S. will take effect. They also withdrew the original timing rules from the December 2025 proposal.

The proposal does not change the actual rules. It only affects when those rules will start to apply.

Comments are due by July 31, 2026. Proposed §§1.892-4(d) and 1.892-5(e) from the December 2025 proposal were withdrawn as of June 1, 2026.

What Changed

The December 2025 proposal would have applied the new rules to taxable years beginning on or after the publication of the final regulations.

Commenters argued that the approach did not provide sufficient protection for existing investments and requested transition relief for:

• Existing debt holdings.

• Existing ownership interests in entities.

• Investments made under binding commitments entered into before the final regulations become effective.

• Additional time to restructure legacy holdings if necessary.

Treasury and the IRS agreed that the final rules generally were not intended to apply retroactively to existing holdings and proposed a new transition framework.

Debt Acquisition Rules

The proposal would delay application of the new debt acquisition rules until the later of:

• The first day of the taxpayer’s first taxable year beginning after publication of the final regulations.

• Ninety days after publication of the final regulations.

The proposal would also preserve current-law treatment for:

• Debt acquired before the end of the transition period.

• Debt acquired after that date pursuant to a binding commitment entered into before the transition period ends.

Treasury further clarified that merely holding previously acquired debt in later years does not, by itself, constitute commercial activity under these rules.

Effective Control Rules

The proposal provides a similar transition period for the effective control provisions. The new rules would generally apply only after the later of:

• The first day of the foreign government’s first taxable year beginning after publication of the final regulations.

• Ninety days after publication of the final regulations.

Existing entity interests generally would continue to be evaluated under the current rules unless the foreign government later acquires additional interests that independently create effective control under the final regulations.

Why It Matters

• This is primarily a transition-relief package rather than a substantive policy change.

• Treasury acknowledged concerns that the original applicability dates could affect existing sovereign investments in unintended ways.

• Existing debt holdings and ownership interests receive significant protection under the proposal.

• Binding commitments entered into before the applicability date receive grandfather-style treatment.

• The proposal signals Treasury’s continued effort to balance anti-abuse concerns with the need to maintain an attractive environment for sovereign wealth fund investment in the United States.

Next Steps

Treasury and the IRS said they received 18 comments on the December 2025 proposal and are still reviewing key issues about the debt acquisition and effective control rules. They are also looking at market practices and the broader goal of supporting both current and future sovereign wealth fund investment in the U.S.

The Takeaway

The proposal greatly lowers the risk that the final §892 rules will disrupt existing investments by sovereign wealth funds and foreign governments. For most affected taxpayers, the main benefit is the transition relief and grandfathering, not changes to the actual rules.

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List of Citations

• IRC §892: Exempts certain foreign government investment income from U.S. taxation.

• IRC §7805(a): General Treasury regulatory authority.

• Proposed Treas. Reg. §1.892-4: Rules addressing debt acquisitions and commercial activity.

• Proposed Treas. Reg. §1.892-5: Rules addressing effective control of entities by foreign governments.