Under IRC section 7491, in any court proceeding the IRS has the burden of proof with respect to any factual issue relevant to determining a taxpayer’s liability for any income, self-employment, gift, estate and generation skipping transfer taxes if
The taxpayer introduces credible evidence with respect to the issue.
The taxpayer has complied with the requirements to substantiate any item.
The taxpayer has maintained all required records.
The taxpayer has cooperated with reasonable requests from the IRS for witnesses, information, documents, meetings and interviews.
In the case of a partnership, corporation or trust, the taxpayer is described in IRC section 7430(c)(4)(A) (ii). The Senate committee reports show this means corporations, partnerships and trusts with net worth over $7 million are not eligible for the benefits of the burden-of-proof provision.
Mr. Griffin is a real estate developer. He and his wife jointly own all the stock of Griffin California Enterprises Inc., an S corporation. Griffin California owns 60% of two California partnerships, Orange Tree Commerce Center and Texas Jacks. Neither spouse owns a direct interest in either partnership. During 1995 and 1996, Mr. Griffin paid delinquent real property taxes on behalf of Orange Tree and Texas Jacks to avoid foreclosures on the partnerships’ assets. He deducted these payments on schedule E of his jointly filed individual tax return, saying the payments were made in connection with rental property he owned in Fairfield, California.
Upon audit, the IRS determined the deductions were improper and the payments should be treated as capital contributions to Griffin California and deducted by the partnerships. At trial the Tax Court noted that, as a general rule, “a taxpayer may not deduct a payment made on another’s behalf unless the payment represents an ordinary and necessary expense of the taxpayer’s own business, as distinct from the business of another person or of some other entity in which the taxpayer may have an ownership interest.” The court recognized an exception to this general rule allowing a payment to be personally deducted if it qualified as an ordinary and necessary expense of one’s own business—the Lohrke exception (see Lohrke , 48 TC at 688).
Mr. Griffin testified he had to pay the taxes to preserve his integrity and standing with the bank to stay in business. The Tax Court held that the Griffins had not proved the property tax payments were expenses of a business separate from the corporation in which the couple were mere investors. The court said in a footnote that, based on the preponderance of evidence, the decision would be the same even if the burden of proof were on the IRS. The Griffins appealed the case, claiming they had presented credible evidence they had made the payments to “promote” their own real estate and construction business.
Result. For the taxpayer, in part. The Eighth Circuit Court of Appeals vacated the Tax Court decision and remanded the case for further proceedings. Citing OkerLund , 53 Fed.Cl. 341, the Eighth Circuit said credible evidence is “the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness).” The conclusion was that Mr. Griffin’s testimony, in the absence of any evidence or presumptions to the contrary, was credible and that the Tax Court had erred in failing to shift the burden of proving the nonapplicability of the Lohrke exception to the IRS. In light of this failure, the case was remanded to the Tax Court to decide the issues.
The provisions shifting the burden of proof are relatively new; the effective date was July 23, 1998. Taxpayers—and their CPAs—should understand decisions such as Griffin so they are fully aware of their rights in any legal proceedings.
Griffin v. Commissioner, 91 AFTR2d, 2003-486.
Prepared by Karyn Bybee Friske, CPA, PhD, associate professor of accounting, and Darlene Pulliam Smith, CPA, PhD, professor of accounting, both of the T. Boone Pickens College of Business, West Texas A&M University at Canyon.