Tax Strategy Problem

I:15-61

Your client, Home Products Universal (HPU), distributes home improvement products to independent
retailers throughout the country. Its management wants to explore the possibility of opening its own
home improvement centers. Accordingly, it commissions a consulting firm to conduct a feasibility
study, which ultimately persuades HPU to expand into retail sales. The consulting firm bills HPU
$150,000, which HPU deducts on its current year tax return. The IRS disputes the deduction,
contending that, because the cost relates to entering a new business, it should be capitalized. HPUs
management, on the other hand, firmly believes that, because the cost relates to expanding HPUs
existing business, it should be deducted. In contemplating legal action against the IRS, HPUs
management considers the state of judicial precedent: The federal court for HPUs district has ruled
that the cost of expanding from distribution into retail sales should be capitalized. The appellate court
for HPUs circuit has stated in dictum that, although in some circumstances switching from product
distribution to product sales entails entering a new trade or business, improving customer access to
ones existing products generally does not. The Federal Circuit Court has ruled that wholesale
distribution and retail sales, even of the same product, constitute distinct businesses. In a case
involving a taxpayer from another circuit, the Tax Court has ruled that such costs invariably should be
capitalized. HPUs Chief Financial Officer approaches you with the question, In which judicial
forum should HPU file a lawsuit against the IRS: (1) U.S. district court, (2) the Tax Court, or (3) the
U.S. Court of Federal Claims? What do you tell her?

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The appropriate forum for filing the lawsuit from the IRS would be the U.S. Tax Court. The U.S. Tax Court,
established in 1942, has national jurisdiction and hears only tax-related cases. In considering its lawsuit against
the IRS, HPU don't want to file its lawsuit in U.S. District Court as a result of that fact how the company
distributes products to companies nationwide. Each state has one or more U.S. District Court along with the
courts are outside of one another. Due to this fact, the decision made through the U.S. District Court in a single
state might not apply in another state. Since HPU distributes products nationwide and would like to expand
nationwide, the company would want the case to be heard in a court which includes national jurisdiction.
The U.S. Tax Court concentrates on handling tax disputes that occur prior to Internal Revenue Service makes an
assessment of an formal tax. HPU can decide to file for their lawsuit in another court forum. However, the U.S.
Tax Court is the only forum where HPU will surely have its case heard without paying the amount in dispute. If
the truth was tried inside the United States Court of Federal Claims or perhaps a U.S. District court, the tax
would have to become paid prior to the lawsuit may be filed. The Legislative Branch of the United States
government helps to make the U.S. Tax Court unique and singular. By having the case tried within the U.S. Tax
Court, the control over Home Products Universal can have the business's CPA's represent them in the court even
though the CPA's don't have any legal training.
U.S. Tax Court can be a court of national jurisdiction as well as rulings are uniform for everyone regardless of
their place of work debt management companies; http://www.debtsolutions4ultd.co.uk/, or residence. The Tax
Court just isn't bound from the decisions with the U.S. District Court or U.S. Court of Federal Claims even if
the U.S. District Court has jurisdiction over the taxpayer. Cases in the U.S. Tax Court are decided by judges,
who are experts inside field of tax law, without jury trials. Judges inside the Tax Court are appointed by the
President and serve regards to 15 years. The U.S. Tax Court is a bit more relaxed compared to other formal
courts which will help facilitate dispute settlement more cooperatively.

Case Study Problem

I:15-62

A client, Mal Manley, fills out his client questionnaire for the previous year and on it provides
information for the preparation of his individual income tax return. The IRS has never audited Mals
returns. Mal reports that he made over 100 relatively small cash contributions totaling $24,785 to
charitable organizations. In the last few years, Mals charitable contributions have averaged about
$15,000 per year. For the previous year, Mals adjusted gross income was roughly $350,000, about a
10% increase from the year before.
Required: Applying Statements on Standards for Tax Services No. 3, determine whether you can
accept at face value Mals information concerning his charitable contributions. Now assume that the
IRS recently audited Mals tax return for two years ago and denied 75% of that years charitable
contribution deduction because the deduction was not substantiated. Assume also that Mal indicates
that, in the previous year, he contributed $25,000 (instead of $24,785). How do these changes of fact
affect your earlier decision?

Statements on Standards for Tax Services (SSTS) No. 3 states that a CPA "may in good faith rely, without
verification, on information furnished by the taxpayer or by third parties" (Para. 2, reproduced in Appendix E of
the text). Thus, you may accept Mal's information at face value. His increase in AGI of over $30,000 may
explain his increase in charitable contributions of approximately $10,000. In the second scenario the provision
from SSTS No. 3 that a CPA "should make reasonable inquiries if the information furnished appears to be
incorrect, incomplete, or inconsistent either on its face or on the basis of other facts known to a member" would
be pertinent. Recently, the IRS audited Mal's return, and Mal lacked substantiation for about 75 percent of the
charitable contributions he had claimed. (He may have made the contributions, but he could not prove that he
did.) Further, the round amount ($25,000) reported by Mal suggests that Mal may be estimating what he
contributed. You probably should request to see substantiation (canceled checks, etc.) for the contribution(s)
claimed. For charitable contributions of $250 or greater made after December 31, 1993, no deduction is
allowed unless the donee organization substantiates the contribution with a contemporaneous, written
acknowledgement. Mal needs to be made aware of this rule for his current year's return.