Eighth Circuit Reverses Tax Court on Burden of Proof

In Griffin, 8th Cir., 1/14/03, vactg and remdg TC Memo 2002-6, the Eighth Circuit ruled that the taxpayer introduced credible evidence sufficient to shift the burden of proof to the Service under Sec. 7491(a). Sec. 7491 was enacted in 1998 as a key provision of the Internal Revenue Service Restructuring and Reform Act of 1998. Griffin is the first circuit court case in which the taxpayer prevailed under Sec. 7491(a).

Background

A taxpayer generally bears the burden of proof under Tax Court Rule 142(a). However, Sec. 7491(a)(1) specifies that if, in any court proceeding, a taxpayer introduces credible evidence as to any factual issue relevant to determining his or her income, estate or gift tax liability, the Service shall bear the burden of proof on that issue. According to Sec. 7491(a)(2), the taxpayer must satisfy recordkeeping and substantiation requirements and cooperate with the Service on reasonable requests for witnesses, information, documents, meetings and interviews.

Sec. 7491(a) does not apply to corporations, partnerships and trusts whose net worth exceeds $7 million, nor if any other statute specifies a specific burden of proof. Congress enacted Sec. 7491(a) to create a better balance between individual and small business taxpayers and the Service when these taxpayers litigate with the Service; see 1998-3 CB 994.

Sec. 7491 does not define credible evidence. The Conference Committee Report states that credible evidence is evidence which the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to presumption of IRS correctness); see 1998-3 CB 994-95. This would be evidence sufficient to rule in the taxpayers favor in the absence of contrary evidence.

Facts

Robert and Julia Griffin owned 100% of the stock of Griffin California Enterprises, Inc., an S corporation; Griffin California owned 60% of two partnerships. One of the partnerships owned a shopping mall, and the other a dance hall. Robert Griffin personally guaranted loans to construct these properties, even though the Griffins had no direct ownership interest in the partnerships or the properties.

In 19951996, Robert Griffin paid delinquent real property taxes on the properties. The taxpayers deducted these payments on Part I of their Schedules E, claiming the taxes were on property they owned, which was incorrect. The Service determined that the payments were effectively capital contributions to Griffin California and deductible as tax payments only by the partnerships. The partnership deductions resulted in a 60% flowthrough to Griffin California. The combined deficiency was over $100,000.

Tax Court

Case law has established that a taxpayer may not deduct payments made on behalf of another entity in which the taxpayer has only an ownership interest. However, a taxpayer could deduct such payments as ordinary and necessary expenses if they promote the taxpayers own business interests. The taxpayer must show direct and proximate adverse consequences to his or her own business from a failure to pay the other entitys obligation.

Robert Griffin testified in Tax Court that he had been a building contractor and land developer for 30 years, had developed 2530 major projects and had obtained financing essential to such projects; thus, a default on the partnerships loans would have destroyed his ability to obtain future financing. He also testified that he owned 20 S corporations, and, thus, that he incorporated for liability reasons. The Service argued that Griffins testimony was self-serving and not credible; further, the Griffins accountant had testified that the tax payments were made in connection with the S corporations.

The Tax Court ruled that the Griffins did not prove that the property tax payments advanced a business carried on in their individual capacities. It also ruled that Griffins testimony was not credible evidence under Sec. 7491(a). Finally, the court noted that, based on a preponderance of the evidence, it would have decided the issue in favor of the Service even if the burden of proof had been on the Service.

Eighth Circuit

On appeal, the Eighth Circuit ruled that Griffins testimony did satisfy the Sec. 7491(a) credible evidence requirement. Assuming no contrary evidence or presumptions, the Griffins would prevail on the deductibility of the tax payments. Thus, the Service has the burden of proof that the tax payments were not deductible.

The Eighth Circuit did not elaborate on why it ruled that Griffins testimony constituted credible evidence. Apparently, it took a broader view of what constituted a business in Griffins individual capacity, thereby accepting his treatment of all of his businesses as one, unified by his reputation. Also, Griffin pointed out he would go out of business if he did not pay the taxes, arguably satisfying the direct and proximate adverse consequences requirement. The Eighth Circuit then ruled that the Tax Court erred in summarily concluding that the outcome is the same regardless of who bears the burden of proof. It remanded the case back to Tax Court to determine if the Service met its burden of proof that the tax payments were not deductible.

Conclusion

Griffin provides an important precedent for shifting the burden of proof to the Service under Sec. 7491(a)(1), provided that the taxpayer satisfies Sec. 7491(a)(2). This precedent could assist practitioners in negotiating with the Services Office of Appeals on taxpayers behalf. Future cases will clarify how the Tax Court and the other circuits will apply Griffin.

From Peter C. Barton, MBA, CPA, J.D., Professor of Accounting, and Roy C. Weatherwax, Ph.D., CPA, Professor of Accounting, University of WisconsinWhitewater, Whitewater, WI (Neither affiliated with American Express Tax and Business Services Inc.)