LPCiminelli Interests, Inc. v. United States, 110 AFTR 2d 2012-6631 (W.D. N.Y. 2012) ruled that a consolidated group did not have to amend its returns to assert that a subsidiary became worthless before the year the IRS claimed it was worthless. This ruling confirms the general rule that taxpayers have no obligation to amend a previously filed return. It also illustrates the pitfalls of dealing with broken subsidiaries, and the wisdom of sometimes doing nothing.
Facts. The common parent of the group owned a subsidiary that went out of business several years before the 2004 year for which the IRS asserted it had discharge of indebtedness income. On its 2004 return, the group reported that the subsidiary was out of business and no longer in the group, but did not report an excess loss account or include discharge of indebtedness income (substantial sums were owed to third parties and unpaid). After the IRS realized that Section 108(a) provides an exception for insolvent taxpayers, it asserted a new ground for assessment: the group’s failure to report in 2004 the excess loss account of the subsidiary in the year it became worthless.
The taxpayer paid and sued for refund. It asserted that the subsidiary had become worthless in an earlier year that was closed and so it did not own any additional tax for 2004. The court found that worthlessness occurred prior to 2004, in a year that was closed. It ruled that the anti-avoidance rule in Reg. §1.1502-19(e) could not be relied on by the government to nevertheless assess for 2004 because failure to amend prior returns to show the subsidiary as worthless was not evidence of such avoidance.
The taxpayer had taken the deposition of the IRS audit agent and the court refused to allow it into evidence. The court stated that it was not relevant how or why the IRS examination proceeded as it did; all that was relevant was whether the taxpayer owed additional tax for 2004—i.e., the ultimate tax liability issue.
Lessons. This case suggests two lessons. First, when an insolvent subsidiary has an excess loss account, and also owes debts, the group might be motivated to delay reporting the worthlessness of the subsidiary, or liquidating it, for fear of having to recognize the excess loss account. There are many considerations at play in these cases. Second, time and money was spent by the taxpayer trying to prove improper IRS audit technique, oral concessions, etc. Such efforts are sometimes in reaction to the IRS practice of making taxpayer state of mind an issue in tax cases. However, pursuing such discovery may not turn out to be money not well spent by taxpayers.
