More To The Story Than Meets The Eye

Pendergraft v. U.S. was decided on July 22, 2010. PPC's description of the case is: Mortgage Refinance Proceeds: Taxpayers filed an amended return based in part on their claim that the IRS incorrectly characterized a $35,103 bank deposit from a mortgage refinance as taxable income. The IRS denied the claim because: "You did not document that your share of the loan proceeds were deposited into the accounts considered in determining gross receipts. Rather it appears that your share of the loan proceeds were deposited into one of the accounts not provided to the examining agent which she requested." After noting that funds received from a mortgage refinance are not taxable, the Court of Federal Claims concluded that taxpayers produced sufficient evidence (a letter from Kanaly Trust Company) establishing that they received a check for $35,103 representing one-half of the mortgage refinancing proceeds. Pendergraft v. U.S. , 106 AFTR 2d 2010-XXXX (Ct. Fed. Claims).

I thought this would be an interesting case to read in full. How could the IRS argue that loan proceeds are taxable income? Is this a matter of an IRS correspondence case where the IRS agent added up all bank deposits and the taxpayer explained the additional deposit amount was due to a refinance and the IRS did not understand the explanation? Is this a case where the IRS is ignorant? Is this a case where the IRS tries to extract money from the taxpayer? Or is there more to the story?

There IS more to the story. The case states: The Government highlights the fact that since 1997 Plaintiffs have “created a series of illegal trusts that they believed would enable them to avoid all income taxes.” Gov't Opp. & Cross Mot. at 5. This is not the first time the IRS has had to re-examine Plaintiffs' tax returns. Id. In fact, Plaintiffs filed Form 1040EZ returns between 1998 and 2001 reporting zero taxable income, even though they had received substantial income. Id.; see also NHUSS Trust v. Comm'r, 90 T.C.M. (CCH) 374 [TC Memo 2005-236] (2005) (holding Plaintiffs in the case at bar liable for negligence penalties that arose as a result of the underpayment of taxes in 1999 and 2000). The instant refund claim is a continuation of Plaintiffs' “brazen” “tax-avoidance scheme.” Gov't Opp. & Cross Mot. at 5; see also id. at 6–13 (characterizing Plaintiffs' previous “[s]ham [t]rust [s]tructure and 2005 Tax Court [l]itigation,” and questioning Plaintiffs' 2001 tax return).

Originally the taxpayers filed a joint zero-taxable income return Form 1040EZ for the tax year 2001, then they filed a revised joint tax return claiming an adjusted gross income of $310,701. And then they filed another 1040X.

While the proceeds of a loan refinance are not taxable, is it any surprise that the IRS was suspicious?

And the moral of the case? A brief description of a case, no matter how carefully written and edited, does not tell the whole story. And, many times, we need the truth, the whole truth, and nothing but the truth.