Winter v. Comm'r of Internal Revenue

• Citation: 135 T.C. 238,135 T.C. No. 12
• Decision Date: 25 August 2010
• Docket Number: No. 5035–05.,5035–05.
• Parties: Michael C. WINTER and Lauren Winter, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: United States Tax Court

135 T.C. 238

135 T.C. No. 12

Michael C. WINTER and Lauren Winter, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 5035–05.

United States Tax Court.

Aug. 25, 2010.

P, as an employee of a subch. S bank, received a bonus that was repayable in part if he quit or was fired for cause. P reported the full amount of the bonus but now argues that part was a nontaxable loan. P, as a shareholder, reported his share of the company's earnings from its regulatory financial filings and not from the Schedule K–1 which the bank prepared for him. P did not notify R of this inconsistent reporting; and only after the issuance of the notice of deficiency did R assess the income tax resulting from this inconsistent treatment.

R contends: (1) The entire bonus was taxable income in the year received, (2) P should have reported his shareholder income consistently with the bank's Schedule K–1, and (3) P failed to include some dividend, interest, and gambling income on his return. R issued a notice of deficiency determining a deficiency and imposing an accuracy-related penalty under sec. 6662(a), I.R.C.

P has conceded R's adjustments relating to dividend, gambling, and interest income. P and R agree that this Court has jurisdiction to decide all issues. However, the Court raises the question of whether secs. 6037(c) and 6213(b)(1), I.R.C., remove the adjustment relating to P's inconsistently reported shareholder income from our jurisdiction. This Opinion addresses only that question.

Held: R's failure to assess the amount of the deficiency attributable to the amount reported inconsistently with the Schedule K–1 before issuing the notice of deficiency does not exclude this amount of tax from the deficiency as defined in sec. 6211, I.R.C., and we have jurisdiction to redetermine R's adjustment.

John B. Beery, Joseph M. Laub, and John J. Scharkey III, for petitioners.

Kathleen C. Schlenzig and Julie A. Jebe, for respondent.

OPINION

GOEKE, Judge:

Michael Winter owned stock in the subchapter S bank where he worked. The bank paid him a large bonus in 2002 but then fired him and demanded part of the bonus back in 2003. On his 2002 Federal income tax return Winter reported the full amount of his bonus and his share of the bank's income and deductions—not as those items were reported by the bank but from his own estimates of what they were.

The parties have argued mostly about the consequences of Winter's failure to report his income from the bank in a manner consistent with the bank's reporting on its return and about the taxability of his bonus in the year he received it. We ourselves question whether we have jurisdiction over these issues because the Internal Revenue Code provides that adjustments arising from inconsistencies between the return of a taxpayer and that of an S corporation in which the taxpayer has an ownership interest should be treated as math errors. The parties tell us that this has no effect on our jurisdiction. This Court agrees with the parties.

Background

Builders Bank (Builders), a corporation wholly owned by Builders Financial Corp. (BFC), hired Winter in 2001 to be its chairman and CEO and granted him a large number of stock options. Winter exercised these options, and by 2002 he owned over 26 percent of BFC. Builders also paid Winter a $5 million bonus that was repayable in part if he quit or were fired for cause. BFC was an S corporation.

Within a year Builders grew dissatisfied with Winter. It fired him on December 26, 2002, and claimed the firing was a termination for cause. In early 2003 it demanded repayment of the unearned portion of the bonus, which by that time was a bit more than $4 million. Winter refused to pay, and he and Builders took their dispute to State court, where Winter argued that Builders had no cause to fire him. The case seems to have been settled, because it was dismissed in January 2004 without opinion.

But before then, in 2003, Winter needed to figure out how much income he had and how to report it on his 2002 income tax return. S corporations ¹ ARE REQUIRED TO send their shareholders schedules k–1, sharEHOLDER'S Share of Income, Credits, Deductions, etc., listing the amounts of passthrough income or loss they should report on their individual income tax returns.

On its 2002 tax return ² BFC deducted about $1 million of Winter's bonus payment as a salary expense. BFC split the remaining $4 million—reporting $2 million as prepaid compensation and reducing retained earnings by the same amount, neither of which it deducted against income for 2002. BFC included a copy of each shareholder's Schedule K–1 in the 2002 return that it filed, including one for Winter that showed $820,031 in ordinary passthrough income and $5,062 as his share of BFC's charitable contributions. The Internal Revenue Service (IRS) later audited BFC's return but ended up accepting it as filed.

S corporation shareholders usually report their shares of the corporation's items the same way those items are reported on the Schedules K–1, if only because they know S corporations send the information to the IRS. But Winter broke this pattern. Instead of using the information on the Schedule K–1, he looked up BFC's regulatory financial statements on the FDIC Web site, took the net loss reported there, and multiplied it by his percentage ownership at the end of 2001. (Winter owned 26.82 percent of BFC at the end of 2001 and claims he was unaware of an equity distribution that left him with only 26.32 percent at the end of 2002.) This calculation would probably work if BFC treated each item identically for both tax and regulatory reporting purposes. But BFC's 2002 regulatory statements showed a charge against earnings for the entire bonus paid to Winter, in contrast to its 2002 tax return on which it claimed a deduction for just one-fifth. Winter's calculations—based on the regulatory report—therefore showed a total 2002 passthrough loss of about $1.2 million and not the passthrough income of about $820,000 that BFC had reported on Winter's Schedule K–1. Winter also failed to claim his share of BFC's charitable contributions reported on its tax return.

Winter's excuse for this deviation from normal reporting procedures was that he never received a Schedule K–1. The record shows, however, that Builders sent an overnight package via FedEx to Winter on March 13, 2003. Builders claims that the package held a cover letter and Winter's 2002 Schedule K–1. Winter claims that he never got the package. We find that Builders used the correct name, street address, State, and ZIP Code but listed the wrong Chicago suburb (Highland Park instead of Deerfield) on the mailing label. There was another Michael Winter who lived in Highland Park, but his house number, street name, and ZIP Code were all different. The parties offer no evidence that this other Michael Winter received the package; and though FedEx did not obtain a signature, Builders did receive confirmation of delivery on March 14, 2003. Winter also never asked Builders or the IRS for another copy of the Schedule K–1.

On February 24, 2006, respondent issued Winter a notice of deficiency, including respondent's determination that Winter should have reported BFC income consistent with the income shown on the Schedule K–1. After the issuance of the notice of deficiency, respondent summarily assessed the amount of tax based upon the reporting inconsistent with the Schedule K–1.

Winter was a resident of Illinois when he timely filed his petition, and he petitioned the Schedule K–1 disputed amount as well as other issues. Trial was set to begin in Chicago when the parties agreed to submit the case for decision under Rule 122 on March 13, 2006. In the course of drafting the Opinion, the Court identified a possible jurisdictional problem and asked the parties for their views. We therefore decide whether we have jurisdiction before addressing the substantive issues in a subsequent opinion.

Discussion

The issue is whether this Court has jurisdiction over the adjustment to Winter's distributive share of S corporation income or whether respondent must assess the tax related to the adjustment as a math error under section 6213(b)(1), precluding the inclusion in the notice of deficiency of the increase in tax relating to that adjustment. The parties argue that the examination for petitioners' 2002 tax year determined there was a deficiency, as defined in section 6211(a), and that a notice of deficiency was therefore a proper way for the IRS to provide petitioners with respondent's determination.

The concern regarding our jurisdiction arises because Winter failed to comply with section 6037(c) by either reporting consistently with the Schedule K–1 as required by section 6037(c)(1) or notifying the IRS of the possibility of an inconsistency as required by section 6037(c)(2)(A). Section 6037(c)(3) provides potential consequences of Winter's failure to comply:

(3) Effect of failure to notify. * * *

* * *

any adjustment required to make the treatment of the items by such shareholder consistent with the treatment of the items on the corporate return shall be treated as arising out of mathematical or clerical errors and assessed according to section 6213(b)(1). Paragraph (2) of section 6213(b) shall not apply to any assessment referred to in the preceding sentence.

Section 6213(b)(1) provides:

SEC. 6213(b). Exceptions to Restrictions on Assessment.—

(1) Assessments arising out of mathematical or clerical errors.—If the taxpayer is notified that, on account of a mathematical or clerical error appearing on the return, an amount of tax in excess of that shown on the return is due * * * such notice shall not be considered as a notice of deficiency * * * and the taxpayer shall have no right to file a petition with the Tax Court based on such notice, nor shall such assessment or collection be prohibited * * *

Reading the two sections together, our colleague suggests that when a...