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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

The Rich Are Different - They Pay More

Dec 03, 2013

The Tax Court released a very interesting and to some degree an entertaining case on Tuesday. Michael D. Brown was considered a super life insurance agent to the Forbes 400. He normally would not handle any life insurance policies with a face value less than $10 million and in many cases, he was the agent for $300 million plus policies.

During his career it became apparent that he needed a private jet to get him quickly to meet with his rich clients (they don't like to wait). Over time, he had acquired one smaller private jet, which was found lacking since it was considered a "4 hour" jet. It could not get from Los Angeles to New York without refueling. This led him to look for a better jet and he finally found one for the reasonable price of $22 million at the end of 2003.

When touring a similar plane, he noted a conference table and decided he wanted that in his new plane and an upgrade from 17" monitors to 20" monitors. Since this would entail substantial modifications to the plane, the seller indicated they would need to have the plane in the shop for 5-6 weeks.

Normally, this would not be a big deal, but during 2003 and 2004, the Tax Code allowed a 50% bonus depreciation on new assets placed in service by December 31, 2004. Mr. Brown wanted the deduction in 2003, so he took delivery of the plane on December 29; flew it from Portland to Seattle, then to Chicago and back to Seattle all in the same day. These trips were all for "business".

As you can tell, the IRS audited his return and disallowed the depreciation deduction of over $11 million. As part of the audit, they then determined that Mr. Brown seemed to be "shall we say" very creative with his accounting and asserted a 75% fraud penalty on underreporting of over $30 million of taxable income. Since the tax on this would be over $10 million, the fraud penalty alone was over $7 million. Mr. Brown settled with the IRS on all of other audit issues except for the 50% bonus depreciation on the airplane right before trial. Most likely the primary reason for going to trial was not related to the deduction (it would be allowed in 2004), but the 75% fraud penalty the IRS was trying to collect.

The Tax Court agreed with the IRS that the plane was not placed in service by December 31, 2003, but rather early in 2004. This resulted in moving the deduction from 2003 to 2004. The Court indicated that the plane delivered to Mr. Brown in 2003 was not ultimately the plane he placed in service which happened in 2004. Yes, he flew the plane around for a day before year-end on "business", but the actual plane he placed in service included the conference table and upgraded monitors which was not completed until 2004. Also, Mr. Brown appears to have prepared documentation substantiating the business use only when he was finally audited. However, the Tax Court was kind to Mr. Brown and did not allow the 75% fraud penalty on the early deduction.

Now you are probably asking what this court case has to do with farming. Other than it being an interesting case to read, we have many farmers who "shall we say" speedily purchase farm equipment at year-end to get a Section 179 or bonus depreciation deduction. Also, since farm buildings qualify for bonus depreciation, there is sometimes a mad rush to get the building "finished" by year-end. Most of these assets are placed in service properly and timely, but this court case is a good example of what happens when you do it wrong. As this case sometimes proves, the "Rich are Different - They Pay More".

If you are interested in reading the case, you can find it here. Also, Janet Novak of Forbes has more detail on the case here.

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