Calculating Cost Basis Wrong Can Be Costly!
Oct 31, 2013
The Tax Court case released the Moore vs. Commissioner case (T.C. Memo 2013-249) yesterday and this is a very good case of how some taxpayers who really should know better, still attempt to fight a losing cause with the IRS in the Tax Court. Here is a brief summary of the facts of the case:
- Mr. Moore started his career as a CPA ;
- He then went to work for Dallas Peterbilt, Inc. (an S corporation) which later became ATS;
- Over time he bought 5% of the company from one shareholder and then later on purchased about $5.8 million of ATS shares from Mr. Baker;
- Mr. Moore borrowed 100% of the money from ATS (with a promissory note) and paid a total of $5.353 million to Mr. Baker;
- Mr. Moore then sued ATS claiming that the stock bought from Mr. Baker was only worth $1 million and that he should only be liable for $1 million not $5.353 million. The claim was that Mr. Moore only paid the higher amount as a favor to ATS;
- The lawsuit was settled for the $1 million amount and Mr. Moore's loan to ATS was reduced to this number which appears to be paid off at a later point in time;
- In 2005, Mr. Moore sold his stock for $3 million and claimed a basis in his ATS stock of $4,502,519 resulting in a capital loss of $1,502,519;
- Mr. Moore calculated his basis using the original $5.353 million paid to Mr. Baker less other S corporation adjustments reducing his basis to the amount shown;
- The IRS audited the return and assessed tax based upon using $1 million for his original basis and indicated a capital gain of $2 million resulting in additional tax of $746,984 plus a Section 6662(a) accuracy-related penalty of $149,397;
The Tax Court ruled with the IRS. Since the debt owed and ultimately paid by Mr. Moore was based upon the $1 million value, that is the value that must be used for the basis calculation. Mr. Moore had used a National Top 10 CPA firm and I believe the ultimate benefit is that the Tax Court ruled the $149,397 penalty did not apply, therefore, it was probably worth going to Tax Court to get this eliminated. Also, the Tax Court determined that both the Taxpayer and the IRS forgot to include the original $212,334 paid for the first 5% stock purchase.
The basis in property consists of cash and property "paid" to acquire the property (excluding inherited or gifted property). In this case, the taxpayer argued that the original debt amount should be the basis amount. However, it usually ultimately comes down to what is the actual out-of-pocket cash ultimately paid by the taxpayer will be the basis (other than S corporation adjustments) and in this case, he only paid $1 million plus $212,334.
Most likely the CPA kept track of the stock basis using the original amount paid for the stock and probably was not aware of the law suit that ultimately reduced the value down to a $1 million. If the taxpayer had timely given this information to the CPA, it is highly unlikely this ever would go to Tax Court.