8 Unfair 2011 Tax Decisions

 Sometimes the IRS and the Courts are wrong even when they are right.  The taxpayers in these cases might have had the law against them, but I still think they had right on their side.  I realize my sympathy is not worth anything to them, but they have it anyway as a Christmas present.  I decided to leave it at 8 so as not to be compulsive about lists of 10.

1.Wholly Screwed by Whole Life � John M. Sanders v. Commissioner, TC Memo 2010-279

Mr. Sanders took out a whole life policy in 1979.  He paid $31 per month for 27 years.  Over the years he borrowed against the policy. Total borrowing was $7,136.  New York Life informed him in 2006 that his debt on the policy including interest was $17,203 which was $517 more than the surrender value of the policy.  If he did not pay $517, the policy would terminate.  That is what happened.

He received a 1099-R from New York Life showing a distribution of $17,292.  The taxable amount was $7,175.  That is the gross distribution of $17,292 less premiums of $10,117.  Mr. Sanders did not understand:

The Tax Court had no sympathy:

So what happened ?  The mathematics that Mr. Sanders did in his head indicated that he received about $3,000 less than he put into the policy.  The problem was that the interest that accumulated on the loan was non-deductible while the dividends on the policy, accumulating at a much lower rate, were taxable income when �paid�.

2.  Even a Tax Attorney has Trouble Believing it - Bruce A. Brown, et ux. v. Com. TC Memo 2011-83

The Browns had basically the same story as Mr. Sanders except for larger numbers and the company being Northwestern.  The Browns are both attorneys and Mrs. Brown has an LLM in taxation.  They thought Northwestern analyzed the transaction incorrectly and ended up with an accuracy related penalty.

There were a couple of other cases like this.  My friend, Perry Smith, thinks it is a fair deal, but I think it stinks.  These policies were sold as a kind of one stop financial solution to all your problems.  If, God forbid, you die young your heirs get a pile of money. If, God willing, you live to an old age you have a pile of money.  And if you should have needs in between you can borrow something from the pile.  They did not explain that option 3 allows you to generate phantom income from a tax favored vehicle.

3. Being a Landlord is not a Passive Activity Except in the Tax Law � Todd D. Bailey, Jr., et ux. v. Commissioner, TC Summary Opinion 2011-22