Monthly Archives: January 2016

Court: No Pay for Employees Monitoring Electronic Devices during Lunch

A federal district court recently sided with an employer in a dispute regarding whether employees had to be compensated for on-call time, activities before and after their shifts, and work during lunch breaks.

Facts of the Case

In Brand v. Comcast Corp., a cable, entertainment and communications company in the state of Illinois employed line technicians to maintain its cable network infrastructure. A line technician is responsible for maintaining node health, repairing outages, signal testing and addressing other system issues for the network plant.

The Portal-to-Portal Act was passed by Congress in 1947. It eliminates from working time certain travel, walking time and other similar preliminary and postliminary activities performed prior or subsequent to the “workday” that aren’t made compensable by contract, custom, or practice. It should be noted that “preliminary” activities do not include “principal” activities.

—The U.S. Department of Labor

A group of employee line technicians alleged that the company violated federal and state wage laws by not compensating them for on-call time, pre-shift and post-shift activities, and for work they performed during lunch breaks.

On-Call Time

The employees were required to check for outage notices sent to their personal devices during lunch breaks. The employer provided line technicians with company vehicles that had to be used exclusively for business purposes.

The line technicians argued that they should be compensated for lunch breaks because:

  • They had to respond to pages quickly (within about five to 10 minutes).
  • They had a 30-minute time limit to report to work after responding pages.
  • They were required to stay with their company vehicles during on-call shifts, seriously restricting their ability to engage in personal activities.

A regulation from the Fair Labor Standards Act (FLSA) states that an employee who is required to remain on call on the employer’s premises, or stay so close that he or she can’t use the time effectively for his or her own purposes, is considered working while “on call.” An employee who isn’t required to remain on the employer’s premises but is merely required to leave word at his or her home or with company officials where he or she may be reached isn’t considered working while on call.

The U.S. District Court for the Northern District of Illinois ruled that the employees didn’t have to be paid for their on-call time. The court answered the question of “when is on-call time compensable?” by stating it isn’t based on whether employees are inconvenienced while conducting personal activities, but whether they can conduct personal activities while on call. The district court noted that other courts have found similar conditions to the ones that the line technicians were working under insufficient to prove that employees should be compensated for on-call time.

Also, in this case, there wasn’t evidence that the on-call time was spent predominantly for the benefit of the company. The employees only had travel restrictions during their one-week on-call shifts, which they rotated through approximately every six weeks.

The employer also had a rule that allowed for random drug and alcohol tests at any time. The district court said that other courts have routinely held that such a rule isn’t sufficiently restrictive to convert on-call time to work time.

Activities Before and After Shifts

The employees sought compensation for unrecorded time that they spent before and after their shifts doing the following tasks:

  • Logging into their computers,
  • Obtaining and reviewing assignments electronically,
  • Conducting vehicle inspections, and
  • Loading, unloading or securing equipment in and from their company vehicles.

The Portal-to Portal Act narrowed the scope of employer liability under the FLSA by excepting from coverage two activities that previously had been treated as compensable, including activities which are preliminary to or postliminary to the principal activity or activities. Although the Portal-to Portal Act didn’t define “principal activity,” the U.S. Supreme Court has interpreted the term to embrace “all activities which are an integral and indispensable part of the principal activities.”

In ruling that the employees shouldn’t be compensated for their pre-shift and post-shift activities, the district court said that the employees failed to explain why the tasks they identified here are qualitatively different than the kinds of pre- and post-shift tasks that many other courts have found to be incidental (rather than integral and indispensable) to the use of a company vehicle.

The employees also argued that they were entitled to compensation for performing these activities because the company has written employment policies which state that line technicians will be compensated for the activities. The district court refuted this argument because there was no evidence that Comcast had ever paid employees for these activities. In addition, the employees failed to produce any previous court rulings in which a court had held that a general employment policy alone was sufficient to establish a legally binding obligation to compensate for time that is otherwise not compensable.

Lunch Breaks

To survive summary judgment with respect to the lunch-break claims, the employees had to offer sufficient evidence from which a reasonable jury could conclude the company had “actual or constructive knowledge” that the employees were working through lunch without pay. The employees argued they were required to monitor work devices during their lunch breaks and this policy demonstrated that the company had actual knowledge that they were working through lunch without pay.

The employees didn’t survive summary judgment on this issue because they failed to provide sufficient evidence that the company required them to continually and actively monitor their devices while on break. There was testimony that some employees sometimes received outage notices via text, email, phone or radio during lunch, but the employees testified that if they received these messages, they suspended their lunch breaks and resumed them later, if possible.

One employee testified that no manager ever told him he had to watch his computer for communications during lunch and said that he does so because he has “nothing to do.” There have also been no previous court rulings that suggest monitoring a radio or similar device is a substantial job duty as long as the employee can still spend his lunch break primarily for his or her own benefit without persistent interruptions.

(Brand v. Comcast Corp., No. 12 CV 1122, 9/28/15)

If you are looking for assistance or guidance with business consulting or corporate transactions, call us at 214-696-1922 and ask for Mark Patten.

McKinnon Patten & Associates LLC is a top Dallas, TX CPA Firm that provides businesses with proven expertise in all areas of business planningbusiness accounting,  Family Office, and business taxes .

Repossessing Investment Property Sold in a Seller-Financed Deal

Let’s say you sold investment real estate in a seller-financed installment sale transaction. Later, you’re forced to repossess the property because the buyer fails to meet his payment obligations. What are the federal income tax consequences of the repossession? This article will provide the answer.

Repossession Tax Basics

Under Section 1038 of the Internal Revenue Code, repossessing investment real estate triggers a taxable gain if you’ve collected cash from the buyer (other than interest on the installment note) before the repossession occurs. Specifically, you must report the down payment and all interim installment note principal payments (meaning principal payments received before the repossession) as taxable gain — to the extent those payments exceed the amount of taxable gain you’ve already reported before the repossession.

This is a fair outcome, because you’re basically back where you started before the sale but with additional cash in hand from the down payment and/or installment note principal payments that were collected before the repossession.

Your repossession costs (attorney fees and so forth) are generally added to the tax basis of the repossessed property. So your post-repossession basis in the property will usually equal its basis at the time of the installment sale plus any repossession costs incurred to get the property back.

The amount of taxable gain reported before the repossession includes the total of:

  • Any ordinary income from depreciation recapture reported in the year of the installment sale;
  • Gain from the down payment (if any); and
  • Gain reported on the receipt of any interim installment note principal payments.

Important: Any interest collected on the installment note counts as ordinary income taxed at your regular rate. The taxable income from interest is in addition to the taxable repossession gain.

The Repossession Gain

The character of the repossession gain is the same as the character of the deferred gain from the installment sale. Therefore, the repossession gain will usually be a Section 1231 gain that is taxed at the same rate as a long-term capital gain.

Holding Period and Depreciation

Your holding period for the repossessed property includes your ownership period before the ill-fated seller-financed installment sale plus your ownership period after the repossession. It does not include the period that the buyer from whom the property was repossessed owned the property.

After you get it back, the repossessed property is depreciated as if it had never been sold. The IRS has not issued guidance explaining how repossessed MACRS property is supposed to be depreciated (MACRS is the current federal income tax depreciation regime, which has been in place since 1986). Presumably the post-repossession depreciation rules are analogous to the “old rules” for ACRS property (ACRS was the federal income tax depreciation regime before MACRS).

Under those “old rules,” post-repossession depreciation resumes using the remaining depreciation period and the applicable depreciation rate at the time of the ill-fated installment sale. Any basis in excess of the basis at the time of the installment sale (such as additional basis from repossession costs) is treated as the cost of a new asset and is depreciated under the current MACRS rules.

Requirements for Favorable Rules to Apply

The Section 1038 rules for calculating the repossession gain and the tax basis of the repossessed property are mandatory and they are taxpayer-friendly. However, the favorable Section 1038 rules only apply when all the conditions listed are met:

  • You must be the original seller of the repossessed property and the repossession must be undertaken to enforce your security rights in the property that you sold in the installment sale deal.
  • The installment note receivable must have been received by you as the seller in the original sale.
  • You cannot pay any consideration to the buyer to get the property back unless the reacquisition and payment of the additional consideration was provided for in the original sales contract or the buyer has defaulted or default is imminent.

What If the Section 1038 Rules Don’t Apply?

If all the preceding conditions are not met, you can’t use the taxpayer-friendly Section 1038 rules to calculate the taxable repossession gain and the post-repossession tax basis of the property. Instead the repossession gain (or loss) must be calculated using the “regular” tax rules (those that apply in the absence of the special Section 1038 rules).

Under the regular rules, the repossession gain (loss) equals the fair market value (FMV) of the property on the repossession date minus the basis of the installment note receivable at the time of the repossession minus any repossession costs (see the example below for how to figure the note’s basis). In many cases following the regular rules will result in a significantlylarger taxable repossession gain, which is why the Section 1038 rules are described as taxpayer-friendly. Finally, under the regular rules, the basis of the repossessed property equals its FMV on the repossession date.

Example: You sold a commercial building and underlying land on March 1, 2012 for $1.2 million. On that date, you received a $100,000 cash down payment and a $1.1 million installment note receivable that charged adequate interest according to IRS rules. The note called for annual principal payments of $40,000 to be paid for five years (2011-2015). On March 1, 2017, the remaining principal balance of $900,000 ($1.1 million minus $200,000 in principal payments) is scheduled to come due. (In other words, this was a balloon payment installment.)

You only received four $40,000 principal payments (in 2012 to 2015) before the buyer ran out of cash and stopped paying.

Assume your tax basis in the property at the time of the ill-fated seller-financed installment sale deal was $800,000. Therefore, your installment sale gross profit percentage was 33.333 percent ($400,000 gross profit/$1.2 million sale price). On December 1, 2016, you successfully repossess the property after incurring $24,000 in legal fees and related costs.

Your repossession gain and post-repossession basis in the property are calculated as follows:

Repossession Gain Calculation

Down payment ($100,000) and interim principal payments ($160,000) received: $260,000
Gain already reported ($260,000 times 33.333 percent) $ 86,667
Taxable repossession gain (line 1 minus line 2) $173,333

Repossessed Property Basis Calculation

Face value of installment note receivable on repossession date ($1.1 million minus $160,000 interim principal payments received) $940,000
Uncollected gross profit ($940,000 times 33.333 percent) $313,333
Adjusted basis of note (line 1 minus line 2) $626,667
Taxable repossession gain (see above calculation) $173,333
Repossession costs $ 24,000
Basis of repossessed property (line 3 plus line 4 plus line 5) $824,000

Bottom Line: After the repossession, you’re basically back in the same position as before the installment sale except:

1. You received $260,000 in cash from the down payment and the interim installment note principal payments (all of which you must report as taxable gain).

2. You incurred $24,000 in repossession costs (which are added to the basis of the repossessed property). You must report the $173,333 repossession gain on your 2016 tax return.


While the Section 1038 rules are fair, you might initially be surprised to discover that you have a taxable gain upon repossessing investment real estate after an ill-fated seller-financed installment sale deal. However, taxable repossession gains will often be larger in circumstances when the favorable Section 1038 rules do not apply. Consult with your attorney and tax adviser for details on the tax implications of real estate repossession transactions.


For assistance with residential, commercial and industrial property types call 214-696-1922 and ask for Mark Patten.
McKinnon Patten & Associates is a Dallas CPA firm that provides services for real estate industry companies. Our clients include real estate investors and real estate operators.

Be on “High Alert” for Scams from Those Claiming to be from the IRS

phone scamThe Treasury Inspector General for Tax Administration (TIGTA) urges taxpayers to be on “high alert” about IRS employee impersonators. According to TIGTA, since October 2013, thieves have stolen millions of dollars from taxpayers believing the fraudulent calls saying that they owed the government money and cash needed to be sent immediately.

The TIGTA states that they receive thousands of calls every month with reports of these robbery attempts. It is very important, especially during the upcoming tax season, to be aware of things to look for that should be a RED FLAG.

  1. The IRS virtually always contacts by mail, not by phone and NEVER cell phone.hang up
  2. Payment will not be asked for using a prepaid debit card, money order or wire transfer. They will not ask for a credit card over the phone.
  3. They may know the last four digits of your security number and may be able to make the caller ID look like it is coming from the IRS.


If you get a call from someone claiming to be from the IRS, hang up and call the IRS at 800-829-1040.


McKinnon Patten is a local Texas CPA Firm providing local businesses and individuals with tax and accounting services.

Business Valuation Approaches As Easy As 1, 2, 3…

How would you value a business? The three approaches appraisers use to value a business are essentially a matter of common sense. You start with the balance sheet and adjust the book values of assets and liabilities to their market values. Then you turn to the income statement and evaluate how much cash the business is expected to generate in the future. Finally, you investigate how much competitors have sold for in the past.

Official Definitions

The following definitions have been universally adopted by all of the major business valuation organizations in theInternational Glossary of Business Valuation Terms:

Asset approach. A general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities.

Income approach. A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount.

Market approach. A general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.

The International Glossary of Business Valuation Terms is a joint effort of the:

  • American Institute of Certified Public Accountants (AICPA),
  • American Society of Appraisers (ASA),
  • Canadian Institute of Chartered Business Valuators (CICVA),
  • National Association of Certified Valuation Analysts (NACVA), and
  • Institute of Business Appraisers (IBA).

If an expert belongs to any of these organizations, he or she should be familiar with its definitions. It’s also a useful reference to valuation end-users who need clarification of valuation jargon when reviewing a written appraisal report.

Although these techniques sound simple, do-it-yourself appraisals can generate misleading results. Each approach requires subtle nuances and fine-tuning, and each business requires a customized approach.

What’s in a Name?

In business valuation jargon, the three approaches are called:

1. The asset (or cost) approach;

2. The income approach; and

3. The market approach.

Several methods are categorizing within each broad approach. For example, the guideline public company method and the merger and acquisition method both fall under the market approach umbrella. The excess earnings method is generally considered a hybrid method that combines elements of the asset and income approaches.

When Assets Count

The asset approach starts with the balance sheet. Unreported assets (such as internally-developed intangible assets) and hidden liabilities (such as pending litigation or IRS audits) are identified. Then all the company’s assets and liabilities are adjusted to their current fair market values.

For some working capital accounts — such as accounts receivable or inventory — book value may be a reasonable proxy of fair market value. But other items — such as real estate or equipment — may require outside appraisals, especially if they were purchased decades earlier and fully depreciated. Assets are summed and liabilities are subtracted to arrive at the company’s net asset value.

This approach is most often used when valuing asset holding companies or when using the liquidation premise of value. It can also serve as a “floor” for a subject company’s value. If the income and market approaches generate results below the results of the asset approach, the appraiser may rely exclusively on the asset approach. In other words, no rational controlling owner would sell the company for less than its adjusted net asset value.

When Cash Is King

Now turn to the income statement and analyze how much cash the business, business interest or intangible asset will generate, including when it’s eventually sold. Under the income approach, future cash flows are converted to their net present value using a discount (or capitalization) rate commensurate with the investment’s risk.

Common methods under this approach include:

  • Capitalization of earnings method. Here, value is calculated by dividing a single period’s cash flows by a capitalization rate. This technique is most appropriate when a company’s (or investment’s) cash flow has stabilized, enabling the valuator to assume a constant growth rate.
  • Discounted cash flow method. Under this technique, the valuator discounts future cash flows over a discrete period of years and then adds to that a “terminal value,” which is also discounted to its present value. Discount rates represent the cost of capital, taking into account the time value of money and risk.

Although cash flows are the most common economic benefit used in the income approach, valuators can also use net income, pretax earnings or another income stream. Different discount rates apply to different income streams, however.

Although the income approach can be difficult to explain to laypeople, it’s widely used in financial markets. Increasingly, courts and the IRS are embracing this valuing approach, too.

What Will the Market Bear?

The IRS, the Financial Accounting Standards Board (FASB) and many courts favor the market approach for its perceived simplicity and objectivity. It’s based on the principle of substitution. That is, an investor will pay no more for an investment than it would cost to purchase a comparable substitute investment.

The merger and acquisition method derives value from controlling interests in similar publicly-traded or privately-held businesses (also known as guideline companies or comparables). Alternatively, value comes from similar publicly-traded stock prices in the guideline public company method.

Selection criteria — such as industry, size, financial performance and transaction date — are used to narrow down transaction databases into a meaningful sample of guideline transactions. Once the valuator selects a sample of similar transactions, he or she picks an income stream to use to develop pricing multiples. Common examples include price-to-earnings, price-to-operating cash flows and price-to-EBITDA (earnings before interest, taxes, depreciation and amortization).

Statistical analysis and graphs are sometimes used to demonstrate how closely the guideline transactions relate to one another. Valuators generally prefer samples with high correlation coefficients and low variances, for example. Finally, the most relevant pricing multiples are applied to the subject company’s income stream to determine its value.

Picking the “Right” Approach

Valuators consider all three approaches every time they value a business. But in the end, they may only use one or two methods to arrive at their final value conclusions. What’s most important is that the final value is supported by concrete evidence from the marketplace and any contradictory value indicators are reconciled against the valuator’s conclusion. The appraisal report should explain why an approach was either selected or not selected in determining the value of the subject business.

Keep Family Disputes from Sinking Family Finances

Intergenerational squabbles don’t just make for tense holidays. Failures of trust and communication can put family wealth into jeopardy.

Read more at institutional investor

Source: Keep Family Disputes from Sinking Family Finances

Rig Trends: 2015 – A Year to Forget for Rig Market

oilgasThis past year in the offshore rig market was one many would like to forget. Oil prices plummeted to below $40, and as a result, rig utilization declined throughout the year and day rates followed suit. Early contract terminations, particularly for floating rigs (semisubmersibles and drillships), have become more commonplace than at any other time in history, and delivery dates for rigs under construction continue to be delayed. Spending by oil companies fell by 20 percent in 2015 and a further 11 percent drop has been forecast for this year. However, as bad as 2015 may have seemed, indications are that 2016 could be just as bad or even worse – so forgetting about the past year may be easier than one would think. The following is a recap of some of the key numbers from 2015 and how those numbers might change this year. As of Dec. 30, 2015, the price for Brent crude oil was $36.46. Prices hit a high for 2015 at $64.56 May 31, 2015, representing a 43 percent drop by the end of the year. Even as of Oct. 31, prices stood at $48.12, meaning prices fell another $12 the final two months of 2015. Overall for the year, Brent crude averaged around $55. According to RigOutlook, which provides a three-year outlook of the offshore rig supply, demand and day rates, the price for a barrel of Brent crude should average around $45 in 2016, with the range running from $40 to as high as $55. Obviously, the oil market faces many uncertainties heading into 2016, including the pace and volume at which Iranian oil reenters the market, the strength (or weakness) of energy demand and the responsiveness of non-OPEC (Organization of the Petroleum Exporting Countries) production to low oil prices.
Turning to the rig market, the decline in rig utilization can be illustrated quite simply. In January 2015, worldwide jackup utilization stood at 75.1 percent, with 396 of 527 units under contract. By the end of December, it had dropped to 62.1 percent, a 13 percent decrease. For floating rigs, it was a similar story. In January 2015, 254 of 366 units were under contract for utilization at 69.3 percent. At the end of December, 201 of 359 floaters were contracted for utilization at 55.9 percent, a 14 percent decline. While some regions of the world will fare better than others, the uptick in early contract terminations, drilling project postponements and the number of operators not exercising options on existing contracts will very likely continue to drive utilization down in 2016. Looking at new construction, there were 33 rigs delivered in 2015, consisting of 11 drillships, 18 jackups and four semisubmersibles. As of Jan. 5, RigLogix showed there were 103 rigs (excluding four tender-assist units) scheduled to be delivered in 2016, made up of 76 jackups, 14 drillships and 13 semisubmersibles. However, it is doubtful all of these rigs will end up being delivered. There have already been 96 delivery dates extended and with market conditions expected to remain in place or deteriorate a bit further, rig owners will continue to postpone final rig payments (some are as much as 95 percent of the construction cost) as long as possible. In addition, some construction contracts will be cancelled, turning shipyards into sales agents as they try to dispose of unwanted rigs that are either completed or near finished. As for rig attrition, RigLogix shows there were 41 rigs removed from service in 2015, comprised of 15 jackups, 20 semisubmersibles and six drillships. Most of the 41 rigs were retired during the first-half of the year – 31 to be exact. The slow pace of attrition that occurred in the last six months of 2015 was unexpected, but we believe that as 2016 progresses the heightened pace of attrition will resume. When utilization falls, day rates are never far behind, and 2015 was no exception to that rule. According to RigLogix, the average day rate contract fixture for the jackup market in January 2015 was $122,167. By the end of the year, not only had the number of fixtures dropped, but so had the average to $98,016, a 20 percent decrease. For floating rigs, the decline was even more severe. In January, the average contract fixture averaged $392,417, but in December the number had fallen to $264,571, a 32.5 percent decline. It should be noted that these averages include numbers for all rigs, notwithstanding region or rig class. For this article, fleet averages were used only to illustrate the direction of the market. In some areas of the world, rates currently being signed for new jackup contracts are approaching operating costs, while in others significant rate reductions have taken place. However, on a positive note, some of those contract renegotiations have also resulted in additional contract term. For those jackups and floating rigs still earning the high day rates agreed to from a few years ago, it is likely just a matter of time before those are renegotiated down or in the most extreme cases contracts terminated. In summary, 2016 is likely to be a survival year for those companies that operate in the offshore rig arena. Oil prices, barring any political or other unforeseen events, will likely stabilize in a range that will not enable much spending by operators. Contract terminations will continue to strip rig owners of much needed revenue and rig attrition could reach record numbers. Utilization will continue its downward slide and day rates will follow, and new construction deliveries will be kept to as much of a minimum as is possible.
Source: RigZone

Love In The 21st Century: Bad Breakup Leads To Form 1099, Lawsuit

Source: Tony Nitti, a Forbes Contributor: view article on


As the town of Springfield’s resident oligarch, C. Montgomery Burns earned the ire of the townspeople through any number of misdeeds, including blocking out the sun, having the Rolling Stones killed, and stealing Christmas from 1981 through 1985.

But even the fictional Mr. Burns never sunk as low as his real-life namesake, who wound up in the Tax Court yesterday. That Mr. Burns, after bestowing nearly a million dollars worth of cash and cars on his girlfriend only to watch the union come to a quick and painful end, responded by issuing her a Form 1099.

Facts in Blagaich

Gather ’round, readers, and I’ll tell you a tale of a relationship built on the pillars of mutual trust and financial dependence that somehow went wildly astray.

Mr. Burns, then 71 years old, met Diane Blagaich, then 53, in 2009. Their relationship blossomed, but neither was determined to marry. Intent on solidifying their undying commitment to one another in a less formal but still legally binding manner, Burns and Blagaich entered into an agreement in 2010 whereby Burns would pay his girlfriend $400,000. In return, Blagaich would…accept the cash. Oh, and in addition, both Burns and Blagiach were required to “be faithful to each other and refrain from engaging in intimate or other romantic relations with any other individual.”

On top of the $400,000 he was contractually required to pay Blagaich, Mr. Burns handed another $273,000 and a $70,000 Corvette to his girlfriend in 2010. Early in 2011, however, Burns discovered that Blagaich had failed to live up to her obligation of fidelity by carrying on with another man throughout the duration of their relationship. In retaliation, Burns slapped a civil suit on Blagaich in 2011, and as one final kick-in-the-ass, filed a Form 1099 with the IRS stating that he had paid her income of nearly $750,000 in 2010. As you might imagine, however, Blagaich had reported no part of the amounts received as taxable income on her 2010 tax return.

The civil suit soon went to trial, and in late 2013 the state court found that Blagaich had fraudulently induced Mr. Burns to enter into the contract, and required her to repay the $400,000 she received pursuant to the agreement. The court further concluded that the remaining $273,000 of cash and the Corvette were gifts that Blagaich was entitled to keep.

IRS Responds

The IRS, having received a Form 1099 indicating that Blagaich had received income of nearly $775,000 in 2010, adjusted her tax return and assessed a tax deficiency and an accuracy related penalty.

Blagaich countered with two arguments. First, she maintained that the IRS was bound by the state court’s finding that $273,000 of the total payments were “gifts,” and were thus excludable from her taxable income under Section 102. The IRS countered by arguing that because  it was not a party to the civil suit, it was not required to adhere to the court’s findings. The Tax Court sided with the IRS, noting that the Service had no active, participatory role in the litigation. Thus, the matter of whether the $273,000 of cash and cars constituted income or a gift for federal tax purposes is a question that must be answered in a subsequent trial.

Next , Blagaich argued that her 2010 income should not include the $400,000 she was required to repay to Mr. Burns, because her requirement to repay the amount permitted her to invoke the principle of “rescission.’

As a cash basis taxpayer, Section 451 requires Blagaich to include in her gross income amounts received under the so-called “claim-of-right doctrine.” A taxpayer receives income under a claim-of-right whenever she “acquires earnings, lawfully or unlawfully, without the consensual recognition…of an obligation to repay.” Stated in English, if you receive cash that you’re not immediately obligated to repay, you’ve got income.

The doctrine of rescission represents a minor exception to the claim-of-right doctrine. It provides that a taxpayer doesn’t need to report an amount as income if their right to the income is rescinded and they either 1) make repayment or 2) recognize a liability to repay within the year of receipt.

If you’re particularly astute, you’ve already noticed the problem with Blagaich’s argument. She received the $400,000 in 2010. She maintained until 2013, however, that the cash represented a tax-free gift. There was no evidence to indicate that Blagaich had any obligation to repay the $400,000 at the end of 2010 — the year of receipt — and thus, the Tax Court concluded, the principle of rescission did not apply.

Thus, Blagaich was left with $400,000 of income in 2010, with the possibility of another $273,000 to be tacked on soon.


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