Wallis v. Commissioner

Donald Wallis (plaintiff) was a tax lawyer for 35 years and was a partner of law firm Holland & Knight (H&K). Pursuant to his H&K partnership agreement, Donald received 50 Schedule C units every year valued at $15,000 annually. The Schedule C units’ value was payable quarterly upon Donald’s departure from the firm under specified circumstances without regard to H&K’s income or Donald’s equity share. Donald withdrew from H&K in March 2003. In 2005, Donald received $80,000 from H&K for his Schedule C units. In connection with these payments, H&K provided Donald and the Internal Revenue Service (IRS) with an IRS Form 1099-MISC, which described the payments as nonemployee compensation. H&K deducted the payments from income in computing its 2005 taxes. By contrast, Donald and his wife, Kathryn (plaintiff), treated the payments as long-term capital gains rather than ordinary income on their 2005 joint tax return. The Wallises did not notify the IRS that they treated the payments differently from the way H&K treated them. The IRS asserted that the payments were guaranteed income that was taxable as ordinary income. The Wallises disputed the IRS’s position by suing the IRS commissioner (defendant) in the United States Tax Court. The Tax Court agreed with the commissioner, ruling that the Wallises had a tax deficiency for 2005 and were liable for an accuracy-related penalty pursuant to 26 U.S.C. § 6662. The Wallises appealed, arguing that they treated the payments properly because H&K made them in exchange for Donald’s interest in partnership property. The Wallises further argued that an accuracy-related penalty was improper pursuant to 26 U.S.C. § 6664 because they had good cause for their position and acted in good faith.