                               T.C. Memo. 2015-49



                         UNITED STATES TAX COURT



             YIGAL ELBAZ AND BONNIE ELBAZ, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 24093-12.                          Filed March 17, 2015.



      Zack Kuperwaser, for petitioners.

      Diana P. Hinton, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      COLVIN, Judge: Respondent determined the following deficiencies and

accuracy-related penalties with respect to petitioners’ Federal income tax for

taxable years 2007 and 2008:
                                       -2-

             [*2]                                                Penalty
             Year                   Deficiency                 sec. 6662(a)
             2007                     $1,318                       $264
             2008                     19,268                       3,854

      After concessions,1 the sole issue for decision is whether $54,507

petitioners received in 2008 from a refund of State income tax is taxable income.

We hold that it is.2

                              FINDINGS OF FACT

      Petitioners resided in Hewlett, New York, when they filed the petition in

this case.

A.    Qualified Empire Zone Enterprise Credit (QEZE)

      The State of New York provides tax benefits to businesses that invest in

certain designated areas of the State. One of these benefits is the Qualified Empire

Zone Enterprise credit for real property taxes (QEZE real property tax credit). The

QEZE real property tax credit is provided to businesses that qualify as a Qualified


      1
        Petitioners concede the $1,318 deficiency and $264 accuracy-related
penalty for tax year 2007. We have rounded monetary amounts to the nearest
dollar. Unless otherwise indicated, section references are to the Internal Revenue
Code in effect for the year in issue.
      2
       Petitioners concede that if the Court holds that the $54,507 New York State
overpayment is includable in their Federal taxable income, then they are liable for
the accuracy-related penalty.
                                          -3-

[*3] Empire Zone Enterprise (QEZE) for taxes paid on real property in an Empire

Zone. See N.Y. Tax Law sec. 15 (McKinney 2014 & Supp. 2015). A business

must submit an application in order to become a QEZE. A business may become

eligible to claim various targeted tax credits if its application is accepted, it

operates within a designated area, and it meets certain annual employment

requirements. Id. subsecs. (a) and (b).

       If a business qualified as a QEZE before April 1, 2005, the amount of the

credit equals the product, or pro rata share of the product, of (1) the benefit period

factor, (2) the employment increase factor, and (3) the eligible real property taxes

paid or incurred by the QEZE during the taxable year. Id. subsec. (b). The income

tax credit may not exceed the amount of real property taxes paid. See id. subsecs.

(b), (e).

       A taxpayer that is a sole proprietor of a QEZE, a shareholder of a New York

S corporation that is a QEZE, or a partner in a partnership that is a QEZE is

entitled to the credit. Id. subsec. (a); Maines v. Commissioner, 144 T.C. ___, ____

(slip op. at 4) (Mar. 11, 2015). Each shareholder or partner is allocated his or her

pro rata share of the entity’s QEZE credit. It is creditable against New York

income tax and refundable to the extent that it exceeds the taxpayer’s income tax

liability.
                                          -4-

[*4] B.      Petitioners’ Interest in the Entities

      Petitioner Yigal Elbaz (petitioner) holds 50% interests in the following three

entities (hereinafter referred to collectively as the entities): (1) Superflex, Ltd., an

S corporation, (2) Superflex Management, LLC, a limited liability company

treated as a partnership for Federal income tax purposes, and (3) Superflex Realty,

LLC, which is also a limited liability company treated as a partnership for Federal

income tax purposes. On June 6, 1995, New York State provided a Certificate of

Eligibility for the QEZE credit to Superflex, Ltd. On July 31, 2001, New York

State provided a Certificate of Eligibility for the QEZE credit to both Superflex

Management, LLC, and Superflex Realty, LLC.

      Superflex, Ltd., paid New York State property tax of $28,053 in 2007,

which it subsequently deducted on its 2007 Form 1120S, U.S. Income Tax Return

for an S Corporation. Superflex Management, LLC, deducted $65,039 on its 2007

Form 1065, U.S. Return of Partnership Income, at least $59,375 of which was

property tax paid to the State of New York. Superflex Realty, LLC, deducted

$62,691 on its 2007 Form 1065, at least $42,888 of which was property tax paid to

the State of New York. For 2007 and 2008 petitioners jointly filed Forms 1040,

U.S. Individual Income Tax Return. They also jointly filed Forms IT-201, New

York State Resident Income Tax Return, for taxable years 2007 and 2008.
                                        -5-

[*5] As a 50% shareholder in Superflex, Ltd., and a member with a 50% interest

in both Superflex Management, LLC, and Superflex Realty, LLC, petitioner

submitted Schedules K-1, Shareholder’s Share of Income, Deductions, Credits,

etc. for 2007. The deduction of real estate taxes by the entities reduced the

amount of income that petitioners reported on their 2007 Schedule K-1 (Form

1065).

C.    Petitioners’ 2007 Tax Return

      On Schedule A, Itemized Deductions, of their 2007 Form 1040, petitioners

deducted State and local income taxes of $122,742. On their 2007 Form IT-201

petitioners claimed credits and payments totaling $155,684, which consisted of (1)

$54,507, the pro rata share of their QEZE refunded credits, (2) $52,017 of New

York State withholding tax, and (3) $49,160 of estimated tax payments. The

QEZE credit of $54,507 derives from petitioner’s ownership interests in Superflex,

Ltd., Superflex Management, LLC, and Superflex Realty, LLC. The amounts of

income petitioners reported from each are as follows: $3,375 from Superflex,

Ltd., $29,688 from Superflex Management, LLC, and $21,444 from Superflex

Realty, LLC.

      For 2007 petitioners owed New York State tax of $92,076. Petitioners

claimed an overpayment of $63,608. This amount is the difference between
                                          -6-

[*6] (1) the payments totaling $155,684, which consisted of (a) petitioners’ pro

rata share of their QEZE refunded credits, (b) their New York State withholding

tax, and (c) their estimated payments, and (2) petitioners’ New York State tax

owed totaling $92,076. On their 2007 Form IT-201 petitioners applied this

overpayment to their 2008 estimated tax.

D.    Petitioners’ 2008 Tax Return

      On Schedule A of their 2008 Form 1040 petitioners deducted State and

local income taxes of $93,635. Of that amount, $63,608 is attributable to the

overpayment petitioners claimed for 2007, which includes the $54,507 of QEZE

credits petitioners received as a result of petitioner’s interests in the entities. In

2008 the State of New York issued a Form 1099-G, Statement for Recipients of

State Income Tax Refunds, to petitioners for tax year 2007 reporting the payment

of $9,101. Petitioners reported this amount as income received on their Form

1040. Petitioners did not report as income the remaining $54,507, which consisted

of the QEZE refunded credits.

                                       OPINION

      The issue for decision is whether $54,507 petitioners received as a refund of

State income tax is taxable income for 2008.
                                        -7-

[*7] A.      State Tax Deductions and the Tax Benefit Rule

      1. State Tax Deductions

      A taxpayer may deduct certain taxes paid or accrued during the taxable year,

including income, real property, and personal property taxes imposed by local,

State, and foreign governments. Sec. 164(a). A taxpayer who itemizes his or her

deductions must include State income tax refunds in income for the year received

if the taxpayer deducted State income tax payments made in the preceding year.

Maines v. Commissioner, 144 T.C. at ___ (slip op. at 12). State tax refunds,

however, are not income unless the taxpayer deducted them for the previous year.

See id. at ___ (slip op. at 13) (citing Tempel v. Commissioner, 136 T.C. 341, 351

n.19 (2011), aff’d sub nom. Esgar Corp. v. Commissioner, 744 F.3d 648 (10th Cir.

2014).

      2. Tax Benefit Rule

      The tax benefit rule eliminates some of the inequities that would otherwise

result from the annual accounting system used for Federal income tax. See

Hillsboro Nat’l Bank v. Commissioner, 460 U.S. 370, 377 (1983). An item is

excluded from income if inclusion would be fundamentally inconsistent with the

taxpayer’s treatment of the item for the prior tax year. Id. at 383-384; Maines v.

Commissioner, 144 T.C. at ___ (slip op. at 11-12). Generally, under section
                                         -8-

[*8] 111(a), if a taxpayer deducted a tax on a prior year’s return that resulted in a

tax benefit, the taxpayer’s subsequent recovery of the tax is included in gross

income for the year in which the taxpayer receives it. Kadunc v. Commissioner,

T.C. Memo. 1992-61, aff’d without published opinion, 981 F.2d 1251 (4th Cir.

1992).

B.    Petitioners’ Arguments

      1. Chief Counsel Advice 200842002

      Petitioners rely on IRS Chief Counsel Advice 200842002. However, a

“written determination” of the Commissioner may not be used or cited as

precedent, sec. 6110(k)(3), and written determinations are defined to include Chief

Counsel advice, sec. 6110(b)(1)(A); see also Ellison v. Commissioner, T.C.

Memo. 2004-57, slip op. at 18 (“Parties are statutorily proscribed from citing chief

counsel advice as precedent.”). Thus, we may not use or cite as precedent IRS

Chief Counsel Advice 200842002 in deciding this case.

      2. Nature of the QEZE Credit

      Petitioners point out that they did not deduct New York State real property

taxes for 2007 on their Form 1040; that is, the entities that paid the real property

taxes in 2007 deducted these taxes on their Federal returns. Petitioners argue that

because the entities, not petitioners, deducted the real property taxes, petitioners
                                         -9-

[*9] received no Federal income tax benefit from the New York State real property

taxes paid.

      Petitioners’ QEZE credit was based on the real property taxes the entities

paid. In Maines, as here, the property tax was paid and deducted at the entity

level, which led to decreased income that was passed through to the taxpayers, and

which led to decreased tax liability. Maines v. Commissioner, 144 T.C. at ___

(slip op. at 27). The decreased tax liability is a benefit, and receiving an untaxed

cash refund of the previously deducted taxes would be fundamentally inconsistent

with the previous treatment to the extent the taxpayer benefited from the decreased

passthrough income. Id. The tax benefit rule applies whether or not the taxpayer

personally claimed the earlier deduction if the taxpayer’s tax-free receipt of the

QEZE credit is fundamentally inconsistent with the earlier tax treatment. Id.

C.    Conclusion

      Though the entities deducted the real property taxes, petitioners calculated

their proportionate share of the entities’ net real estate income on their Schedule

K-1. The entities’ deduction of real property taxes led to a lower amount of

income reported on petitioners’ Schedule K-1. This lower amount of income

petitioners reported resulted in reduced tax liability for 2007, which is a benefit to

petitioners. The receipt of a refund of this previously deducted tax is
                                       - 10 -

[*10] fundamentally inconsistent with the previous treatment to the extent

petitioners benefited from the decreased passthrough income. Thus, we conclude

that the $54,507 petitioners received in 2008 from a refund of State income tax is

taxable income.

      To reflect the foregoing,


                                                Decision will be entered for

                                      respondent.
