Beyoncé Tries to Turn Lemons Into Lemonade in Tax Court

By: Kristen A. Parillo

A Tax Court petition filed by pop icon Beyoncé was in sync with her elusive persona, giving up few details on her challenge of an IRS deficiency notice asserting that she owes $2.7 million in tax and penalties.

The petition, filed April 17 with the Tax Court, disputes the IRS’s disallowance of various business expense deductions claimed by Beyoncé on her personal tax returns for tax years 2018 and 2019. The filing in Knowles-Carter v. Commissioner was first reported by Law360.

According to the deficiency notice attached to the petition, for the 2018 return the IRS:

• added $1,499 in royalty income that Beyoncé failed to report on Schedule E, “Supplemental Income and Loss”;
• disallowed $761,455 in other expenses reported on Schedule C, “Profit or Loss From Business”;
• disallowed $473,738 in legal and professional services reported on Schedule C;
• disallowed a $868,766 deduction attributable to a charitable contribution carryover; and
• disallowed a qualified business income deduction of $3,581.

For the 2019 return, the IRS:

• disallowed $9,801 in other expenses reported on Schedule E;
• disallowed $11,948 in utility expenses reported on Schedule E;
• disallowed $54,610 in taxes reported on Schedule E;
• disallowed $24,691 in management fees reported on Schedule E;
• disallowed $33,301 in insurance expenses reported on Schedule E;
• disallowed $75,677 in depreciation expense reported on Schedule E;
• disallowed $3,326,103 in depreciation expense reported on Schedule E; and
• disallowed a qualified business income deduction of $14.

The expenses were generally disallowed because of a failure to substantiate, according to an explanation of items included with the notice.

The IRS asserts that Beyoncé has tax deficiencies of $805,850 for 2018 and $1,442,747 for 2019 and is liable for section 6662(a) substantial understatement penalties of $161,700 for 2018 and $288,549 for 2019.

Light on Details

Tax Court petitions typically don’t provide a high level of detail, but even under that standard Beyoncé’s filing seems unusually terse.

The paragraph identifying the IRS’s alleged erroneous determinations simply states for each disputed item that “Respondent erred in determining that” the deduction should be disallowed. Likewise, the paragraph outlining the facts on which Beyoncé is relying to support her assignment of errors says that “Petitioner properly reported” each disputed item.

Given the lengths to which Beyoncé has gone to maintain tight control of her image and to keep her personal life out of the spotlight, it’s unsurprising that the petition provides a minimal amount of information. But attorneys who represent celebrities in Tax Court have to strike the right balance between protecting their clients’ privacy and providing enough information to satisfy the petition content requirements in Tax Court Rule 34(b)(1). That rule requires “clear and concise assignments of each and every error” that the petitioner alleges the IRS made in determining a deficiency or liability, as well as “clear and concise statements of the facts on which the petitioner relies to establish the errors alleged in the petition.”

Whether Beyoncé’s petition meets that standard could be an open question.

“Technically the IRS could potentially insist on more detailed factual allegations, but the spirit of federal court pleading is ‘notice’ pleading, and it’s hard to see how the IRS is prejudiced here,” Steven Toscher of Hochman Salkin Toscher Perez PC told Tax Notes.

“You combine that with the legitimate concern for privacy, and it would be a waste of everybody’s time to make an issue of this,” Toscher continued. “The Tax Court requires a full exchange of information under its Branerton rules, and that is the better approach if the IRS actually needs further detail they do not already have.”

Speculation

As for what Beyoncé and the IRS are fighting about, the petition and deficiency notice provide only a few nuggets.

Justin Miller, national director of wealth planning at Evercore Wealth Management, said the disallowance of $761,455 in “other expenses” reported on Schedule C caught his attention. The deficiency notice said that Beyoncé didn’t establish that the expenses were paid or incurred during the tax year and that they were necessary and ordinary to her business.

The potential overlap between business and personal expenses is an especially thorny question in the entertainment industry, Miller said. Whether clothing or other attire, hair and makeup services, and even plastic surgery can be deductible business expenses becomes a question of fact, he said.

“Everybody’s trade or business is different, so what is ordinary and necessary for a worldwide entertainer?” Miller said.

The dispute over the charitable deduction is also interesting, Miller said, noting that the substantiation rules are strict and the entire deduction amount could be disallowed if either the contemporaneous written acknowledgment or qualified appraisal was done incorrectly.

“It’s an important reminder that when you make a charitable contribution, you’ve got to get it right upfront because you can’t go back and remedy mistakes after the fact,” Miller said.

It’s possible that Beyoncé’s attorney drafted the petition with few details because they intend to settle with the IRS, Miller said. “This might’ve been a strategic decision to show they’re serious. I’m just surprised it’s gotten this far and has gone to Tax Court.”

Miller noted that taxpayers and their representatives speak with many other individuals within the line of management at the IRS before resorting to litigation. “Typically, even if there’s a problem at the initial audit level, there are a lot of processes and procedures you will go through before filing that Tax Court petition,” he said. “So it is surprising that they weren’t able to resolve the issues.”

The petitioner in Knowles-Carter v. Commissioner, Dkt. No. 5695-23, is represented by Michael C. Cohen of De Castro, West, Chodorow, Mendler & Glickfeld Inc.