As tax professionals, we frequently encounter the intricacies of tax law, particularly when advising clients on refund claims. A recent case, Scott L. Shleifer and Elena Shleifer v. United States of America, heard in the United States District Court for the Southern District of Florida, offers crucial insights into the stringent requirements for substantiating deductions and the critical role of the variance doctrine in tax refund litigation. This article will detail the facts of the case, the taxpayers’ requests for relief, the court’s analysis of the applicable law, and its ultimate conclusions, providing valuable lessons for practitioners.

Case Overview and Factual Background

The case arose from a tax refund suit initiated by Mr. Scott L. and Mrs. Elena Shleifer, a married couple, seeking a $1,898,786 refund in income tax for the 2014 tax year. Mr. Shleifer, a partner at an investment firm, frequently traveled for business. To facilitate his travel, he was the sole owner of SLS Travel LLC ("SLS"), an entity established to hold his business travel assets, specifically a 37.5% undivided interest in a private jet purchased for $19,687,500. Notably, SLS was not operated to generate a profit. Despite his investment firm offering reimbursements for commercial airfare for business travel, Mr. Shleifer opted to use the private jet through SLS and personally bore the costs. In 2014, he flew 54.1 hours, with 31.1 hours attributed to business flights.

The Shleifers initially filed their 2014 Form 1040 jointly, including a Schedule E “Supplemental Income and Loss” to claim $2,625,979 in deductions for travel expenses as unreimbursed partnership expenses. They timely paid the tax due on this original return.

In October 2018, the Plaintiffs filed an amended return (Form 1040X) for the 2014 tax year, seeking the $1,898,785 refund. The basis for this amended return was that they had "inadvertently neglected to claim a depreciation deduction for a business asset purchased and placed in service in 2014". The amended return included a Form 4562, reporting a total depreciation deduction of $5,917,589 related to the private jet. This amount comprised both ordinary depreciation under 26 U.S.C. §§ 167(a)(1) and 168(a), and a "bonus depreciation deduction" under § 168(k)(1)(A), which provided for a special allowance of 50% of the adjusted basis for qualified property. The parties did not dispute the accuracy of this depreciation calculation. Crucially, the Plaintiffs reported this depreciation deduction on a Schedule C “Profit or Loss From Business,” stating that SLS had zero gross profits and income. This deduction, if allowed, would have reduced their 2014 tax liability by $1,898,785.

In July 2020, the IRS selected the amended return for examination. The IRS requested documents from the Shleifers’ accountant, John Ablamsky, to substantiate the claimed Schedule C deduction. Ultimately, the IRS determined that the Plaintiffs failed to substantiate their entitlement to the reported business loss and resulting refund through the Schedule C, proposing disallowance on March 23, 2022.

Following this, on April 26, 2022, Mr. Ablamsky spoke with the examining IRS agent. During this conversation, he orally advised the agent that the depreciation deduction had been reported as an unreimbursed partnership expense in 2015 and subsequent tax years. He also explained that the deduction should have been reported on a Schedule E in the amended return, not a Schedule C. The amount of the depreciation deduction would have been the same whether reported on a Schedule E or C. The IRS agent even noted in his activity record that the "Depreciation Expense is an investment expense that can be deducted against Flow-thru income on Sch. E" and acknowledged in his written report that the deduction might have been valid on a Schedule E. However, neither Mr. Ablamsky nor the Plaintiffs submitted any written request or documentation to substantiate or initiate an examination for a Schedule E deduction. Due to the lack of a formal response, the IRS issued a Notice of Disallowance on July 6, 2022, denying the refund claim, leading the Plaintiffs to initiate the lawsuit.

Taxpayer’s Request for Relief

The Plaintiffs moved for summary judgment, arguing they should be awarded the $1,898,785 refund because the depreciation deduction should have been allowed as an unreimbursed partnership expense. They asserted that the depreciation deduction for the private jet, though incorrectly claimed on Schedule C, met the substantive requirements for depreciation under the law.

In response, the United States also moved for summary judgment, contending that the Plaintiffs were entitled to neither the deduction as a trade or business loss (Schedule C) nor as an unreimbursed partnership expense (Schedule E). Furthermore, even if the latter deduction were valid, the variance doctrine precluded the Court from considering that argument.

Court’s Legal Analysis and Application

The Court first confirmed its jurisdiction over the case, noting that the Plaintiffs had met the procedural requirements by timely filing a claim for refund with the IRS and initiating the suit within the statutory period. It then proceeded to analyze the merits of the arguments presented by both parties.

Legal Standard for Summary Judgment and Tax Refund Suits

The Court reiterated that summary judgment is appropriate when there is no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. A critical point in tax refund suits is that the taxpayer bears the burden of proof to establish that the IRS’s determination is incorrect. Income tax deductions are viewed as "matters of legislative grace," meaning taxpayers must strictly comply with the specific requirements for any deductions claimed. When reviewing a summary judgment motion, the court must view all evidence in the light most favorable to the non-moving party.

Disallowance of Schedule C Deduction

The Court first addressed the Plaintiffs’ original claim for a depreciation deduction as a loss from a trade or business on Schedule C. A Schedule C is appropriate for reporting trade or business income and expenses. Depreciation under 26 U.S.C. § 167(a)(1) can be claimed for property used in a trade or business. However, the foundational requirement for such a deduction is that the "primary purpose for engaging in the activity must be for income or profit" [23, citing Lockett v. Comm’r].

Applying this to the facts, the Court highlighted that the Plaintiffs admitted SLS was not operated to generate a profit in 2014. SLS did not pay wages, offer travel services to the public, or have any operating costs other than the depreciation loss for the private jet. No gross receipts or sales were attached to the Schedule C to substantiate a business loss. Given these undisputed facts, the Court concluded that SLS was not operated with the primary purpose of generating income or profit. Consequently, the Plaintiffs were not entitled to the deduction as a business loss as originally sought through the Schedule C in their amended tax return.

Preclusion by the Variance Doctrine

The core of the Court’s decision centered on the variance doctrine, which precluded consideration of the Plaintiffs’ argument that the depreciation deduction should be allowed as an unreimbursed partnership expense on Schedule E.

The variance doctrine is designed to "afford the IRS an opportunity to consider and dispose of a claim without the time and expense of litigation" [30, citing Hawco Equities, Inc. v. United States]. Under 26 U.S.C. § 7422(a) and Treasury Regulation § 301.6402-2(b)(1), a taxpayer’s refund claim must "set forth in detail each ground upon which a credit or refund is claimed and facts sufficient to apprise the Commissioner of the exact basis thereof". This requirement ensures the IRS is fully informed of the basis for the refund claim, allowing it to investigate adequately. Subsequent litigation is strictly limited to the grounds "fairly contained within the refund claim," and federal courts lack jurisdiction to entertain allegations that "impermissibly vary or augment" these original grounds [29, citing Charter Co v. United States]. While "crystal clarity and exact precision are not demanded," the taxpayer must, at minimum, identify the "essential requirements" of each refund demand [32, citing Charter]. The central inquiry is whether the claim presented to the court was "previously submitted to the [IRS] in a manner that enabled an intelligent administrative review of the claim" [33, citing Perkins v. United States].

The Court found that the Plaintiffs’ original amended return for 2014 specifically limited their claim to a depreciation deduction for a business loss via Schedule C. The explanation on their Form 1040X explicitly stated they "inadvertently neglected to claim a depreciation deduction for a business asset" and only reported the $5,917,589 depreciation on Schedule C. Although they included a Schedule E with their amended return (as they did with their original return), they did not propose deducting the private jet’s depreciation as an unreimbursed partnership expense on it. This omission, particularly while other unreimbursed partnership expenses were explicitly included on Schedule E, would have actively diverted the agent’s attention from that possibility.

The Court emphasized that Mr. Ablamsky’s oral representation to the IRS agent – made after the initial disallowance – that the deduction had been taken on Schedule E in subsequent years and should have been on Schedule E for 2014, was insufficient to overcome the variance doctrine. The Plaintiffs provided no written documentation or formal claim to substantiate this new ground.

The Plaintiffs argued that the claim should not be precluded because it involved the same tax year, asset, depreciation calculation, and resulted in the same overpayment. However, the Court firmly rejected this argument, citing precedent that "the government is not required to be so prescient" and that merely notifying the IRS of a desired deduction is insufficient; the "essential requirements" must be identified [37, 38, citing Charter and Sanders v. United States]. The IRS "is not required to act as a detective and to search for clues as to whether the plaintiff might desire tax refunds" [44, citing VDO-ARGO Instruments, Inc. v. United States]. Information "somewhere in its possession" or claims for other years are insufficient to establish proper notice for a claim for the year in question [44, 45, citing Gustin v. United States].

To claim an unreimbursed partnership expense, a taxpayer must prove that the partner was required to pay specific partnership expenses from their own funds under a partnership agreement [40, 41, citing McLacuchlan v. Comm’r]. This would have required the IRS agent to examine Mr. Shleifer’s investment firm, his role, and the firm’s policies regarding partnership expenses and reimbursements. The Plaintiffs admitted that some of this essential information was not documented, requiring "more in-depth examination by the IRS". The Court found that since none of the essential elements for an unreimbursed partnership expense were alleged or substantiated during the administrative process, the examining agent could not have been put on notice. This "failure to allege precisely the basis of [their] [refund] claim [] resulted in [the] dispute . . . arising for the first time in this lawsuit" [42, citing Sanders]. Allowing jurisdiction would "frustrate one of the purposes of the Treasury Regulation—allowing the IRS to resolve disputes in the first instance without litigation".

Finally, the Court specifically stated that oral claims, even if they give actual notice to an IRS employee, are generally not valid [52, citing Vintilla v. United States]. There "must . . . be some written component to the informal claim" [53, citing Cencast Services, L.P. v. United States]. The Plaintiffs’ oral communications, though they highlighted the issue, were not sufficient to satisfy the detailed written requirements of the Treasury Regulations.

Conclusion

The Court concluded that the Plaintiffs’ original amended return and their subsequent administrative process failed to "enable an intelligent administrative review of the claim" by the IRS [54, citing Perkins]. They did not meet the Treasury Regulation’s requirement to "state the exact basis of [their] claim so that the [IRS] was not left to [its] own devices in order to discover the precise nature of [their] . . . claim" [55, citing Sanders].

Although the outcome was "costly and the result is harsh," the Court explicitly stated it lacked jurisdiction to adjudicate the substantive requirements for a Schedule E deduction that the Plaintiffs advanced belatedly. To do so would have frustrated the very purpose of the variance doctrine, which is to allow the IRS the opportunity to resolve disputes administratively before litigation.

Therefore, the Defendant’s Motion for Summary Judgment was GRANTED, and the Plaintiffs’ Motion for Summary Judgment was DENIED. This case serves as a stark reminder of the paramount importance of accurately and comprehensively asserting all grounds for a tax refund claim, in writing, during the administrative process, to avoid jurisdictional preclusion in subsequent litigation. Tax professionals must ensure that refund claims precisely detail the legal basis and supporting facts to facilitate proper IRS review and preserve all potential avenues for relief.

Prepared with assistance from NotebookLM.