Heiress Seeking $7.5 Million in Tax Deductions : Courts: Joan Irvine Smith is challenging IRS’ rejection of business-related claims. She is also seeking $601,280 in additional write-offs.

Less than two years after ending her marathon financial battle with Irvine Co. owner Donald Bren, heiress Joan Irvine Smith is involved in a new high-stakes dispute with another formidable foe: the Internal Revenue Service.

In a petition filed in U.S. Tax Court earlier this year, Smith is challenging an IRS ruling that she is not entitled to about $7.5 million in business deductions she claimed on returns for the years 1980 through 1987.

Smith could not be reached for comment Tuesday, and her attorney, William T. Sherwood Jr., of Arlington, Va., declined to comment.

The period in question covers a portion of the time Smith has been co-owner with her former husband, trainer Morton (Cappy) Smith, of a horse breeding operation in Middleburg, Va., a wealthy rural enclave in Virginia about 12 miles west of Dulles International Airport. Her neighbors, for a time, included actress Elizabeth Taylor and her ex-husband, U.S. Sen. John W. Warner (R-Va.)

According to Smith’s petition, the IRS issued a notice of deficiency on Nov. 6, 1991, asserting that she was not entitled to $2.5 million in farm losses and $5 million in miscellaneous business-related deductions she claimed for the years 1980 through 1987.

The petition also says that Smith should be allowed to deduct an additional $601,280 for business expenses incurred in 1985 and 1986 that she had not previously claimed.

The IRS notice, according to Sherwood’s petition, says Smith was not entitled to the farm loss and miscellaneous business deductions because she was not, in fact, operating the farm for the purpose of making a profit.

Her attorney, however, claims in the petition that Smith was running the farm as a legitimate business “including raising, showing, breeding, training, racing and selling horses in an activity entered into for profit.”

Since 1985, Smith--now a Laguna Beach resident--has also owned a 22-acre equestrian center and training facility, the Oaks, in San Juan Capistrano.

Smith told The Times in a 1987 interview that she had not left California since 1977, not even to visit her Virginia farm, because of the demands of her efforts to influence operations at the Irvine Co., which owns the huge Irvine Ranch land holdings assembled in the late 1800s by her great-grandfather, James Irvine.

Bren acquired controlling interest of the Irvine Co. in 1983 for a reported $500 million and agreed shortly after to acquire the 11% stake in the company held by Smith and her mother, Athalie Clarke.

But in a lengthy legal battle that began that same year, Smith claimed that Bren grossly undervalued the huge Irvine Co. holdings in computing the value of her shares. She claimed that her family’s stake was worth $330 million. Bren put the price at $114 million.

In June, 1990, a court referee in Michigan--where the Irvine Co. is incorporated--ordered Bren to pay Smith and Clarke $149 million. When interest was added, Smith and her mother collected a total of $255.8 million, which was paid to them last June.

It appears that the IRS wants at least $2.5 million of Smith’s money for back taxes and penalties on the deductions denied by the agency.

According to Smith’s appeal, the IRS maintains that, through “negligence or intentional disregard for the rules and regulations,” she underpaid her federal income taxes annually from 1982 through 1987.

But Smith’s petition says the IRS erred in finding that she under-paid by deducting “non-tax shelter items for which there is no substantial authority, or which are not adequately disclosed in the returns or in a statement attached to the returns.”

Sherwood, however, does not supply any such statement or disclosure in his petition, maintaining that all appropriate records have been made available to the IRS.

Joan Irvine Smith and the IRS

The heiress is challenging an IRS denial of more than $8 million in business deductions from 1982 through 1987, including farm losses and miscellaneous losses and operating expenses.

Miscellaneous Additional Year Farm Losses Deductions* Expenses 1982 $ 75,637 N/A -- 1983 528,740 N/A -- 1984 373,309 N/A -- 1985 328,915 N/A 362,920 1986 216,088 N/A 238,360 1987 1,014,244 N/A -- Total 2,536,933 $5,050,791 601,280

Total disallowed deductions: $8,189,004

* Miscellaneous dedictions were not itemized

Source: Court petition

Researched by DALLAS M. JACKSON / Los Angeles Times