Leslie Book

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Counsel Clarifies the Limited Rights of Unenrolled Preparers in Tax Court Cases

Taxpayers who have filed a petition in Tax Court often still rely on their tax return preparers to help try to resolve the matter. Most unlicensed tax return preparers are not admitted to practice before IRS Counsel attorneys. Despite that, in a 2014 Chief Counsel notice the IRS emphasized that Counsel attorneys should interact with a taxpayer’s representative if there is a valid POA on file authorizing the representative to act on the taxpayer’s behalf.

Last week, in  Notice CC-2017-007 Counsel clarified its earlier procedure and discussed issues relating to a representative who is an “Unenrolled Return Preparer.”

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As we have discussed before, following the judicial rejection of the Service’s plan to require unlicensed preparers to pass a test and complete continuing education requirements, the Service launched a voluntary testing and education program called the Annual Filing Season Program (see for example Some More Updates on IRS Annual Filing Season Program and Refundable Credit Errors). Under that program, unlicensed preparers take 18 hours of continuing education and take a test on federal tax law. The return preparer seeking to obtain certification of compliance with the annal filing season program must also renew their preparer tax identification number (PTIN) and consent to adhere to and be subject to the obligations in Circular 230 addressing duties and restrictions to practice before the Service and Circular 230 § 10.51, which addresses sanctions and disreputable conduct. The benefits of opting in to the Annual Filing Season Program include becoming part of a searchable database of preparers and the right to represent taxpayers in examinations, though not before Appeals, Counsel or Collection.

That representation ability is a key perk for unenrolled preparers; it generally was available to all signing preparers before 2015 though by now limiting representation to the unenrolled preparers who comply with the Annual Filing Season Program, the Service has hoped to generate interest in and demand for what it required through its ill-fated mandatory testing and education regime.

Form 2848 specifically now has a designation for the class of unenrolled preparers who opt in to the Annual Filing Season Program; designation “h”, which is for “Unenrolled Return Preparer.”

Last week’s Chief Counsel notice discussed the limits of these representational rights for Unenrolled Return Preparers. Most importantly, representation is still limited to matters involving examination of a tax return. A challenge for the Service is drawing the line between assistance in an exam matter and in a matter that progresses beyond an exam because the taxpayer, often with shadow assistance by an unlicensed preparer, has filed a petition in Tax Court. Despite the limits of the representational powers of unenrolled return preparers, in the current Chief Counsel Notice the Service clarified that “if the involvement of an unenrolled return preparer is beneficial to the resolution of the case, Counsel attorneys may work with the unenrolled return preparer, in a non-representative capacity, to develop the facts of a case.”

In the Notice, Counsel thus takes a practical approach to the issue. Most cases in Tax Court involve pro se taxpayers, and many disputes in court revolve around facts. My experience is that in many instances the involvement of a third party can assist in the resolution of the case. The 2017 Chief Counsel Notice states that the preparer may assist the taxpayer in gathering information or in substantiation of items on the return, and that Counsel attorneys may permit the preparer to attend meetings.

The Notice does remind its attorneys to clarify with the taxpayer and the preparer that for the unenrolled return preparer there is no general authority to represent taxpayers in Tax Court cases, and that Counsel has no obligation to communicate with the preparer or even include the preparer in meetings if the preparer is abusive or if the interests of the preparer conflict with the interests of the taxpayer.

There are a couple of points worth highlighting in the Notice. First, with the increased reach of special due diligence penalties applying to more refundable credits, it is becoming somewhat more likely that a conflict between a preparer and a taxpayer may arise. In addition, as with other third parties who are not representatives of a taxpayer, Counsel’s communications with unenrolled preparers could expose the Service to possible 6103 violations if the communications proceed without the involvement of the taxpayer. As such, the Notice reminds its attorneys that it should communicate with the unenrolled preparer only if the taxpayer “is present, either in person or on the telephone, or in the unenrolled return preparer’s capacity as a third party record keeper or a potential witness.” In addition, because I suspect that taxpayers may not fully appreciate the limited powers of unenrolled preparers, the Notice states that to “avoid confusion Counsel attorneys should clarify with both the petitioner and the unenrolled return preparer that unenrolled return preparers do not have the authority to represent petitioners in dealings with Chief Counsel, even if the petitioner purports to consent to the representation.”

Conclusion

In sum, the Notice seems helpful for all parties. As taxpayers become more familiar with the limits associated with preparers who have not opted in to the Annual Filing Season Program, the Service encourages what it could not mandate; that is, the use of preparers who in fact have demonstrated some minimal level of competence and who demonstrate the additional accountability and visibility associated with the annual filing season program. I think that the approach of providing the incentive to use some preparers as compared to others, so long as that incentive is tied to furthering the goal of good tax administration rather than lining the pockets of some preparers over others, is a good model for IRS oversight over an industry that plays a key role in tax administration.

Court Allows IRS to Proceed With Summons Issued to Taxpayer in the Medical Marijuana Business

Last week’s article in the New York Times Legal Marijuana Ends at Airport Security, Even if It’s Rarely Stopped discusses the increasingly odd situation of passengers who are legally entitled to possess and use marijuana finding themselves at risk when they transport marijuana across state lines, even if the air travel originates and ends in states where the possession and use is legal. The federal income tax treatment of the marijuana industry likewise reflects an odd reality: those in the business are expected to pay tax on their sizeable profits, yet Section 280E prohibits those in the business from claiming deductions that they would be entitled to if they were trafficking in other products that did not constitute a controlled substance under federal law.

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In the NYT article, a spokesperson for TSA stated that it does not actively look for marijuana when it screens passengers; yet if an agent comes across it in her screening (as an agent did with my banana and apple I forgot about placing in my wife’s carry on bag on our flight last month from Frankfurt), she will alert local law enforcement.

In contrast with TSA, IRS appears to be pretty active in enforcing its mandate under Section 280E.  High Desert Relief v US, out of a district court in New Mexico, highlights a couple of procedural issues, including the IRS’s ability to use its considerable summons powers to gather information about the businesses and their compliance with the federal civil tax laws.

High Desert Relief (HDR) operates a legal medical marijuana business in New Mexico (its motto is “relief through high quality medicine”). IRS began examining its 2014 and 2015 tax years, and as part of the examinations it issued third party summonses to a bank and the New Mexico Department of Health and another state agency.

HDR sought to quash the summonses, essentially on the ground that the IRS could not satisfy the Powell requirements that its actions were conducted pursuant to a legitimate purpose because IRS was using its civil summons powers to conduct a criminal investigation. The government responded and included an affidavit from the Revenue Agent, claiming that she issued the summonses to “assess the correctness of [HDR’s] returns and determine if HDR has unreported taxable income” and to “substantiate the gross receipts reported in HDR’s tax returns.”

As part of its argument, HDR claimed that Section 280E requires a “finding of criminal behavior” that is beyond what was needed in the summary summons process. Unfortunately for HDR, a number of cases have already rejected this and similar arguments. Section 280E, though referencing a criminal statute, does not require any outside determination that a crime has been committed. Quoting from a 2016 federal district court case out of Colorado, Alpenglow Botanicals v US, the opinion explained that

[t]rafficking as used in § 280E means to buy or sell regularly. Californians Helping to Alleviate Med. Problems v. C.I.R., 128 T.C. 173, 182 (T.C. 2007). As such, the real issue here is whether the IRS has authority to determine if, in the course of plaintiffs’ business, they regularly bought or sold marijuana. The Court cannot understand why not. Such a determination does not require any great skill or knowledge, certainly not skill or knowledge of a criminal investigatory bent….

While Section 280E references a criminal statute, as the HDR court explained, IRS civil examinations can investigate “whether a party violates the [Federal Controlled Substances Act] without conducting a criminal investigation.”

There were a couple of other arguments worth highlighting. HDR argued that the information was available for the IRS; under US v Powell, in establishing that the summons was issued in good faith, IRS must show that the information was not already in the Service’s possession. HDR had claimed it made all the requested information available to the IRS. Yet, in making the information available, HDR conditioned its release on it getting “assurance from the IRS, that the IRS will use the information furnished for this civil audit, and not to support the IRS’s determination that the Taxpayer’s business consists of illegal activities.”

The court found that this conditioned availability was not enough. In addition to HDR not showing that there was a complete overlap between the requested documents and what HDR offered to make available, the court pointed to Section 6103(i). That, in certain situations, requires IRS release of tax return information for other federal laws not relating to tax administration. Restricting the IRS’s use of the information was not the same as providing the requested information.

Another issue in the case received relatively little attention and perhaps is the meatiest of the procedural issues. HDR argued that it was not given sufficient notice of the IRS’s use of a third party summons. Section 7602(c) (1) states that during an IRS inquiry and IRS employee may not contact a third party “with respect to the determination or collection of the tax liability of such taxpayer without providing reasonable notice in advance to the taxpayer that contacts with persons other than the taxpayer may be made.”

The IRS argued that its sending to HDR a Publication 1 was sufficient notice. That publication, which IRS sends to every taxpayer subject to audit, states the following:

            Potential Third Party Contacts

Generally, the IRS will deal directly with you or your duly authorized representative. However, we sometimes talk with other persons if we need information that you have been unable to provide, or to verify information we have received…. Our need to contact other persons may continue as long as there is activity in your case.

Without analysis, the district court in New Mexico found that the generic publication was adequate for purposes of Section 7602(c)(1). As I recently described in the revision to the Saltzman Book IRS Practice and Procedure treatise in the chapter on examinations at 8.7[4] Third Party Contacts and in Chapter 13 addressing the IRS summons power, last year in Baxter v US a federal district court in California concluded that in fact the generic notice is insufficient to meet IRS’s notice requirements for these purposes. The district court held that the government had to tell the taxpayer which third party it was going to contact. This issue deserved a little more attention in the opinion, and as I have noted in the Saltzman write up, the courts are applying Section 7602(c)(1) and reaching differing outcomes. IRS in years past given more specific notice but lately has defaulted to its Pub 1 for these purposes. The current IRS approach seems to be inconsistent with regulations and Congressional purpose in enacting the notice provisions, and I suspect that other courts will give this issue greater attention.

A final issue in HDR is worth mentioning. The taxpayer argued that the “federal criminal drug laws with respect to state-legal marijuana sales [are] dead letter.” As such, it looked to old cases under Section 162 that allowed beer and liquor distributors deductions for activities that technically violated state laws, such as gifting beer or providing rebates to distributors. States turned a blind eye to those practices and did not enforce the laws prohibiting them. The main difference is that while Section 162 disallows deductions for activities in violation of state law, the Code itself provides that the limitation on deduction under Section 162 only applies if the state law is “generally enforced.” No such limitation appears in Section 280E.

The bottom line for HDR is that Section 280E does not in any way limit the government’s broad reach to access documents and information in a civil examination. The tax system thus contributes to the schizophrenic legal approach to the marijuana business. While the federal government is willingly collecting tax revenues and enforcing the internal revenue laws, the marijuana industry operates on a different substantive plane.

Arrests Made in IRS Scam Call Center Probe; Dark Web a Home for Stolen Tax Information

In New York Times Article on Call Center Tax Scams Highlights How Criminals Prey on Our Citizens Fear of IRS I discussed how a New York Times reporter uncovered some of the methods and motives of the overseas IRS imposters who preyed on American fear of IRS. The other day the Wall Street Journal reported that Indian police have arrested the apparent ringleader of the scammers in Indian Police Arrest Man Allegedly Behind Tax Scam Call-Center Network. The same day as the WSJ article Accounting Today had a story about how Americans’ tax information is out there on the dark web, for sale and available for scammers seeking to file fake returns and access refunds.

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First, I will briefly discuss the call center scams. Most are familiar with them; as the WSJ reported, the scammers “received phone numbers and other details about U.S. taxpayers from a contact in the U.S. Call-center workers would make hundreds of calls, telling whoever answered they owed back taxes and risked financial ruin, humiliation and arrest if they didn’t pay immediately.”

The WSJ article discusses how the call center scammers were taking in about $150,000/ day. Indian authorities arrested the ringleader and seized his Audi R8 as evidence.

A DOJ indictment from last fall named the ringleader as one of the co-conspirators. The indictment discusses the IRS scam as well as a few other confidence scams that prey on the vulnerable and unsophisticated, including one where callers impersonating ICE agents threaten deportation unless the victim paid a fee.

These schemes suggest that the callers know something about how some Americans fear IRS and government in general. As I discussed last week in a brief post on a TIGTA review of IRS CI conduct in investigating structuring violations the IRS does not help itself when it fails to respect taxpayer rights when it investigates structuring violations. As the TIGTA report described, “when property owners were interviewed after the seizure, agents did not always identify themselves properly, did not explain the purpose of the interviews, did not advise property owners of any rights they might have, and told property owners they had committed a crime at the conclusion of the interviews.” This kind of behavior (and the publicity surrounding it) plants the seeds of fear.

Added to the mix of likely confusion and fear is the onset of private debt collection, an issue Keith has discussed and one that is likely to contribute to new opportunities for scamming Americans. The upshot is I suspect that while perhaps the Indian authorities have put one bad guy away, there are many more right behind him, and many future victims who are a mere phone call (or text) away.

On to the dark web. Wikipedia defines the dark web as “content that exists on darknets, overlay networks which use the public Internet but require specific software, configurations or authorization to access.” Last week Accounting Today in Tax refunds are selling cheap on the Dark Web discusses how there is a fully active market for sales of individuals’ W-2s. There is a sobering link to an IBM study outlining a 6,000 per cent increase in IRS scam emails over the past year, and how cybercriminals are selling W-2 information for $30, with an additional $20 charge for last year’s AGI, a necessary bit of information to allow a scammer to efile a return.

The Accounting Today story is terrific and I recommend a read; it has useful screenshots showing ads on the Dark Web and includes some new vocabulary that the fraudsters use to discuss the crimes. The piece ends with a reminder of how the fraudsters depend on people opening and responding to phishing emails and that “[n]o matter how enticing—or scary—the supposed offer or threat is in the supposed IRS letter, which will try to entice you into clicking on a link, or opening a file, resist, and forward the phishing attempt to the IRS at phishing@irs.gov.”

Good advice.

S Corp Shareholders Unable to Deduct Losses As Guarantee Does Not Create Basis

While not a procedure case, for those wanting a primer in an important nook when it comes to the tax treatment of shareholder positions in S Corporations, I recommend a reading of this week’s Tax Court opinion in Phillips v Commissioner.

Phillips addresses the limits on shareholders’ ability to generate basis when the shareholders guarantee a corporate debt rather than make a bona fide loan themselves to the corporation. The facts in Phillips involve shareholders in S Corps that were in the business of developing and selling real estate in Florida, a business that was hit hard by the great recession. Husband and wife Robert and Sandra Phillips personally guaranteed loans of the S corporations. When the economy turned south, the banks sued the Phillips (and other guarantors) on the guarantees, resulting in millions of dollars in judgments, which the Phillips were unable to pay.

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How did this trigger a tax dispute? The Phillips increased their basis by a pro rata amount of the creditor judgments. A shareholder’s basis in an S Corp is important as items of loss are passed through reducing basis. A shareholder in S Corps may only claim the benefit of the loss or deduction to the extent of the shareholder’s basis (and basis in bona fide debt the corporation owes him) under Section 1366(d). The judgments were in the many millions of dollars; so were the losses that the S Corp was racking up. So, with the basis creation, the Phillips claimed losses they otherwise would not have been able to use immediately, generating NOLs that they used to carryback to years when everyone in Florida real estate was living high on the hog.

The problem is that there is a long line of cases holding that a shareholder’s loan guarantee for loans that the S Corp itself incurs is insufficient to generate basis needed to soak up the losses. Those cases provide that absent an economic outlay, (i.e, the shareholder paying on the guarantee), there is no basis impact from the guarantee itself.

This is a useful contrast with subchapter K, where partnership liabilities are generally allocated to partners. In contrast, the liabilities of the S Corp only generate a basis kick up when in fact the shareholder makes the loan to the corporation or actually pony up the dollars as a result of the creditor seeking payment on the guarantee. It does not matter that the S Corp shareholders could have structured the financing differently (e.g., borrowed the money and then loaned the $$$ to the corp).

The taxpayers in this case made the creative argument that while they accepted that a guarantee itself is generally insufficient to generate basis, there was enough adverse economic impact on them to justify a basis boost. To that end, the taxpayers emphasized that the creditors sued them individually, obtaining a judgment resulting in liens against their property.

Phillips notes that the taxpayers attempted to make lemonade out of lemons, but restates the maxim that taxpayers are generally stuck with the consequences of the form they choose. In Selfe v US the 11th Circuit found a limited exception for the “no basis from a guarantee rule” if the shareholders can establish that the lender in substance viewed the shareholder as the primary obligor. No doubt the presence of the liens and the judgment has some economic impact, but under 11th Circuit (and other) precedent it was not enough to move the needle:

Petitioners urge that the deficiency judgments against Mrs. Phillips gave rise to an “actual economic outlay” by (among other things) impairing her credit. This argument misapprehends the theory that formed the basis for the Eleventh Circuit’s remand in Selfe. The theory was that the bank, while nominally lending to the S corporation, may in substance have lent to the shareholder, who then contributed the loan proceeds to the corporation. In order to identify the “true obligor” in such circumstances, it is necessary to examine the lender’s intentions and other economic facts existing when the lender makes the loan. A court’s entry of a deficiency judgment against a guarantor many years later, after the corporation has defaulted and the corporation’s collateral has proven insufficient, is simply not relevant in determining whether the lender, when initially extending credit, looked to the shareholder as the primary source of repayment.

At the end of the day, this is a pretty tough outcome for the taxpayers. The rationale for the difference in treatment for S Corp shareholders and partners is due in part on the theory that the S Corp shareholders are generally not personally liable on the corporate debts. The guarantee is a bit too remote; when the creditor comes knocking and in fact obtains a judgment (as here) that liability is no longer remote.

Philips is a good reminder that form matters, especially when using S Corps (a lesson we also explored in Financial Consultant Fails To Avoid Self-Employment Tax With S Corp Structure) and shareholders seeking to ensure basis to offset losses should structure the transaction in the form of a direct loan to the shareholder, followed by a shareholder loan or contribution to capital.

Some More (Depressing) Weekend Tax Reading: IRS in Crosshairs for Violating Rights in Anti-Structuring Investigations

In a widely publicized report TIGTA this week discussed how IRS enforcement of the Bank Secrecy Act’s anti-structuring provisions often violated the fundamental rights of small business owners who obtained money legally but who IRS suspected were structuring transactions to violate the reporting requirements that accompany certain deposits and transfers of cash.

As most readers know, deposits of over $10,000 trigger additional reporting requirements. There are many reasons to avoiding the requirements by depositing amounts less than the trigger; some of the reasons are legitimate and others are done with the intent to shield illicit activities. The BSA is meant to give government the tools to combat money laundering and terror financing, and not to hassle small business owners.  Getting the balance right between enforcement to catch bad guys and not catching good guys requires careful calibration by the administrative agency.  Recent information suggests the IRS dialed up the enforcement side too high.

TIGTA looked at a sample of cases where IRS Criminal Investigation (CI) used its broad forfeiture powers in response to suspicions of structuring. It essentially found that in many cases the underlying activity was legal; using the broad forfeiture powers in response to legal source activities essentially amounts to use of a power that is extraordinary for what is in essence a reporting violation. Moreover, the report discusses how in many instances CI agents did not when interviewing suspects tell them that they were potentially the subject of a criminal investigation or explain their constitutional rights.

The Washington Post article The IRS took millions from innocent people because of how they managed their bank accounts, inspector general finds is typical of the reaction the mainstream press has had to the report; in one word: outrage.

One voice among the many who has criticized IRS practice is the National Taxpayer Advocate.  As she should, the NTA’s criticism focuses on the harm to taxpayers created by CI enforcement practices and the failure of CI to recognize fundamental taxpayer rights – something she has championed.  Following the TIGTA report, the NTA released a statement  expressing concern over CI’s apparent position that taxpayer rights don’t apply in these anti-structuring investigations:

CI takes the position that taxpayer rights, such as those included in the TBOR, only apply when it is conducting investigations under Title 26 of the U.S. Code (i.e., the Internal Revenue Code). CI says taxpayer rights do not apply in the cases examined in TIGTA’s report, either (1) because CI is acting at the direction of the Justice Department in a grand jury investigation or (2) because the structuring laws are codified in Title 31 of the U.S. Code (rather than Title 26), so the subject of the investigation should be viewed as a “property owner” rather than a “taxpayer.”

As a refresher Section 7803(a)(3) requires the Commissioner to ensure that “employees of the Internal Revenue Service are familiar with and act in accord with taxpayer rights as afforded by [Title 26], including [the ten rights in 
the TBOR].”  She points out that the IRS engages in the administration of laws across the federal code including bankruptcy law found in title 11, the freedom of information act (FOIA) found in title 5, as well as numerous other provisions.  The position taken by CI, if applied to all parts of the IRS would create a big gap in the coverage of the taxpayer bill of rights not intended by Congress.

The NTA makes the strong point that Section 7803(a)(3) does not make exceptions or append to the statute that the protections are only meant to apply when the IRS is investigating a Title 26 matter.

The NTA statement connects this issue to fundamental taxpayer rights:

The right to be informed is particularly important because, without adequate information, it is difficult to exercise the right to challenge the IRS and be heard. If people do not know what they are suspected of, they may not provide exculpatory information that they possess. At the same time, the government is more likely to waste resources pursuing cases against innocent people. Pursuing such cases also violates the right to privacy, which includes the right to “expect that enforcement will be no more intrusive than necessary.”

The NTA makes the sensible recommendation that IRS should clarify that its agents should act in accord with taxpayer rights in these investigations. Rights mean different things in different contexts, and there is still the question as to what those rights would mean in these investigations. Yet taking as a starting point that IRS employees should act in accord with respecting these rights is surely a good recommendation for an agency that seems at times to make itself an easy target for critics.  This discussion also offers the opportunity to show how the codification of taxpayer rights may (or at least should) make a difference in the way the IRS approaches enforcement.  Had it followed the provisions in TBOR, CI would likely have avoided this opportunity for adverse publicity.  Maybe it would have caught a few less bad guys, but it could have prevented numerous good guys from getting caught in a net cast too widely.

New Report Discusses the Rebirth of Refund Loans

As this year’s fling season is winding down, the National Consumer Law  Center released a report discussing the filing season issues from the perspective of lower and moderate-income taxpayers. This year’s report discusses some of the main issues in the past filing season, including the Congressionally mandated delay associated with EITC and CTC refunds, the rebirth of a new form of refund anticipation loan, challenges associated with getting a Tax Identification Number, the limited ways in which states regulate commercial tax return preparers, and the onset of private debt collection.

I have been following the refund loan return, which I discussed on PT in Refund Loans on the Comeback, With A Twist and in a follow up to that post.

For those of you unfamiliar with the issue, a refund anticipation loan (or RAL) was a loan that banks made and that was secured by and paid with the proceeds of a taxpayer’s refund. In their heyday they were controversial, in part because they were almost always accompanied by high fees and high effective interest rates. In addition there was significant concern that the fees provided the incentive for preparers and banks to encourage improper claims, especially when IRS shared with preparers a debt indicator that let preparers know if the refund were likely to be delayed or intercepted to apply to a past due tax or other offset.

In 2012, RALs in their earlier incarnation dried up after IRS pulled the debt indicator and federal regulators essentially forced banks out of that business. As I discussed earlier this year, many preparers and partner banks brought back the loans this filing season, though with two key differences: the loans 1) had no stated fee and 2) were non-recourse, meaning that if the refund does not materialize due to say a refund freeze or offset the losses were not the responsibility of the individual filer. It appears that for this filing season the RAL is now a loss leader, or a way to bring clients into the door to generate prep fees and perhaps upsell other products that the preparers offer.

Given the statutory mandated delay in EITC and CTC refunds and the mostly no-fee modern RAL, it is not surprising people were attracted to this product. The NCLS report indicates that this year over 1.5 million RALS were issued, up from about 40,000 in 2015.

The report discusses that not all preparers were genuinely offering a no-fee RAL; some had disguised fees and others essentially wrapped in costs with the fee for preparing a return. Prep fees take a big bite out of many lower-income individuals’ refunds; the report discusses the wide range in fees that preparers charge to prepare EITC returns and discusses a survey from the Progressive Policy Institute that indicates EITC recipients can expect to pay between 13 and 22% of their refunds on tax prep fees and related services.

In years past, in addition to the consumer issues, I was interested in the relationship of RALs and noncompliance. I discussed that issue in a 2009 article in Stanford Law & Policy Review called Refund Anticipation Loans and the Tax Gap. Under the old RAL regime, some argued that the combination of high fees, the IRS’s release of the indicator that allowed preparers to know if the claimant’s refund would be offset or likely frozen, and the recourse nature of the loan created a divergence in the preparer’s interest in turning profits and the general interest in submitting claims that relate to eligible claimants. The dynamics have changed considerably. Since I first discussed the issue Congress tightened up due diligence rules; IRS is (albeit sporadically) enforcing those rules among preparers, and now with this new RAL product preparers rather than filers are on the hook for defaults.

From a compliance standpoint it is possible that the current rise in RALs helps ensure that preparers are actually more invested in performing due diligence, or at least more sensitive to the issues (or at least audit risk), as repayment will be based on the consumer actually getting the refund claimed.

As NCLC discusses, however, compliance is not the only issue associated with the product. It comes back to the healthy prep fees that preparers generate. If the individual were already going to use a preparer for the return, then as the report notes the RAL (assuming no hidden fee or truly no passing on of the higher costs) is just a benefit without much additional expense. But there are free options available for many lower or moderate-income individuals, such as the Free File program IRS itself makes available in tandem with the private sector and VITA sites. So to the extent that the product attracts people to high cost preparers, it creates a different dynamic.

In the past it was generally easy to criticize RALs. Now it is not so clear. The costs of RALs this time out are a little less visible though still present for those now using a paid preparer offering a RAL when they otherwise would not. Also, there are now benefits if in fact preparers’ interests are more closely aligned with the government’s in ensuring that eligible claimants apply and receive an EITC-generated refund.

Some Weekend Reading and Listening

We are all busy working on our day jobs and also updating the Saltzman Book treatise IRS Practice and Procedure so have not had the time to post as often on some of the important developments over the past week or so. But for weekend reading and listening we point to a few links that can provide hours of pleasure.

IRS released its annual data book; it is full of useful statistics, including a robust discussion of enforcement actions, a less robust discussion of service and a breakdown of refunds issued, returns filed and the kinds of stuff that can keep tax nerds entertained for hours.

Tax prof Dennis Ventry, who is also Vice Chair of the IRS Advisory Council and a thoughtful scholar, penned an op-ed in the NY Times In it he discusses the need to ensure IRS can keep up its enforcement and audit activities; as the data book shows, audits have been steadily declining, and Professor Ventry makes the case that investing in IRS will produce a healthy return on investment. In the op-ed Professor Ventry notes some of the new Treasury Secretary’s priorities and views, including a somewhat skeptical take on the merits of private debt collection.

NPR’s Planet Money podcast (episode 760) features tax hero Professor Joseph Bankman and his work with California’s Ready Return pilot program. For those not into podcasts, a brief summary can be found here.

Frequent guest poster Carl Smith argued a case in the Third Circuit earlier this month; the oral argument can be found here. Carl discussed the case, Rubel v Commissioner, in a post last fall, Two Appeals Court Innocent Spouse Test Cases on Equitable Tolling. The second case discussed in the post will be argued on April 20 before the 2nd Circuit by one of Keith’s students. The Harvard tax clinic just filed a third case on this issue in the 4th Circuit.

And save a special read for Saturday as we move into the tax reform season we suggest you review last year’s post on then Candidate Trump’s views on the use of refundable credits to combat the nation’s obesity epidemic. The President responded with the following tweet: “Fake News. PT: SAD; no one has ever heard of those guys. Tax Prof wannabes. They hardly have any page views.”

 

Good Fortune (for the IRS)

This week the Tax Court in Good Fortune Shipping v Commissioner,148 TC No. 10 upheld regulations relating to the exemption of income from the international operation of ships. Taxpayers are frequently teeing up issues relating to the validity of regulations, and this opinion is an important victory for the government. I will briefly describe the case and the way the Tax Court resolved the dispute.

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The statutory scheme under Section 883 (wildly simplified) is that gross income attributable to international shipping activities is exempt from US tax if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. In Good Fortune the owners of the shipping company were in fact residents of a country that did grant a similar exemption, but the shareholders held the stock in bearer form rather than in registered form. The statutory scheme tied the exemption to shares “owned by individuals” of a reciprocating foreign country; the regulations additionally restricted the benefit to shares that were owned in a certain way, and in particular excluded from the possible statutory exclusion scheme shares that were owned in bearer rather than registered form.

Bearer ownership and transferability is generally evidenced by physical delivery; registered form ownership ties ownership to a name that is registered with the corporation or its agent. US tax law has generally frowned on conveying benefits that are dependent on residence of ownership when shares or securities are held in bearer form for the obvious reason that it is easy to circumvent rules that are meant to tie exclusions or reduced withholdings on beneficial ownership in a particular jurisdiction when ownership can be conveyed just by possessing the security. Bearer form ownership promotes privacy, which is a value that tax agencies weigh quite differently than taxpayers.

In Good Fortune, in upholding regulations that essentially stated that bearer shares of a foreign corporation may not be taken into account in establishing the ownership of the stock of the foreign corporation, the Tax Court, applying the two-step Chevron analysis, leaned heavily on Mayo in finding that Congress had not spoken directly on the issue (step 1) and ultimately concluded that the regulations in place for the year in question were a permissible construction of the statute (step 2).

In finding that the precision needed was lacking in Step 1 the opinion emphasized that there was a legislative gap in how to prove ownership:

The words “owned by individuals” in section 883(c)(1) do not, as petitioner appears to acknowledge, explain or otherwise address how to establish ownership by individuals for purposes of section 883(c)(1), let alone how to establish ownership where the shares of the foreign corporation are owned in bearer form. The dictionary definitions of the word “own” on which petitioner relies which petitioner claims are unambiguous definitions, do not address the problem under section 883(c) of determining how to establish ownership by individuals for purposes of section 883(c)(1) that the Internal Revenue Service (IRS) confronts when it examines a return of a foreign corporation seeking the benefits of section 883(a)(1) for a prior taxable year

Upon reaching Step 2, the opinion looked to legislative history to 1986 statutory changes that tied the reciprocal exemption to corporate ownership rather than just the location of where the ship was registered:

A foreign corporation’s entitlement under section 883(a)(1) to exclude certain income from gross income and exempt that income from U.S. tax no longer was based solely upon the country in which the foreign corporation’s vessel was registered or documented. Instead, Congress added in its amendment of section 883 in the 1986 Act a second hurdle to that favorable treatment by enacting section 883(c) in order to curb abuse by residents of certain foreign countries who owned stock in a foreign corporation that was seeking the benefits of section 883(a)(1) where those foreign countries did not provide an equivalent exemption to U.S. corporations.

With that context the opinion discussed how bearer shares, which tie ownership to physical delivery, “make it virtually impossible to know who the actual shareholders or owners of a corporation are because the only proof of ownership is physical possession at a particular point in time of the paper bearer share certificate.” The absence of a registry contributes to ownership anonymity. As such, it was a short step for the court to conclude that the regs passed muster under Step 2:

We conclude that the bearer share regulations do not contravene section 883(c)(1) but are a reasonable construction of that section which provides the IRS with the appropriate tools needed to enforce section 883. The bearer share regulations provide certainty and resolve the difficult problems of proof associated with establishing ownership of bearer shares, especially for prior taxable years. In not allowing bearer shares to be taken into account in establishing the ownership of the stock of a foreign corporation for purposes of determining whether the foreign corporation is described in section 883(c)(1) and thus whether it is entitled to the benefits of section 883(a)(1), the bearer share regulations set forth a sensible approach to effecting the intent of Congress in enacting section 883(c)(1) to ensure that abuse will not occur which will result in certain types of shipping transportation income described in section 883(a)(1) not being taxed.

Good Fortune shows how in the absence of statutory detail on implementation, agencies have considerable discretion in promulgating rules, especially true when the rules relate to exemptions, which as the Tax Court noted here, are to be interpreted narrowly.