Leslie Book

About Leslie Book

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

Tax Free Reorg and Statute of Limitations: When is a Document a Return?

The New Capital Fire v Commissioner case from earlier this month is another in the many cases involving statutes of limitation on assessment. The case involves an old issue;  whether a document constitutes a return for purposes of starting the clock ticking on the statute of limitations on assessment.

In this case, the twist was that one taxpayer (Old Capital Fire)  was merged out of existence in a transaction that was intended to qualify as a tax free reorg under 368(a)(1)(F) (an F reorg) Following the merger, the surviving corporation (New Capital Fire) filed a corporate tax return, and with that return it included a pro forma Form 1120 that it included with its corporate tax return. That pro forma 1120 included the information pertaining to Old Capital Fire’s operations in its last short year.

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Generally speaking, when there is an F reorg, as the opinion discusses, the regs under Section 381 require that “the part of the tax year before the reorganization and the part after constitute a single tax year, and the resulting corporation must file a single full-year return.”

The problem here was apparently IRS argued that there was no valid F reorg. IRS came in 9 years or so after New Capital Fire filed its return and sought to assess a tax relating to the return that it believed Old Capital was required to separately file. If no return was filed, under Section 6501(c)(3) IRS would have an unlimited time to assess additional tax.

The issue that the Tax Court considered was whether the pro forma 1120 that New Capital included with its return was a return for purposes of starting the SOL on assessment for the tax stemming from the supposedly blown reorg.

There is plenty of old law on whether a document filed with the Service counts as a return. In 1984 the Tax Court put together the story in the oft-cited Beard v Commissioner, where it identified the following test:

(1) the document must contain sufficient data to calculate tax liability;

(2) the document must purport to be a return;

(3) there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and

(4) the taxpayer must have executed the document under penalties of perjury.

Most of the New Capital Fire opinion centered on the third requirement, the need to have an “honest and reasonable attempt” satisfy the tax law. The IRS argued that the New Capital return was purposefully misleading. While it was not clear (to me anyway) what led the IRS to label it as such, the opinion noted that the New Capital return had a clear statement regarding the position that Old Capital was merged into New Capital and that the pro forma return reported “income, deductions, and credits that were included in the notice of deficiency at issue in this case.”

The opinion notes that many opinions have liberally applied the third Beard element, with a flunking only if the court found that the pro forma 1120 and the 1120 that disclosed the merger was “false or fraudulent with intent to evade tax as it pertains to Old Capital.” The Tax Court observed that the IRS came up short, as “New Capital’s 2002 return contained sufficient information to calculate Old Capital’s tax liability.”

As the opinion notes, citing cases like Zellerbach Paper v Helvering and Germantown Trust v Commissioner, perfect accuracy is not necessary. Even if New Capital whiffed and there was a separate obligation to file a different return relating to Old Capital’s short year, that mistake did not change the fact that IRS had what it needed to assess any additional tax within the normal time frame.

With that, the court concluded that IRS did in fact receive a return from Old Capital and IRS was out of luck (and time) to assess any additional tax that may have stemmed from Old Capital Fire’s merger.

ABA Tax Section Fall Meeting in Austin

Stephen and I are attending the fall ABA Tax Section meeting in Austin. There are panels about important procedural and administrative issues, including the new partnership audit regime (timely as my colleague Marilyn Ames and I are finishing up a chapter on that for the Saltzman/Book treatise), the many changes in Appeals Office procedures, how to navigate cases before the Office of Professional Responsibility, best practices in reading and drafting the various types of tax guidance, and the possible changes arising due to the tax aspects of healthcare reform.

This morning Stephen will be on a panel I am moderating  discussing Section 7434 and the private cause of action that it allows for fraudulently issued information returns. Joining him on the panel is Mandi Matlock, who splits her time between Mondrick & Associates and Texas Rio Grande Legal Aid (and who contributes to the Effectively Representing book and has also blogged for us). There are many interesting issues relating to Section 7434, including whether the statute supports a claim for improperly issued information returns arising in employee misclassification cases, whether a person who did not have a legal obligation to file the information return is potentially liable and how the courts have approached damages in the handful of cases that plaintiffs have won.

 

Court Grants Government’s Motion in Limine in FBAR Penalty Trial

Last week’s order in Bedrosian v US concerns an evidentiary dispute in an FBAR case. Bedrosian is CEO of pharmaceutical company Lannett. The dispute centered around the government’s motion in limine to exclude any evidence pertaining to its administrative determination to impose penalties for willfully failing to file an annual FBAR form. The government filed its motion, arguing that the evidence pertaining to its the administrative determination was irrelevant in the court proceeding, as the court would be making a de novo review on the merits of the penalty. The court agreed with the government.

I will describe the order and give some context.

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FBAR penalties are steep, especially if the failure to file the report is willful. A willful failure to file carries a penalty of up to the greater of $100,000 or 50% of the account balance.

In Bedrosian, the penalty at issue is about $1 million for willfully failing to disclose an interest in one of two UBS Swiss bank accounts.

Bedrosian had a Swiss account for many years, which he failed to disclose to the IRS. For many years he also did not report the income from the account on his federal income tax returns. He had another more recently opened smaller UBS account, which he began disclosing on an FBAR in the 2007 tax year, though when he filed the FBAR for that smaller account he did not report its income on his 2007 federal tax return.

The account he disclosed had a value of about $230,000; the other undisclosed account was worth about ten times that. In 2008 UBS told Bedrosian that it would be turning over all account information to the IRS. In 2010, Bedrosian amended the earlier FBAR filing and filed a new FBAR showing his interest in both accounts. He also amended his income tax return to reflect the income from the accounts.

The order from earlier this year on the cross summary judgment motions discusses how Bedrosian cooperated with IRS after it began investigating him in 2011. (See Jack Townsend’s Federal Tax Crimes blog post for an excellent discussion of the earlier order and the court’s discussion of the willfulness standard; hard working Jack also beat us to this punch with a post yesterday on last week’s order here). Initially the IRS proposed to only impose nonwillful FBAR penalties; however, for reasons that are not clear the IRS reassigned the matter to another IRS agent, and that agent recommended imposing the willful FBAR penalty. IRS went ahead and proposed to impose the largest willful penalty allowed under the regs; that was just under $1M.

Bedrosian sued claiming that the penalty amounted to an illegal exaction, leading both parties to file summary judgment motions.

After denying both parties’ summary judgment motions, and with the case heading to trial, the government sought to exclude from trial the evidence pertaining to the IRS’s flip flop on its penalty determination. Last week’s order agreed with the government. In so doing the court looked to analogous case law that provides that the “thoughts and analysis, application of facts to law at the administrative level with respect to willfulness have no place in the Court’s de novo review of whether Bedrosian willfully failed to comply with the FBAR requirements.”

Bedrosian cited case law interpreting the Individuals with Disabilities Education Act (IDEA), which also has de novo review of administrative proceedings but has mandated that the earlier proceedings become part of the record in court challenges. The Bedrosian order distinguished that line of cases, as the IDEA statute specifically requires that the courts should receive records of the earlier administrative proceedings.

The key, from the court’s perspective, was that the government’s documents on its FBAR penalty determination were not relevant to its task of making an independent determination on whether Bedrosian acted willfully in failing to file the FBAR. The matter now proceeds to a trial on the merits. As there are many FBAR cases in the pipeline, and only a handful of court opinions and orders, this is an important victory for the government.

 

 

Recent Tax Court Case Sustains Preparer EITC Due Diligence Penalties

Last week in Mohamed v Commmssioner, the Tax Court sustained $7,000 of EITC due diligence penalties against a preparer. The preparer, who was a CPA, had an active business preparing individual tax returns, including many EITC returns. The opinion provides a rare court review of the imposition of these penalties.

The EITC due diligence penalty has been on the books for a while; the current penalty is $500 for each failure to comply. Requirements include preparing and retaining forms like the Paid Preparer’s Earned Income Credit Checklist, and the Earned Income Credit Worksheet. In addition, the rules require that tax return preparer must not know, or have reason to know, that any information pertaining to the EITC is incorrect.

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This penalty is even more important for preparers, as Congress recently expanded the scope of due diligence penalties to include the child tax credit and the American opportunity tax credit.

There are not many cases involving the penalty, and while Mohamed is a summary opinion, it does provide some insights into the process and limits on Tax Court review of the penalty.

The opinion discusses how IRS examined a number of Mohamed’s clients as part of its EITC due diligence audit program. He was visited by a tax compliance officer, who reviewed 50 of Mohamed’s returns. The audit report proposed a penalty on 20 of the 50 returns; while the penalty is not subject to deficiency procedures, the IRM provides and IRS allowed for Mohamed to challenge the proposed assessment before Appeals.

Mohamed met with an Appeals Officer for 6 hours to discuss the penalty; after the meeting Appeals agreed to remove the penalty from 5 of the returns. Appeals also asked for more information on 4 other returns. Mohamed sent documents to Appeals and also had a follow up phone conversation. The correspondence and phone call led Appeals to remove the penalty from another return, bringing the penalty down to 14 returns, or $7,000.

Appeals sent a closing letter indicating that it was recommending a penalty assessment on 14 of the returns; it also let Mohamed know that he could pay the penalty and file a refund claim and eventually sue in district court or the Court of Federal Claims if he wanted court review of the penalty.

IRS assessed the penalty and issued a notice of intent to levy. Mohamed did not pay and instead filed a CDP request. In the hearing he asked to challenge the underlying assessment. The settlement officer refused that request on the theory that he had a prior opportunity to challenge the penalty in the preassessment Appeals hearing.

PT readers are likely familiar with the legal issue; namely whether a prior opportunity to dispute the amount or existence of the liability includes for these purposes an administrative preassessment Appeals hearing. Taxpayers have lost in Tax Court and circuit courts on this issue (For more see Keith’s discussion Continued Developments in Taxpayer Attempts to Litigate the Merits in CDP Cases.)

Given the Tax Court and appellate courts’ views on this issue, it is not surprising Mohamed had an uphill battle. He gamely attempted to distinguish the adverse authority, arguing that Appeals did not give him a chance to rebut its conclusions and that it terminated the process prematurely.

The Tax Court disagreed, emphasizing that he participated fully in the examination process, had a long in-person meeting with Appeals and follow up conversations and correspondence:

In sum, the record shows that in 2015 petitioner was provided a full and fair opportunity to challenge the imposition of the disputed penalties before the Appeals Office and he meaningfully participated in that proceeding. Although petitioner would have preferred to continue to dispute his liability, we are satisfied hat the Appeals Office conducted a fair and comprehensive review of the matter and acted properly in concluding the matter by issuing its closing letter.

That the Tax Court looked into the process that Appeals provided in the preasessment hearing is a slight opening for other taxpayers who may not have had the same opportunities with Appeals. Yet Mohamed is another in the growing line of cases that show that CDP is not an avenue for challenging the amount or existence of a liability even if there is no prior opportunity for court review.

There is one other aspect of the case worth noting. Mohamed also challenged the penalty under Section 6751(b) which requires that no IRC penalty “shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate…”

The court considered this issue on the merits and found that the compliance officer had prepared a Form 8484, which is used to refer preparers for possible discipline to the Return Preparer Office. That form was where the compliance officer proposed the penalties, and the supervisor signed that form and approved referral.   Interestingly the record did not include a Form 8278, which is what IRS typically uses to propose preparer penalties. The lack of that form did not trouble the Tax Court:

On its face, Form 8484 is a report that IRS personnel are encouraged to use to convey information to the OPR about questionable practitioner conduct. Although the form does not function to authorize the assessment of a penalty, in this case the TCO’s acting immediate supervisor placed her digital signature on the Form 8484 indicating that she agreed with the referral of the matter to the OPR and that she approved the audit report (attached to the Form 8484) which recommended that 20 section 6695(g) penalties be assessed against petitioner. The audit report included a detailed explanation in support of each of the 20 penalties. Under the circumstances of this case, we conclude that the TCO’s initial determination to assess the penalties in dispute was personally approved in writing by her immediate supervisor within the meaning of section 6751(b).

As this is a summary opinion not subject to further review, there is no chance to in this case see if the IRS’s failure to seek penalty approval in the proper manner amounted to compliance with Section 6751(b). As we have discussed (most recently in Samantha Galvin’s Designated Order post from a few weeks ago), the 6751(b) issue is one that the Tax Court and other courts are increasingly facing.

Curtain Finally Comes Down On Schaeffler Privilege Dispute

Readers may recall the dispute involving the IRS and richest man in Germany, Georg Schaeffler. Schaeffler and the IRS disagreed on the the scope of the attorney-client privilege and work product protection after IRS looked into the tax consequences of a restructuring transaction following the 2008 stock market collapse that landed right in the middle of Schaeffler’s bid to buy German company Continetal AG .

The issue of waiver in the context of complex commercial transactions when there are teams of advisors is one that has troubled the courts. To ensure the possible existence of privilege, parties working in tandem need to demonstrate a common legal interest. Guest poster Ben Bolas discussed the Second Circuit Schaeffler opinion that pushed back on some other cases that essentially concluded that the existence of a common commercial interest invalidated a common legal interest.

The Second Circuit Schaeffler opinion did not cover all the documents at issue in the summons; that led to a remand to the district court to determine whether other documents were protected by the attorney client privilege or work product doctrine. Following the remand, IRS withdrew the summons and moved to dismiss the petition to quash the summons due to mootness. (As background, a case becomes moot and a court loses jurisdiction if issues presented are no longer live or the parties lack a legally cognizable interest in the outcome).

Schaeffler opposed the motion to dismiss and sought a judgment quashing the summons. The district court found for the IRS, looking to a long line of cases that held that a withdrawal of a summons moots the case.

Last summer in Update on Schaeffler Privilege and Work Product Dispute I discussed that somewhat odd aspect of the dispute; in my post I leaned on my colleague Jack Townsend (and lead author in the revised criminal section of the IRS Practice & Procedure treatise) who suggested that Schaeffler wanted to get some assurance going forward that the IRS would not be able to access certain documents in a subsequent audit.

Schaeffler appealed the district court holding on mootness. In a summary order  from earlier this week, the Second Circuit affirmed the district court. In so doing, the order discussed the “voluntary cessation of illegal activity” exception to the mootness doctrine. That exception states “[a]s a general rule, ‘voluntary cessation of allegedly illegal conduct does not deprive the tribunal of power to hear and determine the case, i.e., does not make the case moot.’”

In making its case on appeal, Schaeffler did not argue that the summons power in and of itself was illegal; instead it argued that by summonsing certain documents it was not entitled to receive (due to privilege) the exception came into play. The Second Circuit did not agree:

Schaeffler contends that by summonsing some documents that may or may not be subject to the attorney-client or work-product privileges, the summons became “illegal.” We cannot endorse such a tortured under- standing of illegality. If the IRS were to exercise its lawful authority and issue a summons in the future, privilege issues could be litigated then. Doing so here, in the absence of a summons, would result in an impermissible advisory opinion.

The Second Circuit was reluctant to issue a blanket rule that would have expanded the considerable scope of its earlier opinion. While the earlier Second Circuit opinion meant that Schaeffler enjoyed a considerable victory, it was not meant to provide carte blanche protection.  In the future, the courts could entertain specific disputes if they were to arise.

While this ends the dispute without the complete victory that Schaeffler sought, the order notes that the IRS had assured the court during oral argument that the case was effectively over and it would not reissue a summons. With the withdrawal came the end of the Schaeffler group’s obligation to turn over documents, and if the IRS keeps to its word the fight over documents pertaining to the restructuring.

Court Sustains Competent Authority Decision to Not Grant Treaty Relief

The other day I discussed Starr International v US, and the lead up to an opinion earlier this month concerning the application of the US –Swiss income tax treaty. Before the court was able to resolve the matter on the merits, the district court addressed its jurisdiction to hear a challenge to the US Competent Authority’s decision to not grant discretionary relief under the treaty. While concluding that it could not order monetary relief, its prior opinion opened the door to Starr challenging the Competent Authority’s decision not to grant a lower withholding rate under the APA.

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The amount at issue was substantial. Starr was one of the largest shareholders in AIG. It received about $190 million in dividends. The US has treaties with many countries; those treaties generally provide exceptions or reduction to the default 30% withholding on some US sources of income, including dividends. The US Swiss treaty reduced withholding to either 5% or 15 %, depending on the Swiss entity’s ownership of the US corporation.

Most treaties have some form of anti-treaty shopping provisions that are meant to ensure that only bona fide residents of contracting states can take advantage of the treaty. The Swiss treaty has such a provision, Article 22, which, according to the treaty’s technical explanation (sort of treaty analogue to legislative history, which Treasury staffers draft and present to the Senate during the Senate’s treaty ratification process), denies treaty benefits to those who establish “legal entities . . . in a Contracting State with a principal purpose to obtain [treaty] benefits.”

Article 22 has a number of objective tests; an entity can establish that it is a bona fide resident if it meets any of the objective tests. The treaty recognized, however, that a party might be entitled to treaty relief even if it were unable to satisfy any of the objective tests. To effectuate that policy, the treaty provides:

A person that is not entitled to the benefits of this Convention pursuant to the provisions of the preceding paragraphs may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.

It was this discretionary benefit position that was at issue in Starr International. For international tax folks, the opinion has an important discussion of the precise contours of the anti-treaty shopping provision; Starr wanted a more mechanical approach to the issue but the opinion agreed with the government that the test is one that pivots off of a finding that the party seeking the benefits “has or had as one of its principal purposes the obtaining of [treaty] benefits.”

After agreeing that the treaty rule revolves around a principal purpose analysis, the court turned to the APA. Under the APA a reviewing court must “hold unlawful and set aside agency action, findings, and conclusions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 USC 706(2). As we have discussed, this is generally a deferential standard; the opinion, citing the Supreme Court State Farm decision, notes that by way of example that “[a]gency action is arbitrary and capricious…if the agency ‘entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view or the product of agency expertise.’”

In arguing that the Competent Authority decision was arbitrary and capricious, Starr essentially made two main points: the Competent Authority considered irrelevant information and failed to consider the relevant information.

In finding that the Competent Authority did not consider irrelevant information, the opinion squarely addresses how much it should consider Starr’s prior moves. One of the main points Starr made was that its move to Switzerland was from Ireland, which had an automatic treaty reduction; in other words, it could not have had a principal purpose to get treaty benefits if it moved from a jurisdiction where it already was entitled to benefits. The government noted that Starr had moved previously, and wanted to consider the entity’s history of moving as to show that tax was often a if not the main reason for location.

The court agreed with the government, looking mainly to the treaty’s explanation:

[Starr’s] argument, however, assumes a much narrower inquiry than is called for by the Technical Explanation, which directs the Competent Authority to determine “whether the establishment, acquisition, or maintenance” of a company in the relevant jurisdiction had a principal purpose of obtaining treaty benefits. Technical Explanation 72. Notably, the Explanation does not direct the Competent Authority to ask merely what made a company’s current jurisdiction more favorable than its previous one—although that might be part of the analysis—but rather why a company chose to “establish” or “maintain” itself where it did. In other words, here the question was not simply why Starr chose Switzerland over Ireland, but rather why Starr chose Switzerland over any other jurisdiction where it might have moved.

This broader inquiry required not just a look at Starr’s recent move, but also its overall history of moves.

Starr also argued that the Competent Authority failed to consider the implications of how other bilateral treaties automatically allow treaty benefits to similarly structured entities (a for profit company owned by a charitable entity). Starr argued that there was strong evidence that the US and the Swiss did not consciously exclude that structure from benefits. The opinion gives short shrift to this point:

This argument is a nonstarter. Starr essentially asks the Court to find that the Competent Authority acted arbitrarily and capriciously because it failed to definitively conclude that the text of the U.S.-Swiss Treaty should be overwritten by text in other bilateral tax treaties, and because there is no legislative history to the contrary. But “[t]he interpretation of a treaty, like the interpretation of a statute, begins with its text.” Starr I, 139 F. Supp. at 226 (quoting Abbott v. Abbott, 560 U.S. 1, 10 (2010)). So at the very least, it was not unreasonable for the Competent Authority to decline to read into the treaty a provision that was not there. Moreover, it bears emphasizing that the Competent Authority reached no conclusion one way or the other on the matter, and therefore the analysis appears not to have grounded its final determination. It is therefore misleading for Starr to characterize it as a “justification,” although perhaps accurate to call it “irrelevant.”

Conclusion

On the merits, the opinion is a major victory for the government. Yet it is  an important procedural victory for taxpayers. It is another defeat of the reflexive government argument that some of its decisions are completely insulated from court review. It also is a roadmap for showing how parties can use the APA to challenge the somewhat murky world of Competent Authority decisions under treaties.

Starr v US and The Power to Confer Discretionary Treaty Benefits: Part 1

It is not often that the courts wrestle with the application of discretionary treaty provisions. Earlier this month, in Starr International v US , a DC federal district court found that the Competent Authority did not act arbitrarily or capriciously in denying discretionary relief under the U.S.-Swiss Treaty. In today’s post, I will  discuss the jurisdictional battle that led to last week’s opinion. I will follow up in Part 2 with a discussion as to the court’s application of the APA to the treaty claims.

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In 2015, in District Court Hands IRS Loss in its Bid to Exclude Discretionary Treaty Benefits From Judicial Review I discussed the fight between The Starr International Group and the IRS over Starr’s efforts to get the benefits of discretionary treaty relief that would have reduced US withholding on AIG dividends. Much of the post discussed the government’s unsuccessful efforts to convince the court that the decision was not subject to court review. That opinion, and my post, discusses why there is a strong presumption against unfettered agency discretion.

Following that setback, the government asked the court to reconsider. In a 2016 opinion, the government did get a victory, of sorts. Despite reaffirming its earlier conclusion about the court’s power to review the IRS’s decision to not grant discretionary treaty relief, the District Court held that separation of powers principles meant that it could not order a monetary refund for Starr even if it felt that the US competent authority improperly applied that the anti-treaty shopping provisions of the US –Swiss tax treaty.

The 2016 opinion explored the  limits of the court’s powers. In so doing, it discusses how in treaties there is a consultation process between the contracting states following one state’s Competent Authority determination that a party is entitled to discretionary treaty relief.  That consultation is an executive branch function. As such, the 2016 opinion concludes that the courts are unable  to mandate that a party is entitled to receive a refund based on a claim that there was an improper application of a discretionary tax treaty provision. On that point, the opinion was clear:

To determine that Starr is entitled to a certain sum of benefits, the Court would be forced to step into the shoes of the IRS and its Swiss counterparts and effectively preordain the outcome of any consultation between the two. This a court may not do.

Yet in that 2016 development the district court concluded that Starr could bring a claim under the APA seeking to set aside the U.S Competent Authority’s determination and that if Starr “prevailed on that claim, [it] would be entitled … to have the matter remanded to the U.S. Competent Authority for further action” consistent with the Court’s opinion.

The 2016 opinion nicely summarizes how the APA provided jurisdiction over Starr’s dispute:

The APA makes “final agency action for which there is no other adequate remedy in a court … subject to judicial review.” 5 U.S.C. § 704. The government concedes that the Competent Authority’s decision constitutes final agency action. And if the Court were to hold that Starr could not challenge the decision through a claim brought under the tax-refund statute, then no other adequate remedy would exist, and review under the APA would be proper. Cf. Cohen v. United States, 650 F.3d 717, 736 [108 AFTR 2d 2011-5046] (D.C. Cir. 2011) (en banc) (directing the district court to consider the merits of an APA claim against the IRS when plaintiffs had “no other adequate remedy at law”).

In allowing Starr to bring a claim under the APA, the 2016 opinion acknowledged that Starr’s ultimate goal was a refund, not just an academic finding that the Competent Authority acted improperly. Yet, the opinion paved the way for the Starr Company to amend its complaint to bring the APA claims and suggested that such a finding might in fact lead to a refund (or at least a consultation about a refund):

As the Court has explained, however, monetary relief of any sort is unavailable to Starr without improper judicial intervention into the consultation process….

The Court declines to assume, however, that Starr would forgo an opportunity simply to have the Competent Authority’s decision set aside as arbitrary, capricious, or an abuse of discretion. Indeed, as the government recognizes, remanding to the agency for further consideration is the norm when a court sets aside an agency’s action. And this relief is not illusory. Regardless of whether the Court possesses the authority to order the IRS to engage in consultation, counsel for the IRS has represented—and the Court would fully expect—that the IRS would not decline to consult with the Swiss in the event that the Court found that the IRS abused its discretion and remanded to the IRS, and the IRS otherwise preliminarily determined that Starr qualified for treaty benefits. Hr’g Tr., ECF No. 34, 42:8-18. The Court thus will not deprive Starr of the opportunity to seek this form of relief under the APA. It will grant Starr leave to amend its complaint to bring such a claim.

Starr dutifully amended its complaint to include APA claims. This led the district court in an opinion earlier this month to apply the APA to the Competent Authority’s decision to deny treat benefits. In Part 2 of this post, I will discuss the court’s analysis as to why under the APA the Competent Authority did not act improperly in finding that the discretionary treaty benefits did not apply to reduce withholding on the AIG dividends.

 

 

Summer Reading: Tax Compliance And Small Business Taxpayers

The Wall Street Journal ran an interesting article last week, Number of Americans Caught Underpaying Some Taxes Surges 40% [$]. The main point in the story is that with the increase in the gig economy many more Americans are left on their own to pay estimated taxes. Many are not complying. The WSJ reported that from 2010 to 2015 there was an increase of about 40% in the number of people penalized for underpaying estimated taxes.

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It is easy to understand why. Without the benefit of withholding that comes with traditional paychecks and in many cases also without information reporting that can remind people that Uncle Sam is looking, there are many challenges to staying on the right side of the tax law.

A report last year from the American University Kogod Tax Policy Center called Shortchanged: Tax Compliance Challenges of Small Business Operators Driving the On-Demand Platform Economy gives the issue a deep dive.

The Kogod Report is terrific. It is well researched. It provides background on the rapid growth of this segment of the economy, with companies like Uber, Airbnb, Etsy and many others pushing Americans into the uneasy tax perch of small business owners. One of the main points in the study is that the tax code is a 20th century code poorly matched with the 21st century economy. Add to the mix a 20th century mode of tax administration and many Americans are ill-equipped to keep records and understand how the law applies to their situation. This all leads to a major tax administration headache.

What I found most interesting in the report is the survey it conducted of about 50 small business owners. While the survey is not meant to be a statistically reliable sample (and in fact may reflect a greater sophistication as all responders were in the National Association of Self Employed) it did provides some insight into many challenges this group faces:

At best, these small business owners are shortchanged when filing their taxes; at worst, they fail to file altogether. Approximately one- third of our on-demand platform operator survey respondents didn’t know whether they were required to pay quarterly-estimated payments and almost half were unaware of any available deductions, expenses or credits they could claim to offset their tax liability. These taxpayers face potential audit and penalty exposure for failure to comply with filing rules that are triggered by relatively low amounts of earned income. Compounding this problem is inconsistent reporting rule adoption that results in widespread confusion among taxpayers

I tip my cap to one of the headings in the report (They Got 1099 Problems and Withholding Ain’t One). The Report and the WSJ article tell of one of the main shortfalls in the US tax reporting system for platform players. Essentially reporting is only required if payments are made via credit card or debit card, and the aggregate number of transactions to one service provider exceeds 200 and the payments exceed $20,000. Absent exceeding both requirements then companies that process credit card payments on behalf of individuals in the gig economy are not required to issue a 1099. Of course, the absence of a 1099 does not mean that the service provider does not have to report income but the absence of reporting leads to either mistakes or intentional non reporting.

Some of the platform players in the economy, like Uber, issue a 1099 even if the service provider does not meet both the 200/20K tests (an earlier WSJ article talks about this; see The Blind Spot in a Sharing Economy: Tax Collection $).

As the report discusses, employment and income tax liabilities, with penalties, can snowball. Not surprisingly, the National Taxpayer Advocate has been on this issue; for example, her testimony last year before the House Committee on Small Business touches on these issues, and lots more, including employee classification issues. She also adds a number of proposals to increase compliance, including changing estimated tax and backup withholding rules for taxpayers with poor compliance history and an increase in IRS education efforts to get people on the right path.

Tax administrators, scholars and legislators have taken note. IRS has put up the Sharing Economy Tax Center on its web page, and there are legislative proposals to change the 200/20,000 rule to trigger mandatory reporting at lower thresholds. UC Hastings Law Professor Professor Manoj Viswanathan has a new article called Tax Compliance in a Decentralizing Economy that addresses some of these issues (I have not yet read though am looking forward to it). Our blogging colleague BC Law Prof Diane Ring at Surly Subgroup also discusses the sharing economy in a post today highlighting worker classification issues. With her BC colleague Shu-Yi Oei Diane co-authored Can Sharing Be Taxed, an article that was in Wash U Law Review last year that also looked at the sharing economy, including reviewing some of the compliance problems implicated in today’s post.

As the Kogod Center reports, it is likely that this part of the economy will grow rapidly in the next few years so one can expect a great deal more attention on the issue.