Villanova Seeks to Hire Faculty Director of Graduate Tax Program

Villanova is seeking to fill a faculty position and is in the process of a national search for a new Faculty Director of the Graduate Tax Program. The Graduate Tax Program is jointly run by the Law School and School of Business, and offers a Masters of Laws for lawyers and Masters in Tax for accountants.

The program is innovative and includes an extensive suite of online classes and classes on the ground. Villanova is looking for an experienced practitioner with teaching experience and management skills.

More information about the position as well as information on how to apply can be found here.

District Court Holds That Premature Withdrawal from Retirement Account Under Threat of Levy Subject to 10 Percent Additional Tax

In this post I will discuss Thompson v US, an opinion from the Northern District of California that explores the limits to an exception to the 10% penalty on early withdrawals from tax favored retirement plans when the distribution is used to pay an assessed federal tax liability on account of a levy.

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The facts of Thompson are straightforward. Facing a significant tax liability and “under imminent threat of levy and lien collection by Field Collections,” the Thompsons withdrew over a million dollars from a retirement account.  There are a number of exceptions to the additional 10% tax on levied on the gross distributions from a retirement plan. The most commonly known is the exception for distributions after an employee turns 59 1/2; another is found in Section 72(t)(2)(A)(vii), which provides that the 10% additional tax does not apply if the distribution is “on account of a levy under Section 6331.”

The Thompons paid the tax and filed a claim for refund, arguing that they were not subject to the early distribution additional tax under the Section 72(t)(2)(A)(vii) “on account of a levy” exception.

After IRS rejected the claim and the Thompsons sued for a refund in federal court, the government filed a motion to dismiss, arguing that the Thompsons’ withdrawal was voluntarily made and thus not “on account” of a levy and thus outside the exception in 72(t)(2)(A)(vii). The Thompsons in response did not deny that there was no actual levy, but instead argued that the government “took all the legally required steps to set in motion a levy, issuing Final Notices/Notices of Intent to Levy on December 12, 2012.” In addition, facing the threat of a Notice of Federal Tax Lien, which posed a “threat to Mr. Thompson’s business, his livelihood and his ability to generate funds sufficient to pay the balance of the liability over time,” meant that the withdrawal was not truly voluntary and and therefore should not be subject to the penalty.

For support, the Thompsons pointed to Murillo v Comm’r, where there was a distribution from a retirement plan that arose due to a forfeiture order and the Tax Court held that the taxpayer was not subject to the penalty, and to an earlier case, Laratonda v Comm’r, where the Tax Court, prior to the statutory exemption for levies now found in Section 72(t)(2)(A)(vii), found that a taxpayer whose funds from a retirement account were withdrawn pursuant to an IRS levy was not subject to the penalty.

The district court distinguished the Thompsons’ facts from the exception the Tax Court fashioned in Murillo and Laratonda:

Plaintiffs rely on the court’s emphasis on the involuntary nature of the withdrawals in Murillo and Laratonda in support of their assertion that they have stated a valid claim. Yet the limited facts alleged here are distinguishable from both Murillo and Laratonda in a crucial respect. Here, Plaintiffs’ retirement account was not, in fact, levied and the distribution was triggered not by any act of the IRS but by Plaintiffs’ own acts. In other words, Plaintiffs were actively involved in the distribution.

For good measure the district court noted that the legislative history to Section 72(t)(2)(A)(vii) explicitly referred to the exception as not applying to voluntary withdrawals to pay in the absence of an actual levy, as well as a 2009 Tax Court case, Willhite v Comm’r, which held that a taxpayer who had withdrawn funds from a retirement account following receipt of a notice of intent to levy was subject to the 10 % penalty.

Conclusion

In finding for the government and granting dismissal of the complaint, the district court did, however, throw a lifeline to the Thompsons. It noted that cases like Murillo suggest that there “may be circumstances other than a levy (for instance, a forfeiture) where a withdrawal is involuntary and therefore does not trigger the 10% penalty under § 72(t).” While noting that the Thompsons did not allege facts to support a plausible inference that the exception applies, it dismissed the complaint without prejudice, meaning that the Thompsons can file an amended complaint, which could include facts that would support such an inference.

In dismissing the complaint the district court held that it “need not decide at this juncture whether Plaintiffs might be able to state a claim based on allegations that the withdrawal was involuntary and coerced for reasons other than the fact that the IRS had set in motion a levy.”

I suspect that the Thompsons may have a difficult time navigating the narrow exception that Murillo supports. The issue of avoiding the 10% additional tax based on the levy exception is one Keith discussed most recently here, when he updated readers on Dang v Commissioner, involving a taxpayer who requested that IRS levy on his retirement account to ensure that the 10% tax did not apply. That post generated thoughtful comments, and Joe Schimmel suggested that perhaps IRS should draft a revenue procedure that allows the taxpayer to elect a levy on a retirement account. If the IRS listened to Joe that would have allowed the Thompsons to avoid what seems like a fairly punitive result of paying what amounts to an additional fairly harsh penalty for their tax troubles–admittedly of their own doing.

One other issue that the Thompons apparently did not raise is whether Section 72(t) is a penalty for purposes of Section 6751(b). As one might expect, another of our longtime readers and pioneer on this issue, Frank Agostino (joined by Malinda Sederquist) has weighed in on this in the latest issue of the Monthly Journal of Tax Controversy. Frank and Malinda point to analogous authority in the bankruptcy context, which has held that Section 72(t) is a penalty for purposes of determining priority status, and they recommend that taxpayers challenge the Section 72(t) 10% addition under Section 6751(b). Frank and Malinda do note that there is a summary non precedential Tax Court opinion holding that Section 72(t) is not a penalty for purposes of Section 6751(b) and they also acknowledge El v Commissioner, a 2015 opinion that held that Section 72(t) is not a penalty for purposes of Section 7491(c).

Whether this can be raised by the Thompsons in an amended complaint is unclear, as they would run into a likely variance challenge if they had not raised the 6751(b) issue in their original claim. I have no doubt, however, that Frank and friends and others will be pressing this issue.

 

 

 

Challenges to Regulations Update: Government Withdraws Appeal in Chamber of Commerce and New Oral Argument Set for Altera

One of the more interesting cases from last year was Chamber of Commerce v IRS, where a federal district court in Texas invalidated temporary regulations that addressed inversion transactions. The case raised a number of interesting procedural issues, including the reach of the Anti-Injunction Act and the relationship between Section 7805(e) and the APA.

Not surprisingly, the government appealed Chamber of Commerce. Over the summer, Treasury issued final regs that were substantively similar to the temporary regs that the district court struck down, and then the government filed a motion with the Fifth Circuit to dismiss its appeal with prejudice.

Last month the Fifth Circuit granted the motion.

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The outcome in Chamber of Commerce illustrates the difficulty that taxpayers face when challenging regulations for process violations (i.e., failing to subject guidance to notice and comment) and in particular challenges to temporary regulations. After all, Treasury can (and did in this case) issue final regs, and Section 7805(b) provides that those regs take effect retroactively upon the earlier of the “date on which any proposed or temporary regulation to which such final regulation relates was filed with the Federal Register” or “the date on which any notice substantially describing the expected contents of any temporary, proposed, or final regulation is issued to the public.”

Chamber of Commerce is to be contrasted with challenges to regs that focus on the substantive way that the regulations interpret a statute; for example, earlier this summer the DC Circuit reversed the Tax Court in Good Fortune Shipping.There, the DC Circuit applied Chevron Step Two and held that Treasury regulations that categorically restricted an exemption to foreign owners of bearer shares unreasonably interpreted the Internal Revenue Code. The taxpayer in Good Fortune challenged the reg the old fashioned way– in a deficiency case as contrasted with the pre-enforcement challenge in Chamber of Commerce.

Probably the most watched procedural case of the year, Altera v Commissioner, also tees up a procedural challenge to regs, and like Good Fortune is also situated in a deficiency case. One of the main arguments that the taxpayer is raising in Altera is a cousin to the challenge in Chamber of Commerce; that is the taxpayer is challenging the way that the reg was promulgated (and the case also involves a Chevron Step Two challenge). In particular, the issue turns on whether the agency action [the regulation] is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 USC 706(2)(A). Altera involves Treasury’s compliance with § 706 of the APA as expanded on in the 1983 Supreme Court State Farm’s “reasoned decisionmaking” understanding of the clause prohibiting “arbitrary” or “capricious” agency action.

As Keith flagged a few weeks ago, after the Ninth Circuit reversed the Tax Court and found that Treasury did enough in its rulemaking and held that the cost-sharing regulation was valid, the Ninth Circuit withdrew the opinion. The Ninth Circuit has now scheduled a new oral argument in Altera for October 16.

Stay tuned.

In Major Victory for IRS DC Circuit Upholds IRS Annual Filing Program

In a major victory for IRS, in AICPA v IRS, the DC Circuit upheld the voluntary annual filing season program. The annual program allows unenrolled preparers to take a competency test and satisfy continuing education requirements in exchange for limited representation rights before Exam and publication in the IRS’s database of preparers, along with enrolled agents, CPAs and attorneys. The opinion reaches the merits of the IRS’s authority to create the annual program. In a prior opinion, the district court had found that AICPA did not have standing to bring the action that challenged the program. The DC Circuit, by reaching the merits of AICPA’s challenge, analyzed the reach of Loving and whether the program was a legislative rule that should have been issued via regulations rather than via a revenue procedure.

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To get to the merits of the dispute the DC Circuit reversed the lower court on statutory standing.  The lower court held that AICPA did not have standing to bring the challenge. The DC Circuit felt that the additional supervisory responsibilities of CPAs and other licensed preparers, and the concomitant possibility that failing to supervise those preparers may bring sanctions under Circular 230, meant that AICPA had enough skin in the game to challenge the program.

The real importance of this decision is twofold:  first, the majority opinion takes a somewhat limited read of Loving, and second, in finding that the program is not a legislative rule for APA purposes and thus was not required to be issued under the APA notice and comment regime, the opinion provides cover for other IRS actions that the IRS may argue are merely interpretive and thus not subject to notice and comment.

As to the AICPA view that the annual program was a backdoor way to avoid Loving and regulate return preparation, the court disagreed, emphasizing that the rules allow for establishing competence in representing taxpayers in the exam process rather than regulate return prep per se:

We see nothing in the Program that attempts to resurrect regulations of the type enjoined in the Loving decisions. Unenrolled tax preparers who participate in the program “consent to be subject to the duties and restrictions relating to practice before the IRS in [certain sections of] Circular 230,”id. § 4.05(4); they do not consent to be governed by Circular 230 insofar as they are engaged in the business of tax preparation.

The Program also ties violations of Circular 230 to the limited practice right, not to the preparation of tax returns: Record of Completion holders “who violate Circular 230 during the course of [their] representation [before the IRS]will have their Record of Completion and ability to represent a taxpayer before the IRS under this revenue procedure revoked.” Id. § 7.01(2). When seen in this light, it is clear that the participants’ commitment to follow Circular 230 is coextensive with the IRS’s authority under § 330(a) to regulate practice before it.

The issue that generated a spirited dissent was whether the program required notice and comment. This case is another in a line of cases where courts (mostly in the nontax context) have struggled to define what in fact is a legislative rule which, under the APA, requires notice and comment, as compared to an interpretive rule that is not required to be issued through notice and comment. Here, that was a crucial issue because the IRS served up these rules via a revenue procedure, rather than via regulations. AICPA argued that the program was in fact a legislative rule and the IRS failure to comply with notice and comment meant that it was improperly established.

The majority’s view that the rules were not legislative stemmed mostly from the voluntary nature of the program:

In this case the Revenue Procedure and associated Program do not bind unenrolled preparers at all; the Program merely provides an opportunity for those unenrolled preparers who both choose to participate and satisfy its requirements.

As to the argument that the rules imposed new burdens on supervisors (more akin to a legislative rule), the majority noted that supervisors had responsibilities under Circular 230 prior to the program, and that the opt in to Circular 230 for the unlicensed preparers who take the annual program does not extend to additional supervisory responsibilities pertaining to return preparation:

Nor does it impose any new or different requirement upon supervisors or unenrolled agents; Circular 230 bound supervisors and unenrolled agents before the Program took effect and continues to bind them now. [note omitted]

In further finding that the rule was interpretive, the majority took a dig at IRS for not being clearer in its revenue procedure that it meant to illustrate the meaning of the statutory term competence:

The AICPA also argues the Revenue Procedure cannot be an interpretive rule, and in its view therefore must be a legislative rule, because it “contains not a word of the reasoned statutory interpretation … that typifies an interpretative rule.” We disagree, although we acknowledge the agency could have been more clear. By clarifying how an unenrolled preparer seeking to practice before the IRS may “demonstrate … necessary qualifications … and competency” within the meaning of § 330(a), the Revenue Procedure “reflects an agency’s construction of a statute that has been entrusted to the agency to administer.” Syncor Int’l Corp. v. Shalala, 127 F.3d 90, 94 (D.C. Cir. 1997); see Interport Inc. v. Magaw, 135 F.3d 826, 828-29 (D.C. Cir. 1998) (holding a rule interpretive where “it explains more specifically what is meant” in another authority, in that case a legislative rule). As stated above, the Program requires unenrolled preparers who want to participate to complete a set number of hours of instruction, on specific topics, and pass a test before gaining the limited practice right. See REV. PROC. 2014-42 §§ 4, 6. Those requirements are the agency’s interpretation of what § 330(a) means by “competency” and the other criteria it lists. [footnote omitted]

The dissent focused on two main issues: first, it noted that the IRS power to allow unenrolled preparers limited rights in examinations initially arose via regulations that were issued with notice and comment, and changes to those rules likewise had to follow from notice and comment. Second, it argued that the majority opinion failed to appreciate the reach of Circular 230 and its possible imposition of monetary sanctions for violations of the annual program.

Practitioners and academics will be digging in deeper on the spirited disagreement between the dissent and majority on whether the program is in fact the product of a legislative rule. The disagreement between the majority and dissent over the reach of Circular 230 (and whether the program imposes the possibility of newer sanctions on supervisors)  reminded me of Karen Hawkins’ insightful 2017 Griswold lecture, where she discussed how “because it has not been amended to reflect current case law, legislation or clarifications….” parts of Circular 230 have “become vague, ambiguous, outdated and, in some instances unadministrable.”

My quick takeaway of the case is that there is significant uncertainty in the reach of Circular 230 and the contours as to what is a legislative rule. IRS should tread carefully when establishing new programs as significant as this. IRS could have benefitted from the input that notice and comment provides, as well as perhaps given it more time to think through how the program could be more effectively administered.

Jurisdiction in the Court of Federal Claims and FBAR Cases

Yesterday, in Paying the Full FBAR Penalty, Keith discussed the Court of Claims opinion in Norman v US, which upheld an FBAR penalty and disagreed with district court opinions in Colliot and Wadhan concerning the intersection of the FBAR regs and the statute.  Keith’s post flags an important split in views concerning the intersection of regs, which cap the penalty at $100,000, and the later-enacted statute, which provides that the maximum penalty “shall be increased” to the greater of $100,000 or 50% of the account.

Keith notes that the case was tried in the Court of Federal Claims; most of the cases concerning FBAR penalties have arisen in federal district courts. There is a side jurisdictional issue in the case, and one of the reasons for the delay between the complaint being filed and the outcome Keith discussed is that the government initially argued in Norman that only federal district courts could hear FBAR cases.

Here is the statutory context of the dispute.

Title 28 Section 1355 states that “district courts shall have original jurisdiction, exclusive of the courts of the States, of any action or proceeding for the recovery or enforcement of any fine, penalty, or forfeiture, pecuniary or otherwise, incurred under any Act of Congress, except matters within the jurisdiction of the Court of International Trade under section 1582 of this title.”

The Tucker Act is also found within Title 28 and waives the federal government’s sovereign immunity from suit and authorizes monetary claims “founded either upon the Constitution, or any Act of Congress, or any regulation of an executive department, or upon any express or implied contract with the United States, or for liquidated or unliquidated damages in cases not sounding in tort.”  The Court of Federal Claims has trial court jurisdiction over “Big” Tucker Act claims against the United States; district court and the Court of Federal Claims have concurrent jurisdiction over claims for $10,000 (so-called Little Tucker Act claims)

In 2016, the government argued in effect that the Tucker Act was preempted by Section 1355 and sought to dismiss Norman’s complaint; the Court of Federal Claims disagreed, finding that 1355 was not meant to give district courts jurisdiction in all penalty cases and also finding that the FBAR penalties in Title 31 did not reflect a “specific and comprehensive scheme for administrative and judicial review” which could also displace its jurisdiction under the Tucker Act.

The 2016 Norman opinion discusses a handful of cases applying 1355 that limit the Court of Federal Claims’ jurisdiction; ultimately it distinguished those cases from Norman as relating to either forfeiture cases or criminal cases.  There is a bit more to the issue, including a 9thCircuit case that suggests that 1355 is only meant to apply when the government is reducing a penalty to judgment. The 2016 Norman opinion did note that there was tension between Section 1355 and the Tucker Act, and substantial ground for difference of opinion in its view that the CFC had jurisdiction, leading it to conclude that the government could file an interlocutory appeal on the jurisdictional issue, which would have allowed for an appellate opinion on that issue before a trial on the merits.

That appeal never came, as the government abandoned its jurisdictional defense. While the government lost the battle in 2016, as Keith discussed, it won the war of the case—at least for now. One expects that Mrs. Norman may try her luck for an appellate review on the merits of the penalty, and see if the panel agrees with the two district court judges that have capped the penalty in line with the regulations. In addition, if Norman appeals one suspects that the circuit court may take a fresh look at the jurisdictional issue.

 

TIGTA Criticizes IRS Efforts at Curbing Preparer Misconduct

TIGTA reports are, by their nature, often critical of IRS performance. IRS Lacks a Coordinated Strategy to Address Unregulated Return Preparer Misconduct details TIGTA’s view that IRS is not doing enough to curb preparer misconduct.

There is a lot in this report. It lays out the recent history of IRS efforts; starting in 2009 with the ill-fated plan to regulate unlicensed preparers via compliance and background checks, qualifying examinations and continuing education requirements. When Loving struck down the 2009 rules, IRS pivoted and the TIGTA report discusses in detail the IRS procedures at SB/SE for examining preparers and the sanctions that IRS can bring on unscrupulous or incompetent preparers even in the absence of the direct oversight.

The main takeaway from the report is that IRS does not have a consistent national return preparer strategy. As the report details, IRS stated that its “overall strategy for addressing preparer misconduct was generally to use the tools at the IRS’s disposal as effectively as possible within resource constraints to improve tax compliance by increasing the accuracy of tax returns and holding tax return preparers accountable for misconduct.” Post-Loving, IRS has shifted resources to a relatively undersubscribed voluntary program for unenrolled preparers while the vast majority of unenrolled preparers continues to operate outside direct oversight.

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TIGTA takes direct issue with IRS claims to address the issue “as effectively as possible.” Starting from a macro perspective, TIGTA notes that there is no evidence of a coordinated IRS strategy; and little in writing that could serve as a blueprint for efforts to address unenrolled preparers. While SB/SE has the main responsibility for addressing preparer misconduct, its Business Performance Review documentation in recent years barely mentions the Return Preparer Coordinator functions in the seven main geographic areas; it also has little discussion of Lead Development Centers, which are the hubs for reviewing referrals of preparer misconduct.

The report goes into great detail as to how this lack of strategy manifests itself in particular problems. Here are some of the highlights:

Limited Priority in Exams: TIGTA notes the relative scarcity of focused preparer examinations (called PACS, or Program Action Cases) in recent years; for example in FY 2016 there were only 140 developed PACs compared to Criminal Investigation’s 248 investigations and 204 indictments in the same period.  As TIGTA notes, the lesser number of civil cases “is unexpected given the respective resources of these two IRS functions, as well as the intensive nature of criminal investigations versus civil penalty cases. The SB/SE Division Examination function has approximately 6,500 revenue agents and tax compliance officers compared to Criminal Investigation’s nearly 2,200 special agents.”

Inconsistent Criteria and Limited Impact For PAC Referrals: TIGTA criticized the differing approaches to focused preparer examinations in the seven geographical areas, with some areas focusing on high refund rates and others looking to numbers of taxpayers connected to a preparer. That contributes to a lack of a national approach to the issue of preparer oversight.Furthermore, TIGTA noted that the preparer exam impact  is often limited as IRS often failed to examine all of the identified preparer’s tax returns.

Assessment of Penalties Not Maximized: The report examines the failure to assess penalties when conduct may have warranted them. For example, it discusses a lack of PTIN penalty enforcement. TIGTA notes that “if penalties had been proposed when the invalid PTINs were identified, more than $122,747,250 could have been assessed, yet only 215 penalties were assessed for all of I.R.C. § 6695(a)-(e) penalties, inclusive of § 6695(c) penalties, totaling $1,572,055 which is 1 percent of the potential penalty assessment for just one of the possible violations.”  Of course, assessing more penalties against a group such as bad preparers in no way guarantees collection of the penalties assessed as discussed in the next section.

Collection of Preparer Penalties is Minimal: TIGTA notes that IRS no longer prioritizes collection of return preparer penalties. TIGTA notes that from CY 2012 to CY 2015, the IRS collected just $46.3 million (15 percent) of the $317.2 million of penalties assessed on individual return preparers; the numbers are even worse for penalties assessed against preparers failing to put a PTIN on returns, with IRS collecting just 8% of those penalties in 2016.  Prioritizing collection from this group would not necessarily ensure a higher return.  Collection may have directed their limited resources to persons more likely to have the ability to pay.

RPO Doing Little to Combat Unregulated Preparer Misconduct:The report discusses the efforts of the IRS Return Preparer Office following Loving. It is not a pretty picture.

The Return Preparer Office, which was originally established to lead the now defunct regulatory effort, is still in existence but now primarily focuses its efforts on tax professionals and those few tax return preparers who volunteer to be subject to certain annual training. The Return Preparer Office checks tax compliance for tax professionals but not for most unregulated preparers. More than 26,000 Preparer Tax Identification Number recipients acknowledged being tax noncompliant. Additionally, while preparing tax returns without a Preparer Tax Identification Number is subject to a penalty, the penalties are assessed on a limited ad hoc basis. In Processing Year 2016, the IRS failed to assess $121,175,195 in Preparer Tax Identification Number penalties.

TIGTA notes that a main part of RPO, the Suitability Office, produces limited benefits:

The resources used by the Suitability Office to conduct credentials research are not commensurate with the benefits realized. At best, preparers who have misrepresented themselves will stop after being notified by the Suitability Office. However, if the preparers continue with the behavior, the IRS is not taking additional steps to address it. The Suitability Office takes no further action if the preparer is unregulated. Even when cases are referred to the OPR, nearly all of them are closed upon receipt because the preparers are not currently practicing before the IRS and therefore, the OPR lacks jurisdiction. The appropriate function to report unregulated preparers misrepresenting themselves as tax professionals is TIGTA’s Office of Investigations.

The report notes that “an even more significant problem is that the Suitability Office no longer devotes any resources to unregulated preparers. Ensuring the tax compliance of tax preparers yields benefits to tax administration; however, the Suitability Office is only checking the status of the relatively small number of tax professionals and volunteers for the AFSP, e.g., those who present the least risk to tax administration.”

IRS Failing to Use Its Information: One of the key benefits of a uniform preparer identification number is the greater ease that the number affords the IRS to track preparer behavior. The report notes that PTINs “allow the IRS to keep track of preparers’ behavior, such as the number of returns they prepare and file, the number of returns by filing method (paper or electronically filed), returns filed with refunds, and returns filed with balances due.”

All of the IRS’ information on preparers is consolidated in the Return Preparer Database. Despite the presence of the information, TIGTA notes that IRS has failed to maximize its potential:

IRS has not yet taken full advantage of its capabilities. Much of the analyses and resulting corrective actions could be performed systemically, with minimal need for employees’ direct involvement. Expansion of the database’s capabilities could allow the IRS to identify and deter additional preparer misconduct, while also freeing employees who are currently performing manual tasks that could be performed systemically by the database.

Given the resources reductions over the past several years, it is particularly important for the IRS to continue developing and taking full advantage of its available systemic capabilities.

Conclusion

No doubt the IRS could improve its police role for return preparers.  Many of the recommendations presented by TIGTA could assist the IRS in improving this role.  The IRS has continued to push for a legislative fix to Loving – a fix that would have come quickly in past decades but not in the Congress since 2010.  The hope for a legislative fix that would allow the IRS to go back to the strategy it had finally decided to employ coupled with the diminution of resources may have something to do with the sluggish action TIGTA perceives coming out of the IRS.  Collection from bad preparers will never be easy.  The IRS will not fix the problem of bad preparers by assessing more penalties.  It needs strong tools to stop them from preparing.  Getting the return right at the outset saves the IRS and taxpayers from time consuming efforts to reconstruct a correct tax assessment.  TIGTA is right to keep reviewing IRS efforts on this important issue.  The IRS is right to keep pushing for legislation to allow it to robustly regulate preparers.  While waiting for Congressional approval, the IRS should look carefully at those suggestions from TIGTA that will allow it to shut down bad tax preparers and pay little attention to the suggestions that cause it to assess large amounts of penalties it will struggle to collect and that may not stop the bad action.

 

 

 

 

 

 

Quick Takes: Altera, Senate Finance Committee Testimony on IRS Reform

I am trying to meet a deadline before a last gasp of summer vacation in California, and I have had a little less time than usual for blogging.  Tax procedure and tax administration developments wait for no one, however, and much has been happening this week. I will briefly discuss and add some links to two major developments: the Altera case and the Senate Finance Committee Subcommittee on Tax and IRS Oversight hearing.

Altera

As I am sure many readers know, the Ninth Circuit reversed the Tax Court in the heavily anticipated case of Altera v Commissioner, a case we have blogged numerous times. The basic holdings in the Ninth Circuit case all involved the broader question as to whether Treasury exceeded “its authority in requiring Altera’s cost-sharing arrangement to include a particular distribution of employee stock compensation costs.”

The Ninth Circuit, in a divided opinion that included now deceased Judge Stephen Reinhardt in the majority, concluded that the Treasury did not. In so doing, it held that Treasury did not violate the APA in its rulemaking, and under Chevron the court deferred to Treasury’s take on the substantive issue of allocation of employee stock compensation costs.

We will have more on this decision in PT. In the meantime, here are some comments on the decision in the blogosgphere:

Dan Shaviro in Start Making Sense trumpets the 9thCircuit getting to the right outcome

Leandra Lederman in The Surly Subgroup, who like Professor Shaviro wrote an amicus arguing for reversal, succinctly summarizes the holding

Jack Townsend, who in his Federal Tax Procedure blog, in addition to linking to his excellent and free tax procedure book offers his take on the case, including his gloss on Chevron and his forecast that if the Supreme Court gets to this one there is a good chance for the Supremes “screwing it up”

Chris Walker at Notice and Comment who expresses unease about the process, especially the aspect of including as part of the majority a judge who passed away prior to the Court’s issuing the opinion

Alan Horowitz at Miller & Chevalier’s Tax Appellate blog, discussing the holding and likely petition for rehearing by the full circuit

Senate Hearing on Tax Administration

The Senate Finance Committee’s Subcommitte on Taxation and IRS Oversight had a hearing yesterday on improving tax administration.

Here is a link to the audio; witnesses, whose written testimony is linked above, were

  • Caroline Bruckner, Managing Director of the Kogod Tax Policy Center at American University ;
  • Phyllis Jo Kubey, Member of the National Association of Enrolled Agents and the IRS Advisory Council ;
  • Nina Olson, the National Taxpayer Advocate ;
  • John Sapp, the current Chair of the Electronic Tax Administration Advisory Committee advising the Internal Revenue Service, and
  • Rebecca Thompson, the Project Director of the Taxpayer Opportunity

Senator Portman’s introductory statement is here—in it he notes the 20thanniversary of the IRS Restructuring and Reform Act, and how he and Senator Cardin recently introduced the Taxpayer First Act(following the House passing its version of legislation).

The National Taxpayer Advocate blogged on the hearing, including her take encouraging “everyone who cares about improving tax administration to watch the hearing and read the testimony submitted.”

Eleventh Circuit Upholds Enforcement of Summons Relating to Law Firm and Its Clients (And Sweeps in the 1980 Miracle on Ice)

The Eleventh Circuit opinion in Presley v US ostensibly is about how IRS can summons a bank for information relating to deposits from a law firm’s clients. The opinion starts with a recounting of the 1980 Winter Olympics, when the US Olympic hockey team, against heavy odds, beat the Soviets.  Drilling into the details, the opinion includes the average age of the US team (22), links to the E.M. Swift’s Sports Illustrated article on the win, references the 2004 Disney movie Miracle, and how one of the players (Jack O’Callahan), was so moved by Coach Herb Brooks’ pregame speech that he could recount it decades later.

What is the connection between the power of the IRS to gather information from third parties and the Miracle on Ice?

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Writing for a unanimous panel, Judge Rosenbaum contrasts the uphill battle that the US hockey team faced from the battle that the plaintiffs faced:

But forget about tough odds the U.S. hockey team faced, Plaintiffs face-off with something even more formidable…

According to the opinion, more formidable than the Soviet team is the considerable power that the IRS has to get information via its summons powers. The opinion nicely summarizes the statutory framework and Supreme Court guidance that stack the deck heavily in favor of the IRS.

The facts are straightforward. The plaintiffs are a lawyer and his law firm, and they sought court protection to avoid their bank’s compliance with summonses the IRS issued in connection with an exam of Presley’s individual income tax liability.

As the opinion discusses the IRS summonses sought records “pertaining to any and all accounts over which [each Plaintiff] has signature authority,” including bank statements, loan proceeds, deposit slips, records of purchase, sources for all deposited items, and copies of all checks drawn.

Presley objected to the bank’s turning over information related to their clients’ trust and escrow accounts, arguing essentially that his clients’ Fourth Amendment expectation of privacy would be violated if the IRS obtained the information about the clients’ financial transactions with the law firm.

The opinion starts by describing that there is some uncertainty whether the law firm, rather than the clients, can make the Fourth Amendment argument. After all, it is the clients whose privacy interests are at stake. This is akin to a standing dispute; i.e., does the law firm have standing to make the case that its clients’ privacy interests may be violated?

The opinion is able to sidestep that issue, noting that unlike traditional Article III standing disputes, Fourth Amendment standing is not jurisdictional, meaning that the opinion can effectively decide the matter on the merits without weighing in on whether technically Presley can in fact make the argument.

Getting to the merits, Presley argued that in light of the clients’ privacy interests in the financial information the IRS must show probable cause to enforce the summons. The court disagreed, noting that probable cause would only be required if the clients had a reasonable expectation of privacy in the financial records.  The opinion says that there is no such expectation, referring to what is known as the third-party doctrine and citing to the 1976 Supreme Court case US v Miller (also involving an IRS summons and a bank):

[A] party lacks a reasonable expectation of privacy under the Fourth Amendment in information “revealed to a third party and conveyed by [that third party] to Government authorities, even if the information is revealed on the assumption that it will be used only for a limited purpose and the confidence placed in the third party will not be betrayed.”

Presley tried to distinguish Miller, because unlike in that case, there was an intermediary between the clients and the bank, i.e., the clients transferred money to the law firm, which then made deposits on behalf of the clients. The court found that distinction insignificant:

Nor does it matter that Plaintiffs’ clients gave their records to Plaintiffs rather than directly to the bank. Plaintiffs conveyed their records, such as checks for deposit in Presley Law’s escrow or trust accounts, knowing that the firm would, in turn, deposit these items with the Bank. So if Plaintiffs cannot escape Miller directly, Plaintiffs’ clients cannot avoid its application indirectly. In short, Miller precludes us from holding that Plaintiffs’ clients have a reasonable expectation of privacy in the summoned records.

There were two other issues of note in the opinion. Presley also argued that even if there was no Fourth Amendment requirement that the government show probable cause to ensure enforcement, the Florida constitution had a heightened privacy protection for these circumstances. The Eleventh Circuit declined to consider the impact of the Florida constitution on the reach of IRS summons powers, noting that state laws that “conflict with federal laws by impeding the ‘full purposes’ of Congress must give way as preempted,” a doctrine known as the Supremacy Clause. That has come up before in tax cases, as courts have enforced IRS summonses despite, for example, state law doctor-patient privileges.

Once dispelling with the argument that the IRS had to establish heightened probable cause to justify the summonses, the opinion rested on a traditional application of the Powell factors, which in effect is a proxy for the Fourth Amendment protection that an IRS search met the lesser standard that it not be unreasonable. Noting that Presley did not claim a conflict with Powell, and that there was no claim that the IRS was using the summons power as a subterfuge to investigate the clients or violate attorney-client privilege, the opinion found “no reason to discern why the summons should not be enforced.”

As a final argument, Presley argued that the district court failed to comply with the so-called John Doe summons procedures under Section 7609(f). That requires the IRS to go to a district court in an ex parte hearing when it seeks information about unnamed third parties. We have discussed that a few times in PT, and I discuss it heavily in Chapter 13 of Saltzman and Book, including in the context of the IRS investigation of crypto currency users.

Here, while the IRS sought information that included information about unnamed third parties (the clients), the main targets were the law firm and Presley himself, who were named on the summons and who did receive notice of the IRS actions. Moreover, the plaintiffs in Presley conceded that their clients were not the subject of the IRS investigation, unlike in the Bitcoin dispute where IRS has been trying to gather information to allow it to determine whether Bitcoin customers were complying with federal tax laws.

For good measure, additional Supreme Court precedent, Tiffany v US, allows the IRS to effectively issue dual purpose summonses that could also provide information about unnamed third parties, provided that the IRS complies with the notice provisions under Section 7609(a)—which it did here.

Taken together, the defenses that the government mustered were more formidable than Vladislav Tretiak, and the bank will have no choice but to comply with the summons and I doubt there will be a Disney movie about this story.