One Hake of a Taxpayer Friendly Reasonable Cause Holding

And, could this be heading to SCOTUS?

The District Court for the Middle District of Pennsylvania just issued a holding in Hake v. United States regarding the reasonable cause exception for the failure to file penalties for executors who failed to file due to bad advice from their lawyer.  This was a fairly taxpayer friendly opinion, following somewhat closely on the heels of the Thouron case in the Third Circuit, which we covered heavily here.  While Thouron could have been limited, somewhat, to its facts, the Hake opinion applied the case broadly, allowing taxpayer reliance on an advisor to eliminate penalties.  Longtime PT readers will know that I dislike the framework from Boyle regarding reasonable cause for reliance on an expert in this area (but other practitioners disagree, including other PT authors).  Our readers will also likely recall that I was fairly heated in my harsh words against the Eastern District’s decision in Thouron before it was reversed by the Third Circuit.  Although I think allowing reasonable cause is the right thing to do for the Hakes, the case isn’t nearly as strong for reasonable cause as Thouron was, at least in my mind.  So, why do I think the Hakes got lucky (or more specifically their lawyer)?

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Mrs. Hake died in October of 2011 after a period of incapacitation, holding substantial assets including a closely held grocery store chain.  Her five children apparently did not agree on much, and that included the administration of her estate and the value of the assets.  Two of her five children, Ricky and Randy, were named executors, and hired the family lawyer to act as estate and tax counsel.  Normally, the estate tax return, Form 706, would have been due nine months following the date of death, in July of 2012. See Section 6075(a).  Due to the disagreements between the family, it was believed that they would not know the actual values of the estate assets at the filing deadline.

The attorney suggested filing a Form 4768 to obtain an extension of time to file the return and pay the tax due.  In June of 2012, the request for extension was filed.  An associate in the office was tasked with determining the extension, and informed the primary attorney, who in turn informed the client, that the filing deadline and the payment deadline had both been extended by a year.

But, that isn’t really a thing.  The estate had received a six month automatic filing extension, and a one year discretionary extension for payment.  This fact didn’t make it to the executors, who thought they were doing substantial good by prepaying the tax in February of 2013 ( about a month after the return was due) and in July the return was filed.  In August of 2013, the Service notified the estate that about $198k of penalties were due for failure to file a timely return under Section 6651, along with $17k in interest.  The estate took administrative steps to seek abatement, but eventually had to pay the tax due.  It then filed a refund suit in the District Court.

As the court stated, the issue was narrowly defined:

When an executor relies upon inaccurate advice from legal and tax counsel regarding the extended deadline for filing an estate tax return, in a factual context where determination of filing and payment deadlines are governed by a series of mandatory and discretionary rules which may vary depending upon the residence status of the taxpayer, does that reliance upon professional advice constitute reasonable cause to avoid the assessment of late filing penalties and interest?

The Court found that yes, it did constitute reasonable cause, which I applaud, and, as I have said repeatedly in the past, in this particular situation I do not think penalties should be imposed on the estate.  However, this is not in line with most of the case law.  The holding does follow the Third Circuit opinion in Thouron, as discussed below, but this fact pattern pushes the boundaries of the Supreme Court’s holding in Boyle further than Thouron did.

To begin the legal analysis, the court covered the general law, including that a six month extension is allowed under Reg. 20.6075-1 for filing, and that an extension to pay is allowed for up to a year under Reg. 20.6081-1(b).  Pursuant to Section 6081(a), however, the IRS is limited in allowing extensions beyond six months for failure to file (unless the taxpayer is outside of the country).

The Court characterizes this extension in an interesting way, stating:

 thus, with respect to payment and filing deadlines, the legal terrain requires subtle multi-faceted analysis. First, one must determine the initial filing and payment deadlines.  Next one must negotiate a series of deadline extensions rules.  Some of these extensions are automatic; others are discretionary.  Further, one must be alert to the fact that the application of these differing rules can lead to different deadlines for payment and filing.  Finally, one must remain mindful of the fact that the filing rules themselves change depending upon residency status of the executors.

The language is clearly framing this as a difficult issue that lay persons generally would not be capable of figuring out, which is not always how the discussions begin in cases following Boyle.    As our readers know, the failure to file penalty has an exception when such failure was due to reasonable cause and not willful neglect. Section 6651(a)(1).  SCOTUS outlined the general test for executors seeking to show reasonable cause in United States v. Boyle when relying on a tax professional.

The District Court discussed Boyle, but largely through the context of Thouron v. United States, the 2014 Third Circuit failure to pay case, which found the executor had reasonable cause for failing to timely pay estate tax because of his reliance on a tax professional regarding the extended deadline.

At the outset, it is important to note that most courts, practitioners, and commentators believe the failure to pay case law and the failure to file case law is largely interchangeable in this area, which I agree with.

The District Court noted the Third Circuit stated Boyle:

identified three distinct categories of late-filing cases. In the first category consists of cases that involve taxpayers who delegate the task of filing a return to an agent, only to have the agent file the return late or not at all…[SCOTUS] held…such…reliance…was not reasonable cause…The second category…is where a taxpayer, in reliance on the advice of an accountant or attorney, files a return after the actual due date, but within the time that the…lawyer or accountant advised the taxpayer was available.  Finally, in the third category are those cases where “an accountant or attorney advises a taxpayer on a matter of tax law.”

The District Court believed that Thouron had instructed it to construe Boyle narrowly, only clearly applying to the first set of failure above.  As to the second set, it believed Boyle did not hold on the issue leaving the lower courts to make their own determinations, and that under the third set of cases, Boyle would not apply.

The government’s contention is that the requirement for timely filing is non-delegable, and reasonable cause based on misunderstanding the deadline is never sufficient.  Such a failure is, in its mind (I am assuming), a malpractice claim between the taxpayer and its advisor.  The Service would never allow reasonable cause in the second set of cases, and would likely argue against it in most of the third set of cases.

The District Court in Hake, in the remainder of the opinion, somewhat appeared to begrudgingly agree with the Third Circuit’s analysis that reasonable cause could, and perhaps should, apply in all second and third category cases.  Towards the end, the Court stated the following not-so-ringing endorsement of its holding:

In reaching this conclusion, however, we wish to emphasize the very narrow scope of our ruling. We do not purport to stake out new or novel legal theories in this decision.  Rather, we attempt to simply and faithfully apply the law of this circuit to the facts of this case.  Moreover, our decision regarding the reasonableness of the executor’s reliance upon legal advice is strictly limited to, and bound up in the facts of this case.

The Court did then note, as a positive, the fact that the executors had overpaid the amount of tax due before the deadline for doing so (making the imposition of the penalty seem a little boorish on the part of the Service).  Finally, in foot note 6, the Court invited the government to consider taking this case up through various appeals to clarify the disparity in case law on this matter that is found in the other Circuits compared to the Third.

I have no specific knowledge of the case, but the opinion seemed to indicate that the district court judge in Hake 1)  doesn’t agree with Thouron completely, 2)  appreciated the fact that taxes were timely (over) paid, and 3)  didn’t want to be overruled on the opinion.

Thouron, however, in my mind left the door potentially open for the judge in Hake  to hold the other way, had it wanted to.  Hake doesn’t clearly state whether it falls within the second or third group of Boyle cases indicated above.  The language of the case would indicate the judge in Hake was analyzing the case under the second group, where the taxpayer files within the time frame erroneously indicated by a practitioner, not where there was clear reliance on legal advice (although the discussion of the complexity of the filing dates does drift into what I would view as a discussion more related to reliance on legal advice).

Thouron, likewise, didn’t specify whether it was a second or third group case.  It stated that Boyle only held on clerical oversight in an agent failing to file by the deadline.  “It did not rule on when taxpayers rely on the advice of an expert, whether that advice relates to a substantive question of tax law or identifying the correct deadline”.

Thouron certainly indicates a willingness of the Third Circuit to allow a reliance case in either a second (advice regarding deadline) or third (reliance on expert for tax law advice), but it does not flesh out the issue any further.

One key distinction between Thouron and Hake, in my opinion, is that Thouron seems more like reliance on an expert regarding tax advice, which happened to impact the filing deadline.  In Thouron, the estate failed to timely pay tax because the estate erroneously believed it qualified for deferral of payment under Section 6166.  That Section allows deferrals on certain closely held business interests, and is incredibly complicated, including substantial regulations, rulings, etc.  Section 6166 itself, which only deals with the extension to pay, is about 4,000 words long.  Determining whether or not an estate qualifies is clearly an expert’s job, and to attempt to penalize an estate for such reliance when the expert is wrong in the analysis is antithetical to the statutes and regulations regarding the reasonable cause exception.  Hake, instead, was just a normal extension request.

While I agree the automatic extension provisions and the discretionary extension for payment can be confusing, and arguably could be expert advice, I think the case is less clear that it would fall within group three.   Again, the holding in Thouron lumps groups two and three together, but it does not state whether Thouron was in one or both groups.  It also does not state that all cases involving an accountant or lawyer advice regarding a deadline would qualify under group two (for instance, it would be interesting to see a court have that type of holding with the same automatic extension to pay income taxes and an extension to pay income tax).  I suspect the Third Circuit would affirm Hake, and probably would have reversed it had the holding been for the government.  Its statements in Thouron were somewhat clear in stating it would find reasonable cause for reliance on determining an extension or on legal advice.

I do not believe Hake has been appealed to the Third Circuit yet, and may not be.  If it or other similar cases should continue to be affirmed by the Third Circuit, it would result in a sufficient split to allow SCOTUS to weigh in on how Boyle should be applied, or more accurately, how the underlying law should be applied in groups two and three.  I think cases in group three have to remain reasonable cause, but it would be really interesting to see what happens with group two.

Effect of General Power of Attorney On Reasonable Cause Exception to Penalties

Chief Counsel Advice memorandums are great sources of statements on IRS policy and the thought process of the Service on various issues.  They often are not long, which can make them difficult to turn into standalone blog posts.  I found one from September fairly interesting though, which discusses penalty abatement for the delinquency penalties when someone is incapacitated.  The CCA touches on two issues, the first time abatement provisions and the impact of a power of attorney on the reasonable cause exception to the delinquency penalties. The power of attorney aspect is fairly interesting, especially in considering the related issue regarding refund limitations periods being tolled by financial disability.

In CCA 201637012, the Service requested guidance on whether a potentially incapacitated person who suffered from dementia could have delinquency penalties abated for reasonable cause.  I found the CCA interesting because it highlighted the fact that the taxpayer had a valid power of attorney in place, and sought guidance on how that impacted the reasonable cause determination.

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The facts indicating that the taxpayer appointed an agent under a durable power of attorney (one that remains operative after someone is incapacitated) prior to becoming incapacitated.  Under the POA, the agent was authorized to file tax returns and handle other tax aspects for the taxpayer.  The agent knew of the POA.  In a later year,  the taxpayer filed untimely returns, and the Service assessed delinquency penalties under Section 6651(a)(1) (failure to file) and Section 6651(a)(2) (failure to pay).

At some point after the filing of the return, the agent under the POA petitioned the state court for an emergency guardian and conservator for the taxpayer.  Usually, when there is a POA in place, we try not to seek guardianship because an agent should have most of the same powers, so I’m curious as to why this was requested.  It is possible the taxpayer was fighting the agent, or power outside of the POA was needed.   The court did appoint the agent as guardian and used the term “incapacitated” in the order.  This was after the late filing, but the CCA seems to indicate it was close enough in proximity to evidence that the taxpayer was incapacitated when the return was not filed.

The two questions presented to Chief Counsel were:

  1. Whether the Service should abate the penalties because of the alleged incapacity.
  2. Whether the Service should deny the request to abate because the POA failed to fulfill the taxpayer’s obligation to timely file and pay tax on behalf of the taxpayer.

Chief Counsel first noted that Appeals should determine if the taxpayer qualifies for First Time Abatement under IRM 20.1.1.3.6.1.  We have discussed FTA on this blog in the past, which can be found here and here.  All tax practitioners should be very familiar with these provisions, as they provide a simple mechanism for eliminating penalties in many cases.  I have used these procedures in various cases, including some very large dollar cases, and have had no issue obtaining waivers when we fit within the framework.

The remainder of the CCA was the portion that I found more interesting.  The CCA went on to discuss reasonable cause for a person suffering from dementia.  As stated above, the taxpayer had a valid power of attorney in place the year in which she failed to file the tax return.  It is alleged that the taxpayer was incapacitated.  Chief Counsel did indicate that it lacked sufficient facts to determine the taxpayer was incapacitated at the time of filing, but seemed to indicate it was possible, and, for purposes of the analysis, assumed that was the case.

The taxpayer requested abatement of the penalties pursuant to Treas. Reg. Section 301.6651-1(c)(1), which provides for abatement due to reasonable cause.  Serious illness of the taxpayer or a family member can be sufficient to show reasonable cause (but not when your preparer is ill).  See IRM 1.2.12.1.2, Policy Statement 3-2.  The CCA indicated that if it could be shown that the taxpayer was demented during the year in question, and was unable to handle her own financial affairs, it could support a finding of reasonable cause.

What I found slightly more interesting was the discussion about the power of attorney.  In the CCA, Counsel states that the POA does not impact the conclusion.  Counsel essentially stated that if the guardian had been appointed during the year in question, reasonable cause would likely not apply.  This was because the guardian would have a duty to handle the finances, and therefore returns, of the ward.  See Bassett v. Comm’r, 67 F3d 29 (2d Cir. 1995) (taxpayer suffered from incapacity due to being a minor, and legal guardian had duty to file returns).  With a POA, however, there may be authorization to take actions regarding returns, but there is no affirmative legal duty to prepare and file returns on behalf of the taxpayer.  Looking to Boyle, Counsel said the duty to file the tax return is on the taxpayer, and not his agent or employee.

I think this is the correct result, but I found it interesting for two reasons.  First, that statement from Boyle is usually used to preclude reasonable cause defenses when a taxpayer fails to file due to the mistake belief that the taxpayer’s accountant, attorney, or other preparer is properly handling the return.  So, for once, I wasn’t muttering frustration about that case.

Second, this position is different than that applicable to seeking a refund due to financial disability.  In general, a refund must be timely made, and that time frame is normally three years from the date the return is filed or two years from the date the tax was paid, whichever expires later.  This statute can be tolled if the taxpayer is “financially disabled.”   Under Section 6511(h), the statute will not expire if the individual is unable to manage his financial affairs because he has a medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than twelve months.  The general IRS requirements for this are found in Rev. Proc. 99-21.  Most focus on this Rev. Proc. is on the required doctor’s certification.  But, the procedure also requires the person signing the claim to certify that no person was authorized to act on behalf of the taxpayer in financial matters during the period of impairment.

The implication is that having a power of attorney in place could preclude the tolling of the statute, because the agent could/should have been acting.  Seeking to recoup improperly paid funds is slightly different that having penalties abated, but the situations are sufficiently similar that it is interesting that the Service has different positions.

Specht v. US: When The Preparer is Not Well – Unreasonable Cause In Late Filing

In February of 2015, in a SumOp, I wrote about the terrible case of Specht v. United States out of the Southern District of Ohio, where the Court upheld delinquency penalties against an estate for failure to timely file and pay estate tax.  This case was a dumpster fire on a train wreck in terms of the facts for the executor in Specht, but the Sixth Circuit affirmed the district court upholding the penalties, which is not unexpected (and I’m sure they didn’t love doing it).  The case does not break new ground, but it is a good example of how difficult arguing the reasonable cause exception to the delinquency penalties can be if the delinquency was based on relying on an attorney or accountant to file.

To the unfortunate facts.  Ms. Specht was the cousin of Virginia Escher, who was worth about $12.5MM on her death (interesting side note, she and her husband apparently were frugal, and accumulated the wealth from her husband working at UPS  — in the late 90’s when UPS issued its IPO, there were all kinds of rumors and stories about all the employees becoming millionaires, and many mangers did get millions – Perhaps Virginia’s hubby was one such lucky employee).  A few months prior to her death, Virginia had her lawyer, Mary Backsman, draft a new will naming Ms. Specht her executor.  Attorney Backsman had over fifty years of estate planning experience, and was well regarded.  Ms. Specht had a high school degree but never went to college, was in her 70s, had never served as an executor, had never been in a lawyer’s office, had never dealt with stock, was not business savvy, and did not even own stock.  Not an ideal executor for a large estate comprised of a large holding of UPS stock, but with competent counsel she should have been able to complete the administration…And therein lies the rub.

Attorney Backsman may have been a phenomenal lawyer for decades, but she was quite unfortunately suffering from brain cancer, which she was not disclosing to clients, and her competency was deteriorating.  Not knowing this, Ms. Specht hired her to assist with the administration.  Attorney Backsman informed Ms. Specht that $6MM in tax would be due nine months from the date of death, and UPS stock would need to be liquidated.  Attorney Backsman also suggested her firm could front the $6MM in tax, and be reimbursed after the fact (what?!?!  Was that the cancer, or did her firm really do that? My firm is not currently floating $6MM for clients).  Specht signed the Application for Authority to Administer Estate and a Fiduciary’s Acceptance, but Attorney Backsman did not explain either or her obligations.

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All parties agree that Ms. Specht relied very heavily on Attorney Backsman to handle the administration, which largely resulted in Ms. Specht calling Attorney Backsman to get updates on the statute.  Ms. Specht asked about the returns repeatedly, and was told that an extension had been obtained for filing the return.  This was not true and the return was not filed nor were the taxes paid.  The Sixth Circuit highlighted the fact that Specht had received multiple notices that probate deadlines were missed, and that she relied on Attorney Backsman’s statement that it was being handled and extension were obtained.  The following year, Ms. Specht was contacted by a family friend who also used Backsman, and was told that Attorney Backsman was incompetent.  Ms. Specht went to see Attorney Backsman, and again accepted statements that the administration was moving forward and extensions were obtained.  She also signed “a blank paper”, which the attorney indicated would give her authority to sell the UPS stock on behalf of the estate (the attorney later claimed that paper was sent to UPS, but it never was).  From middle of August 2010 to October of 2010, the wheels really started to fall off.  Ms. Specht received multiple notices from the Ohio taxing authority indicating the return was late.  Various family members called and begged Ms. Specht to fire the lawyer due to incompetence, and Ms. Specht found out that UPS had not been contacted.  At that point, she fired Attorney Backsman.

Within a few months of hiring new counsel, the UPS stock was sold, the federal estate tax return was filed with payment of the tax and interest.  The Service imposed penalties, which the estate subsequently paid.  Somewhat interestingly, the Ohio taxing authority refunded the penalties imposed due to “hardship caused by Backsman’s representation.”   PA hardly ever imposes penalties on death tax returns, and I have rarely seen it on state death tax returns, so I am not that surprised.

Big Brother, however, decided it needed to refill the coffers of the Holding Company, and imposed substantial penalties.  The IRS imposed $1,189,261 of penalties (and interest) for failure to file and failure to pay tax under Sections 6651(a)(1) and (2).  As the Court noted, quoting US v. Boyle, the penalties are mandatory unless the taxpayer had reasonable case; the taxpayer “bears the heavy burden of proving both 1) that the failure did not result from ‘willful neglect’ and 2) that the failure was ‘due to reasonable cause’.”  469 US 241 (1985).  As Keith noted in his recent post on Kimdun, Inc., if the Court is citing Boyle heavily in a reasonable cause case, your client is probably in trouble.

In Specht, the taxpayer was clearly not sophisticated, made reasonable attempts to comply, and made the reasonable decision to hire the attorney who prepared the estate plan, was very well respected, and had decades of experience…but, under Boyle, that is not really applicable to reasonable cause in this instance.

In Boyle, the Supremes dropped what they believed to be a bright line rule, which sometimes causes reasonable people to fall outside of the reasonable cause exception.  In Boyle, the Court stated, “the time has come for a rule with as ‘bright’ a line as can be drawn…[and] Congress has placed the burden of prompt filing on the executor, not on some agent or employee of the executor.”  The Court believed this meant that Congress intended to place the burden on the executor to determine the applicable deadline and ensure filing in a timely fashion.  Further, “[t]hat the attorney…was expected to attend to the matter does not relieve the [executor] of his duty to comply with the statute.”

The Court looked to its prior holding for guidance, in Vaughn v. United States (also covered here previously).  Mo Vaughn, the rotund slugger, had a shady money manager after his retirement who was probably stealing from him and failing to keep his financial affairs and returns in order (if you wanted to argue that Mo was stealing from the Mets the final two years of his career…).  The Sixth Circuit held there that “Vaughn’s statutory duty is non-delegable and is not excused because of the felonious actions of his financial agents.”  The ultimate tax insult to financial injury.  The Court concluded by essentially stating “reasonable causes” are only something beyond the possible control and oversight of the taxpayer, and taxpayers should know the due date and make sure it is followed.

The Court concluded that Specht had agreed to be a fiduciary, which has obligations that are serious.  The Estate could not show that she met the heavy burden of showing reasonable cause in failing to file the returns before the applicable deadline.

My conclusion the first go around was as follows:

I’ve shared my frustration with this line of cases repeatedly in the past, but I do somewhat understand why the rule is crafted in this matter.  I would be interested to know how the malpractice case panned out.  The coverage may have a maximum payout amount, and if there were a bunch of these cases, the various clients could be dividing up a limited pie.  In theory, the executor could be held liable to the beneficiaries for anything not recouped.  Any result where the executor ends up responsible seem completely inequitable to me.

The estate did sue Attorney Backsman, and that case settled, although the amount is unknown.  Some amount may have been recouped, but, as I noted above, Attorney Backsman, probably had a number of claims brought against her, and it is possible that the malpractice policy limited the total payout.

My position on Boyle and reasonable cause remains the same.  I understand why the bright line is in place, as it would be too easy for executors to simply blame counsel for the mistake.  Serving as executor, however, is not a common occurrence, and, with the current estate tax thresholds, having to file a federal estate tax return is fairly uncommon.  For a sophisticated individual, it is possible to determine there is a nine month deadline.  In my view, the IRS is too aggressive in applying this rule to these type of cases.  For instance, the Service extended it to substantive advice as to when taxes had to be paid under complicated Code Sections in Thouron from the Third Circuit.  It is also drastically out of line with how lawyers and clients interact in this arena.  Every single one of my clients relies on me completely to ensure proper and timely filing.  They look to me, often bewildered, as to when the return must be filed, what the extension can be for, when the tax has to be paid and when that can be extended.  And, given how few of these returns are filed each year, it seems unlikely that John Q. Public is going to realize they cannot rely on me as protection from penalties (query if such reliance is a valid defense in a breach of fiduciary liability case).

Boyle modifies a subjective “reasonable cause” standard, and turns it into an objective line in the case where an executor relies on a preparer to timely file.  The statute, which had objective deadlines, included an exception, which is no longer allowed for receiving advice on a deadline in all deadlines.  Interestingly, the Service also recognized how colossally messed up the Code is, and that people are going to miss deadlines.  You get a free pass on the income tax side with the first time abate exception.  Income taxes are filed by essentially everyone, every single year.  Most people will never file an estate tax return.

I certainly don’t have a better solution at this point, which diminishes the usefulness of this post, but  I always feel bad for the executors.  I understand, however, why the cases are decided as they are under Boyle by the lower court judges.  If possible when bringing one of these cases, I would try to show the missed deadline was tied to substantive advice regarding the due date.  A showing that there was a general understanding, issues were raised, and incorrect advice was given.

There is one other aspect of the case that is worth noting, which was the failed argument regarding Mrs. Specht’s ability or capacity to do the job of executor.  The Sixth Circuit noted that Boyle left open the possibility that an executor’s ability level would potentially impact the reasonableness of the late filing of the return.  The Court specifically highlighted the concurrence by Justice Brennan as stating mental health or diminished capacity as reasons that could get around the bright line rule.  The Court, however, also cited to the rule that a great majority of people can determine the deadline and ensure compliance, which it found true of Mrs. Specht.  Mrs. Specht, although unfamiliar with the rules, did not suffer from a disability that would have caused her to miss the deadline.  This could be an avenue in future cases, with the right fact pattern, to claim reasonable cause when someone has relied on a preparer to ensure timely filing.

In Exelon Tax Court Finds Legal Opinion Not Enough to Defeat Penalties 

I will in this post highlight some interesting parts of last week’s Exelon v Comm’r. The case involves Exelon’s seeking to shelter billions in gains on sales of fossil fuel plants by attempting to shoehorn a sale and leasing transaction into a like-kind exchange. In Exelon, the accuracy-related penalties alone were over $87 million, and the Tax Court found that despite a sophisticated law firm’s legal opinion Exelon was liable for the accuracy-related penalty. In discussing Exelon, I will also flag two other recent opinions involving the same issue.

One of the issues in Exelon was the IRS’s assertion of accuracy-related penalties despite Exelon’s receiving a detailed legal opinion blessing the transaction’s tax consequences. A common issue courts consider is whether reliance on a tax advisor will insulate a taxpayer from civil penalties. As with many issues, the black letter law is relatively straightforward. Derived in part from dicta in the Supreme Court Boyle case, the Tax Court relies on a three-part test case that essentially asks the following questions:

  1. Was the advisor a competent professional who had sufficient expertise to justify reliance;
  2. Did the taxpayer provide necessary and accurate information to the advisor;
  3. Did the taxpayer actually rely in good faith on the advisor’s judgment.

Neonatology Assoc. v Comm’r 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). The cases applying the standard are notoriously fact-specific and difficult to easily synthesize.

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Exelon is a case that has generated a great deal of attention, in part because of the sheer amount of the deficiency, which is over $500 million for the two years at issue. The transactions included complicated sale in lease out (SILO) transaction that Exelon entered into so it could identify a replacement property for 1031 purposes to shelter billions in gain on sales of fossil fuel plants. The opinion has over 150 pages detailing and analyzing the complexities of the transactions and how they should be treated for tax purposes. What is key for purposes of this write up however is after the court found in favor of the IRS on the underlying issue (essentially that Exelon did not acquire the beneficial ownership of the properties it leased back to tax-indifferent public entities and thus could not shelter its gain through 1031), was its conclusion that despite an opinion letter from Winston & Strawn it still found the taxpayer liable for the penalty. Some things to highlight:

  1. IRS argued that Winston & Strawn’s involvement in assisting with structuring the transaction was a per se disqualification for considering the advice reasonable. Some cases have held that the advisor is essentially tainted with a scarlet C for conflict of interest. The opinion cites one of those cases, Kerman v. Commissioner, T.C. Memo. 2011- 54, aff’d, 713 F.3d 849 (6th Cir. 2013). This was not one of those cases; even though Winston & Strawn was paid handsomely for its advice it did not bill based upon the transaction closing but rather its fees were based on normal hourly rates. Because W&S billed on an hourly basis and did not tie its fees to the transaction the Tax Court concluded that the advice was not per se disqualified from protecting the taxpayer under the Neonatology test.
  2. Despite not finding a per se disqualification of the advice based on a conflict of interest, the Tax Court did find that W&S’s actions with the appraisers (Deloitte) prior to issuing its legal opinion tainted its advice because these actions rendered the facts and assumptions it relied on as unreasonable. The Tax Court’s opinion focused on W&S’s discussing with Deloitte what values it expected in the appraisals:

We found that Winston & Strawn interfered with the integrity and the independence of the appraisal process by providing Deloitte with a list of conclusions it expected to see in the appraisals to be able to issue tax opinions at the “will” and “should” level. Such interference improperly tainted the Deloitte appraisal, rendering it useless. Further, because Winston & Strawn directed the conclusions that Deloitte had to arrive at, we are highly suspicious that the tax opinions are similarly tainted.

In other words, factor 2 in the Neonatology test for reliance can be a problem if the advisor is seen as influencing the facts and assumptions that are crucial determinants of the substantive tax advice. As I understand, it is not uncommon for advisors to work with appraisers and other agents of the taxpayers. From what I read in the opinion I do not see evidence that the appraiser acted improperly. W&S’s discussion as to what it needed to issue a will or should opinion alone appears to be sufficient to taint or color the facts that it relied on in issuing its opinion. What the Tax Court does in this opinion is suggest that the allure of fees associated with the appraiser’s understanding as to what the advisor needed is enough to conclude that the advisor has not received accurate information from the taxpayer (here, the taxpayer’s agent, Deloitte). That outcome should give pause to legal advisors who may as a matter of course discuss what they need from appraisers to reach comfort to give tax advice.

  1. The Exelon Tax Court opinion, as many before it, looks to the sophistication of the taxpayer to test whether in fact the taxpayer really relied in good faith on the advice that it received. As the opinion discusses, in Boyle the Supreme Court discusses that it is not incumbent on taxpayers to seek a second or third opinion. Yet, as here, when the taxpayer is sophisticated the court will be more skeptical that there was in fact good faith reliance. What is interesting about the Exelon opinion is that sometimes the sophistication goes beyond tax expertise, especially if the transaction’s form depends on outcomes and decisions that are inconsistent with general business practices. Here there was an expectation that the purported sellers of the replacement properties would in fact purchase the properties back from Exelon, a fact that contributed to the Tax Court’s finding against the taxpayer on the merits and on the penalties:

Sophistication and expertise of a taxpayer are important when it comes to determining whether a taxpayer relied on a tax professional in good faith, or simply attempted to purchase an expensive insurance policy for potential future litigation. Petitioner had been involved in the power industry since 1913 and described itself as “an electric utility company with experience in all phases of that industry; from generation, transmission, and distribution to wholesale and retail sales of power.” Although petitioner did not have experience with section 1031 transactions, it certainly had experience in operating power plants and must have understood the concept of obsolescence…

Our analysis of the test transactions shows that petitioner knew or should have known that CPS and MEAG were reasonably likely to exercise their respective cancellation/purchase options because they would not be able to return the Spruce, Scherer, and Wansley power plants to petitioner without incurring significant expenses to meet the return requirements.

At the end of the day, the Tax Court found incredulous that a taxpayer with Exelon’s sophistication would believe the tax opinion it received because the judge did not believe that Exelon bought into the opinion’s assumptions about the transactions’ counterparties. Rather than seek advice, the Exelon opinion suggests that the taxpayer was purchasing penalty insurance through engaging its legal and tax advisors. In language that is direct and deeply critical of what Exelon and its advisors did, the opinion sums up what it thought of the taxpayer and its advisors’ conduct:

We cannot condone the procuring of a tax opinion as an insurance policy against penalties where the taxpayer knew or should have known that the opinion was flawed. A wink-and-a-smile is no replacement for independence when it comes to professional tax opinions.

Exelon also sought to justify its reliance by noting that its auditor did not flag the transaction but the opinion minimizes that fact (see page 172 note 35):

Unlike petitioner, Arthur Andersen did not have the benefit of vast experience in operating power plants and may have overlooked the issue of return conditions. The record is also silent as to what documents related to the transactions were actually reviewed by Arthur Andersen and to what extent. We are thus not persuaded by petitioner’s argument.

The Tax Court found that the above led it to conclude that Exelon “could not have relied on the Winston & Strawn tax opinions in good faith because petitioner, with its expertise and sophistication, knew or should have known that the conclusions in the tax opinions were inconsistent with the terms of the deal. Second, in the light of the previous conclusion, petitioner’s alleged reliance on Winston & Strawn’s tax advice fails the Neonatology test.” At the end of the day, Exelon did not have good faith and reasonable cause under Section 6664(c) and that it was liable for the penalty due to a “disregard of rules and regulations within the meaning of section 6662 with respect to ascertaining the tax consequences of the test transactions.”

Some Parting Thoughts and A Comparison to Some Other Cases Finding in Favor of the Taxpayer

The case is worth a deep read of the facts, including its discussion of how Exelon’s registering the transaction as corporate shelter did not help and that many of the Exelon higher ups did not read the W&S opinion. It also cryptically notes that IRS conceded the substantial understatement leg of the accuracy-related penalty (page 162), but does not state why.

While I will not discuss extensively here, it is worth contrasting the outcome in Exelon with two other recent opinions. One is Boree v Commissioner, which involves the characterization of an individual’s gain on the sale of subdivided property. In Boree, the Eleventh Circuit affirmed the Tax Court’s finding that the sale generated ordinary income but reversed it on the substantial understatement penalties in large part because the individual was able to show that he relied on his longtime tax preparer in treating the gain as capital gain. The other is Collodi v Commissioner, a summary Tax Court opinion where the Tax Court found that a constantly-travelling gas well worker had no tax home and thus could not deduct his costs on the road. Despite denying the deductions, in Collodi the Tax Court found for the taxpayer’s reliance on his tax return preparer was a defense to the accuracy-related penalties for the deficiency attributable to the denied travelling expenses.

In both Boree and Collodi the taxpayers had no tax or accounting experience. Boree was a former logger who went on to develop land. Collodi worked on gas wells. While both were engaged in their business and had expertise in the businesses, the expertise had no bearing on the tax consequences of the positions on the returns. In both cases the taxpayers relied on their longtime preparers who had tax expertise. Boree is perhaps more interesting in that it is an appellate opinion and it reversed the Tax Court; moreover, in Boree there were some inconsistencies in the return itself that might have generated a question as to whether the taxpayer relied in good faith on the advice (namely that the return reflected some trade or business expenses with the development activity which are inconsistent with the capital gain treatment).

What these cases suggest is that courts will be rightfully skeptical of taxpayers like Exelon where the facts suggest that rather than purchasing tax advice they are purchasing penalty insurance in the form of tax advice. For most individuals who come to the table with little financial or tax sophistication and who have a long history of tax compliance and stable tax advisors, courts tend to respect the relationship between advisor and taxpayer and not second guess the advice for penalty purposes.

African Diamond Scam and Millions in Alimony: (and Some Reasonable Cause and Chenery)

The beginning of some of Judge Holmes’ Tax Court opinions resemble screenplays. Take the opening paragraph from last week’s Leslie v Commissioner.

Fade in:

These cases arise from the unhappy end to a marriage. Maria Leslie got $5.5 million from her former husband under an agreement that said it would be taxable to her and deductible to him. She sent part of it–about $400,000–to an internet scamster who claimed he would invest it for her in an African diamond scheme but who made off with the money. She says the $5.5 million was a nontaxable property settlement and the $400,000 was a theft loss. She also says the IRS should have considered her request for an alternative to forced collection of her tax debt.

A colleague of mine in the Villanova graduate tax program sent me the link to this opinion because of its bringing to life some of the issues we teach in our introductory income tax class. Tax and tax procedure can be dry, especially to outsiders, but Judge Holmes knows and shows these cases have a very real human dimension.

Back to the Leslie case itself. I will simplify the facts and procedural aspect of the case to highlight the main procedural issues, which relate to whether mental illness constitutes reasonable cause and whether IRS counsel can supplement Appeals’ explanation as to why it rejected a collection alternative.

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There were a few years where Leslie received payments under the divorce agreement from her ex-husband, a good portion of which was contingent on a fee her ex, a lawyer, was due to get from his work in a class action suit stemming from the Enron mess. (That litigation eventually led to a $50 million fee for her ex, by the way).

As her marriage broke down and following the divorce, Leslie began to suffer from major psychological illnesses. The opinion notes she had a “lengthy battle with a myriad of psychological and mental-health problems. She began suffering–and currently suffers–from severe major depression, and from schizoaffective disorder dependent-personality disorder. Her condition darkened once the marital- separation negotiations began in 2003, and she began to plan her own death.” The mental health issues led Leslie to an involuntary psychiatric stay and a long list of medications that the opinion notes Leslie was on for many years.

One of the consequences of the upheaval in Leslie’s life was that she did not tend to her tax affairs. She filed many of her returns late, though for most of the years she initially reported the payments from her ex as taxable alimony. She did not report the losses from her diamond misadventures. With unpaid assessments stemming from the alimony and late filed returns, the case gets to Tax Court via CDP, and in the CDP proceeding she filed amended returns claiming the payments from her ex were property distributions and thus nontaxable. She also filed a return claiming the losses from her diamond investment were theft losses. That was important because the theft loss rules treat those losses as ordinary and also allow the victim to carry the losses back and forward as essentially net operating losses.

The opinion has a terrific discussion about the difference between taxable alimony and nontaxable property settlements, and also whether the scamming (which involved a promise of a million dollars if Leslie coughed up $400,000 to help “export” the diamonds) resulted in a theft loss deduction or just a loss stemming from a bad investment. I will not spend time here on the property/alimony or theft loss issues, though note that the IRS prevailed on the alimony issue (with the case turning on the conclusion that under California law the requirement for the ex to make the payments would have terminated if Leslie died even though the agreement did not so provide) but lost on the theft loss issue (because under California law the parting of her money amounted to theft by false pretenses).

The opinion also discusses a couple of interesting procedural issues. To those I turn.

Late Filing and Reasonable Cause

The IRS also assessed late filing penalties. At issue was whether her mental illness amounted to reasonable cause. The opinion discusses how incapacity can amount to a defense to the late filing penalty, with the taxpayer having to show that a mental or emotional disorder “rendered [her] incapable of exercising ordinary business care and prudence during the period in which the failure to file continued.” (citing Wilkinson v. Commissioner, T.C. Memo. 1997-410). Despite the many troubles Leslie was facing the opinion concluded that she did not meet that standard:

But the standard is a tough one to meet, and we did not see enough evidence of her inability to manage her other business affairs during this time. She was, for example, living in substantial part on the income from eight rental properties she got in the divorce, which required her active involvement in their management. We acknowledge she had problems doing this, but because she was still able to live on this income we find that her ability to “carry on normal activities” was not so impaired as to be an inability. See id [Wilkinson v Comm’r]. This is not enough to excuse a late filing.

This is a tough outcome, and when I read the earlier parts of the opinion describing Leslie’s medication and hospitalization I thought it was enough to support reasonable cause. As the opinion notes, however, many cases that explore incapacity emphasize how the illness relates to an inability to manage affairs outside the tax world. Given that Leslie was apparently actively managing her rental properties, or able to sufficiently delegate the responsibilities from the rental business, she came up short.

Chenery and CDP

The other part of the opinion dealt with Leslie’s request for an installment agreement at CDP. Appeals’ determination rejected the request, though it did so with little explanation. At Tax Court, IRS sought to explain why Appeals was within its considerable discretion to reject the collection alternative. That ran smack into the Chenery principle. We have discussed SEC v Chenery, and how taxpayers are pushing its application in deficiency cases. See, for example, Tax Court Rules that APA and Administrative Law Principles Do Not Bar IRS From Amending Answer and Asserting New Grounds for Deficiency and Stephanie Hoffer and Chris Walker’s guest post A Few More Words on Ax and the Future of Tax Court Exceptionalism.

Essentially, Chenery stands for the proposition that the courts are not supposed to allow agencies to argue a new reason for their determination, or justify agency actions based upon arguments or issues that were not properly made below. While the Tax Court is less than bullish on its use in deficiency cases, its use in CDP cases involving collection issues is more entrenched.

At Tax Court, IRS argued that the settlement officer acted within his discretion in not allowing a collection alternative because Leslie did not provide information about the cost of her life and health insurance premiums. Unfortunately for the IRS, the determination made no reference to the missing premium information:

The Commissioner does argue on brief here that the SO was within her discretion to deny collection alternatives because Leslie didn’t supply information about her health- and life-insurance premiums. This was, however, just about the only financial information that Leslie didn’t supply. Even more important, this specific failure–a failure to supply complete information about health- and life- insurance premiums–is not cited in the notice of determination as a reason for refusing to consider an alternative to enforced collection. In reviewing notices of determination, we follow the Chenery doctrine.

After setting out the IRS’s failure, the opinion then proceeds to give effect to Chenery in CDP:

Applying Chenery in a CDP case means that we can’t uphold a notice of determination on grounds other than those actually relied upon by the IRS officer who made the determination. See Chenery I, 318 U.S. at 87-88; Spiva v. Astrue, 628 F.3d 346, 353 (7th Cir. 2010) (agency has the responsibility to articulate its reasoning); Salahuddin, 2012 WL 1758628, at *7 (“[O]ur role under section 6330(d) is to review actions that the IRS took, not the actions that it could have taken”). Those grounds must be clearly set forth so that we do not have to guess about why an officer decided what he did. See Chenery II, 332 U.S. at 195.

As the opinion notes, Leslie had previously submitted a 433 A, and the SO’s failure to prepare an allowable expense worksheet rendered the determination and the SO’s actions overall as not rational:

This makes the determination not rational, in contrast to the run-of-the-rejection-mill case where a taxpayer submits no information or leaves out assets.

Conclusion

The upshot is a remand, where Appeals will have to provide more personalized analysis of Leslie’s finances and work with her to try at least see if an installment agreement is possible. The opinion stands as a reminder between the considerable differences in the procedural posture of deficiency cases from CDP cases. In deficiency cases, IRS still has considerable leeway in making arguments in Tax Court that were not made below. In CDP cases, the Tax Court will be much more vigilant in keeping IRS to what it previously said. It is not enough for the IRS to be right; it has to be right because it was what Appeals considered and explained previously.

 

 

 

Summary Opinions Catch Up Part II

Second part of the catch up.  These materials are largely from February.  One more installment coming shortly.  We may be renaming SumOp.  Although I loved the name (thanks Prof. Grewal), this keeps getting linked as a summary of all Tax Court summary opinions.  Feel free to suggest names, although it may just fall under the Grab Bag title from now on.  And, if you work at a law firm that is taxed as a C-corporation, check out the Brinks, Gibson discussion below.  Might be a little scary.

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  • Most of you probably heard that the Form 8971 was issued for basis reporting in estates.  Form can be found here and instructions here.  First set will (probably, although it has been extended a couple times already) be due June 30th.  Pretty good summary can be found here.  Lots of complaints so far.
  • The Fourth Circuit had a recent Chapter 7 priority case in Stubbs & Perdue, PA v. Angell (In re Anderson).  In Stubbs (great name), S&P were lawyers who represented Mr. Anderson.  Initially, the case was a Chapter 11 case, and S&P racked up $200k in legal fees.  Priority, but unsecured.  There was also over $1MM in secured tax debt.  The bankruptcy converted to a Chapter 7, and S&P were tossed in with the unsecured debtors, which they took exception with.  The Court looked to the current version of section 724(b)(2) of the bankruptcy code.  That section allows certain unsecured creditors to “step into the shoes” of secured creditors, and recover before other creditors.  Due to perceived abuses, that section had been amended in 2010 to limit the expenses that were given super priority, including Chapter 11 administrative expenses when the case was converted to a Chapter 7 case.  The amended provision was in place when the conversion occurred, and the Fourth Circuit relied on that version of the law, disallowing the legal fees super priority.  The law firm argued the prior version of the statute should apply, as it was the applicable statute when the originally filing occurred, but the Fourth did not agree.  Why does this really matter? It is the federal tax liability supported by the federal tax lien that gets subordinated to pay these priority claims.  So, the fight in this insolvent estate boiled down to whether the lawyers, who may have waited too long to convert the case to Chapter 7, or the IRS get paid (of course, the decision to convert is a client decision which puts the lawyer’s ability to get their fees at the mercy of the rationality of the client’s decision. A bad place to be) (thanks to Keith for giving me a quick primer on this subject).
  • The Tax Court in Brinks, Gilson & Lione, PC v. Commissioner has probably caused quite a bit of concern for quite a few law firms – or should (which reminds me, I have something to discuss with the Gawthrop management committee).  McGuire Woods has a good write up, and some insight into planning around the issue, which is found here.  The facts are that the firm would provide partners with a salary, and then at year end it would take all the profits and provide year-end bonuses to the partners, who would treat the amounts as W-2 wages.  This would wipe out the profits, so the c-corporation law firm would have no tax due (sounds familiar to a lot of you in private practice, doesn’t it?).  This firm had close to 300 non-lawyer employees who generated profits, and the IRS said that treating the bonus amount as w-2 income on to the partners on what those other folks generated was improper.  The corporation should have paid tax, and then dividends should have been issued to the partners, who would also then pay tax.  Yikes!  That is interesting enough, but the Court also found that the firm lacked substantial authority for its positions and there was no reasonable cause under Section 6662(d)(2)(B), so substantial penalties were also due on the corporate income tax due (the regulations do not allow for an “everyone else is doing it” defense).
  • Sometimes you go into court just knowing you are going to look like an @s$ for one reason or another.  I may have felt that way walking in to argue Estate of Stuller for the government before the Seventh Circuit.  Not because I would have been wrong, but, based on the opinion, the taxpayer was having a pretty bad year.  In Stuller, the Court held that the penalties for failure to timely file returns were proper when a restaurant business owner (who was a widow) missed the filing deadline.  In the year in question, the husband died in a tragic fire, which also injured the widow.  In addition, a key employee was embezzling from her businesses and she had difficulty tracking down aspects of the probate proceedings.  The Court found all required info could have been found in her records, and she did not exercise ordinary business care and prudence to fulfill the requirements of the reasonable cause exception (it probably didn’t help that she was taking questionable deductions related to her “horse” business that lost like $1.5MM in the preceding years).
  • We have covered Rand pretty extensively here on the blog, including the reversal of it by section 209 of the PATH Act and the Chief Counsel advice that followed, which can be found here.    In February, additional guidance was released stating there are no longer any situations where the Section 6676 penalty is subject to deficiency procedures, which was the same conclusion our (guest) blogger, Carlton Smith, came to in his post discussing the Kahanyshyn case.  Carl, however, reflected upon this more, and concluded there may, in fact, be a situation where the deficiency procedures might apply to a Section 6676 penalty.  I’m somewhat quoting Carl (via email) here.  All intelligent comments are Carl’s, while any errors are assuredly mine:

If you recall from prior posts, in PMTA 2012-016…the IRS changed its position and held that where it had frozen the refund of a refundable credit, there was no “underpayment” for purposes of section 6664(a) because the freezing of the refund should be considered as “an amount so shown [on the tax return] previously assessed (or collection without assessment)” under section 6664(a)(1)(B). So, there can be no assessment of a section 6662 or 6663 penalty in that circumstance.

However, section 6676′s penalty on excessive refund claims can apply even if the refund is never paid. Accordingly, within the PMTA, the IRS states (I think correctly) that where it freezes a refund of a disallowed refundable tax credit, it can assert a section 6676 penalty instead.

The PATH Act did two significant things to section 6676: It removed the previous exception to applying the penalty with respect to EITC claims. It changed the defense to the penalty from the troublesome proof of “reasonable basis” (an objective test) to the easier “reasonable cause” (a subjective one).

So, we may see section 6676 assessments in the future where refundable credits were improperly claimed, but the refund was frozen.…If a taxpayer improperly claimed, say, an EITC, but the refund was frozen, the IRS would later issue a notice of deficiency to permanently disallow the EITC.  The IRS could also assess a section 6676 penalty (assuming no reasonable cause), since it is the claiming of an improper refund that triggers the section 6676 penalty, not its payment.

It is still an open question whether or not the section 6676 penalty on disallowed frozen refundable credit claims will be asserted by the deficiency procedures or the straight-to-assessment procedures usually involved in the assessable penalties part of the Code.

  • In United States v. Smith, the District Court for the Western District of Washington reviewed a community spouse’s argument that her portion of the community property house could not be used to satisfy her husband’s tax debt from his fraud.  I found this write up of the case from a law firm out west, Miles Stockbridge.  The Court upheld the foreclosure, finding the wife did not show that she was entitled to the exception of collecting against community property under Section 66(c), nor did she show that the debt was not a community property debt by clear and convincing evidence, as required under Washington law.
  • Nothing too novel in US v. Wallis, from the District Court of the Western District of Virginia in February of 2016, but a good review of suspension provisions to collection statute.  In Wallis, the Service  took collection actions after the ten year period found under Section 6502 for penalties under Section 6722.  The Court found collection was not prohibited, as the statute was tolled due to the taxpayer’s bankruptcy and OIC/CDP hearings.  Sorry, couldn’t find a free version.
  • The folks over at The Simple Dollar have asked that we provide you with links to some of their content.  This post is about the best tax software for nonprofessionals to use for doing their own taxes.  This site is geared to the general public, but has some basic finance and tax info.  These are usually in the form of listicles, which are completely click bait, but are hard to hate.

 

 

 

 

Summary Opinions for End of December 2015

Happy Presidents’ Day!  While some of you are at home celebrating the lives of Martin Van Buren, Chester Arthur, Tippecanoe and Tyler too, PT is still hard at work churning out tax procedure commentary.  In this SumOp, we cover a few remaining items from December that we didn’t otherwise cover (in detail).  Post includes more of Athletes, the IRS, and rich people behaving badly.  It also has a link to Frank Agostino’s January newsletter, which has a bankruptcy/OIC discussion that is really strong.

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  • The IRS has mud on its face again for wiping another hard drive, this time potentially destroying documents related to the IRS hiring of Quinn Emanuel.  Robert Woods at Forbes has coverage here.
  • Those of you who love the beautiful game should be excited Sepp’s on his way out, but worried that Mascherano’s stout defense won’t extend to his tax fraud conviction.  That’s three Barca players with tax troubles, including Messi and Neymar.  Barca should call me immediately, and bring me in house to review all their players’ finances (and/or play midfield).  Marketwatch has an article, found here, on why so many professional athletes get in tax trouble (recap:  their tax returns are more complicated than your tax return, they are super rich and young, and they often have issues handling their finances).
  • Agostino and Associates have issued their January tax controversy newsletter found here.  The bankruptcy/OIC discussion and which option to use is a great summary of something many of us probably grapple with on a weekly or even daily basis.
  • This is more substantive than procedural, but interesting.  Sometimes cases have the best names based on the underlying dispute.  Loving vs. Virginia is probably the best known.  Green v. US, a recent District Court case out of Oklahoma also fits the bill.  The case involves a bunch of green, in the form of a real estate charitable contributions (Hobby Lobby $$$ and land).  In Green, prior to the case, Chief Counsel had stated that a non-grantor trust could not deduct the full fair market value of appreciated property donated to a charity under Section 642(c)(1).  That section allows for a deduction, without limitation, for property passed to qualifying charities.  The CCA looks to various cases which indicated (tangentially) that the deduction was limited to the adjusted basis.  The District Court of the Western District of Oklahoma held that Section 642(c)(1) had no specific limitation on the deduction amount and the full FMV was allowed.
  • Morales v. Comm’r was decided by the Ninth Circuit in December.  Prior to the opinion, Carlton Smith has covered this case in detail for us, including this post in July, and he cited to it last week in discussing the 6676 penalty.   At issue in Morales was a Rand type case, where penalties were imposed on an “underpayment” created by a taxpayer improperly claiming and receiving the first time homebuyer credit. The question raised was whether a taxpayer must assign errors to each and every alleged error or whether pleadings are sufficient with only a general denial of liability. The Ninth Circuit in an unpublished opinion held that the Tax Court had properly denied the reconsideration of the penalty as the taxpayer had not specifically raised the argument that the credit did not give rise to an underpayment.
  • Before making flippant remarks about this case, I hope the US Attorney involved has obtained proper treatment for the mental illness.  Beyond the wellbeing of that individual, I do not feel terribly bad for the IRS in In Re: Murphy.  In February of 2015, the Assistant District Court found that the IRS violation of a preliminary injunction on collection actions could not be ignored due to the fact that the US Attorney was suffering from substantial mental health issues, including dementia.  In December, the Bankruptcy Court (sorry, no link) concluded it would not review the matter again, and the IRS was responsible for claims under Section 7433, even if the Service likely would have been successful in the case had the US Attorney been competent.  As we’ve seen many cases where taxpayer’s representatives have suffered from illness, but the IRS has still imposed substantial penalties, I’m not heartbroken to see the issue go the other way.
  • Way back in July of 2014, SumOp covered the tax problems of the Hit Dog, Mo Vaughn, where the Tax Court held he lacked reasonable cause for failing to file his tax returns and pay the tax due.  Mo took a swing and a miss with the Sixth Circuit also, which agreed with the Tax Court.  The Court held that simply hiring an attorney, financial advisor and accountant was not sufficient to show reasonable cause, and the fraud and embezzlement of those folks did not constitute disability.
  • Sumner Redstone did not have the best December and early January.  He probably lost a boatload in the stock market, and he was directed to undergo a mental exam to determine if he is incapacitated (his ex-ladyfriend is making this accusation – lover scorned!).  He was also found liable for gift tax from 1972!!!!!!.  Jack Townsend had coverage on his Federal Tax Crimes Blog here. Tax was around $740k.  The interest has to be pretty darn high.  There was one bit of good news, which was that no penalties were imposed.  As Jack notes, this is the interesting aspect of the case.  Underlying question involved the valuation of a closely held business interest, which was based on redemption price on intra-family sale.

Summary Opinions through 12/18/15

Sorry for the technical difficulties over the last few days.   We are glad to be back up and running, and hopefully won’t have any other hosting issues in the near future.

December had a lot of really interesting tax procedure items, many of which we covered during the month, including the PATH bill.  Below is the first part of a two part Summary Opinions for December.  Included below are a recent case dealing with Section 6751(b)(1) written approval of penalties, a PLR dealing with increasing carryforward credits from closed years , an update on estate tax closing letters, reasonable cause with foundation taxes, an update on the required record doctrine, and various other interesting tax items.

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  • In December, PLR 201548006 was issued regarding whether an understated business credit for a closed year could be carried forward with the correct increased amounts for an open year.  The taxpayer was a partner in a partnership and shareholder in an s-corp.  The conclusion was that the corrected credit could be carried forward based on Mennuto v. Comm’r, 56 TC 910, which had allowed the Service to recalculate credits for a closed year to ascertain the correct tax in the open year.
  • IRS has issued web guidance regarding closing letters for estate tax returns, which can be found here.  This follows the IRS indicating that closing letters will only be issued upon taxpayer request (and then every taxpayer requesting a closing letter).  My understanding from other practitioners is that the transcript request in this situation has not worked well.  And, some states will not accept this as proof the Service is done with its audit.  Many also feel it is not sufficient to direct an executor to make distributions.  Seems as those most are planning on just requesting the letters.
  • Models and moms behaving badly (allegedly).  Bar Refaeli and her mother have been arrested for tax fraud in Israel.  The Israeli taxing authority claims that Bar told her accountant that she resided outside of Israel, while she was living in homes within the country under the names of relatives.  Not model behavior.
  • The best JT (sorry Mr. Timberlake and Jason T.), Jack Townsend, has a post on his Federal Tax Procedure Blog on the recent Brinkley v. Comm’r case out of the Fifth Circuit, which discusses the shift of the burden of proof under Section 7491.
  • PMTA 2015-019 was released providing the government’s position on two identity theft situations relating to validity of returns, and then sharing the return information to the victims.  The issues were:

1. Whether the Service can treat a filed Business Masterfile return as a nullity when the return is filed using a stolen EIN without the knowledge of the EIN’s owner.

2. Whether the Service can treat a filed BMF return as a nullity when the EIN used on the return was obtained by identifying the party with a stolen name and SSN…

4. Whether the Service may disclose information about a potentially fraudulent business or filing to the business that purportedly made the filing or to the individual who signed the return or is identified as the “responsible party” when the Service suspects the “responsible party” or business has no knowledge of the filing.

And the conclusions were:

1. The Service may treat a filed BMF return as a nullity when a return is filed using a stolen EIN without the permission or knowledge of the EIN’s owner because the return is not a valid return.

2. The Service may treat a filed BMF return as a nullity when the EJN used on the return was obtained by using a stolen name for Social Security Number for the business’s responsible person. The return is not a valid return.

  • Back in 2014, SCOTUS decided Clark v. Rameker, which held that inherited IRAs were not retirement accounts under the bankruptcy code, and therefore not exempt from creditors.  In Clark, the petitioners made the claim for exemption under Section 522(b)(3)(C) of the Bankruptcy Code for the inherited retirement account, and not the state statute (WI, where petitioner resided, allowed the debtor to select either the federal exemptions or the state exemptions).  End of story for those using federal exemptions, but some states allow selection like WI between state or federal exemptions, while others have completely opted out of the federal exemptions, such as Montana.  A recent Montana case somewhat follows Clark, but based on the different Montana statute.  In In Re: Golz, the Bankruptcy Court determined that a chapter 7 debtor’s inherited IRA was not exempt from creditors.  The Montana law states:

individual retirement accounts, as defined in 26 U.S.C. 408(a), to the extent of deductible contributions made before the suit resulting in judgment was filed and the earnings on those contributions, and Roth individual retirement accounts, as defined in 26 U.S.C. 408A, to the extent of qualified contributions made before the suit resulting in judgment was filed and the earnings on those contributions.

The BR Court, relying on a November decision of the MT Supreme Court, held that an inherited IRA did not qualify based on the definition under the referenced Code section of retirement account.  I believe opt-out states cannot restrict exemption of retirement accounts beyond what is found under Section 522, but it might be possible to expand the exemption (speculation on my part).   Here, the MT statute did not broaden the definition to include inherited IRAs.

  • In August, we covered US v. Chabot, where the 3rd Circuit agreed with all other circuits in holding the required records doctrine compels bank records to be provided over Fifth Amendment challenges.  SCOTUS has declined to review the Circuit Court decision.
  • PLR 201547007 is uncool (technical legal term).   The PLR includes a TAM, which concludes reasonable cause holdings for abatement of penalties are not precedent (and perhaps not persuasive) for abating the taxable expenditure tax on private foundations under Section 4945(a)(1).  The foundation in question had assistance from lawyers and accountants in all filing and administrative requirements, and those professionals knew all relevant facts and circumstances.  The foundation apparently failed to enter into a required written agreement with a donee, and may not have “exercised expenditures responsibly” with respect to the donee.  This caused a 5% tax to be imposed, which was paid, and a request for abatement due to reasonable cause was filed.  Arguments pointing to abatement of penalties (such as Section 6651 and 6656) for reasonable cause were made.  The Service did not find this persuasive, and makes a statutory argument against allowing reasonable cause which I did not find compelling.  The TAM indicates that the penalty sections state the penalty is imposed “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.”  That language is also found regarding Section 4945(a)(2), but not (1), the first tier tax on the foundation.  That same language is found, however, under Section 4962(a), which allows for abatement if the event was due to reasonable cause and not to willful neglect, and such event was corrected within a reasonable period.  Service felt that Congress did not intend abatement to apply to (a)(1), or intended a different standard to apply, because reasonable cause language was included only in (a)(2).  I would note, however, that Section 4962 applies broadly to all first tier taxes, but does specify certain taxes that it does not apply to.  Congress clearly selected certain taxes for the section not to apply, and very easily could have included (a)(1) had it intended to do so.

I’m probably devoting too much time to this PLR/TAM, but it piqued my interest. The Service also stated that the trust cannot rely on the lack of advice to perform certain acts as advice that such acts are not necessary.  I am not sure how the taxpayer would know he or she was not receiving advice if it asked the professionals to ensure all distributions were proper and all filings handled.  I can hear the responses (perhaps from Keith) that this is a difficult question, and perhaps the lawyer or accountant should be responsible.  I understand, but have a hard time getting behind the notion that a taxpayer must sue someone over missed paperwork when the system is so convoluted.  Whew, I was blowing so hard, I almost fell off my soapbox.

  • This is more B.S. than the tax shelters Jack T. is always writing about.  TaxGirl has created her list of 100 top tax twitter accounts you must follow, which can be found here. Lots of great accounts that we follow from writers we love, but PT was not listed (hence the B.S.).  It stings twice as much, as we all live within 20 miles of TaxGirl, and we sometimes contribute to Forbes, where she is now a full time writer/editor.  Thankfully, Prof. Andy Gerwal appears to be starting a twitter war against TaxGirl (or against CPAs because Kelly included so many CPAs and so few tax professors).  We have to throw our considerable backing and resources behind Andy, in what we assume will be a brutal, rude, explicit, scorched earth march to twitter supremacy.  We are excited about our first twitter feud, even if @TaxGirl doesn’t realize we are in one.
  • This doesn’t directly relate to tax procedure or policy, but it could be viewed as impacting it, and we reserved the right to write about whatever we want.  Here is a blog post on the NYT Upshot blog on how we perceive the economy, how we delude ourselves to reinforce our political allegiances (sort of like confirmation bias), and how money can change that all.