District Court Hands IRS Loss in its Bid to Exclude Discretionary Treaty Benefits From Judicial Review

Last month’s Starr v US involves a $38 million 2007 refund suit in the DC district court brought by Starr International (Starr), the then-largest shareholder in American Insurance Group (AIG). In most refund suits there is little question that a district court has the power to conduct a de novo review of the IRS’s decision to deny a refund claim and determine whether a taxpayer is entitled to a refund. Why did the IRS view the case differently?

The issue involves the IRS’s failure under the US-Swiss income tax treaty to grant Starr a discretionary reduction in withholding on US-sourced AIG dividends. IRS argued that its decision to not grant Starr the discretionary treaty-based withholding relief was for it alone to make, and that its decision was not subject to judicial review. The district court rejected the IRS position, and in so doing discussed an aspect of the Administrative Procedure Act that the IRS claimed applied (at least in principle) to the proceedings.

In this post I will summarize the dispute and offer my view as to why as a policy matter IRS should be reluctant to argue for absolute discretion over most substantive decisions it makes, especially one that goes to the merits of a tax liability such as in this case.

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What is the APA provision at issue? The APA states that agency action is generally reviewable “except to the extent that . . . [it] is committed to agency discretion by law.” 5 U.S.C. § 701(a) (note that another statute such as the Anti-Injunction Act may also remove an IRS decision from court review; that was not at issue in this case). Starr did not bring an action under the APA, however, as it brought a refund suit under Section 7422 and 28 U.S.C.
§ 1346(a)(1). As such, Starr argued that the “committed to agency discretion” rule did not apply because it did not bring an APA claim.

The district court rejected Starr’s position and essentially provided that even if the claim itself were not brought under the APA (and by implication even if the APA did not apply to agency determinations of this type), the principle of nonreviewability in 5 USC § 701(a) applies to all agency actions because the APA merely codified traditional principles of nonreviewability. In other words, if the IRS could establish that the decision to grant treaty benefits at issue in the case were committed solely to the IRS’s discretion, then its decision would be unreviewable despite the fact that there was no APA cause of action.

How does an agency establish that something is solely in its discretion and this not subject to court review? The legal inquiry asks generally if there are judicially manageable standards for a court to review. While that seems a somewhat vague principle, it is safe to say that courts are reluctant to let agency actions escape judicial scrutiny.

That limitation on nonreviewability is for good reason, as many administrative law scholars have claimed and common sense dictates. In an article I wrote awhile back on CDP (around page 1167) I have discussed both the legal and policy reasons why unreviewability of agency action should be the rare exception. In that piece I quote extensively from a 1990 article by Ronald Levin in the Minnesota Law Review called Understanding Unreviewability in Administrative Law. Professor Levin summed up the policy reasons nicely:

Scrutiny of administrative action by an independent judiciary is an integral part of the American checks and balances system—a powerful deterrent to abuses of power and an effective remedy when abuses occur. By helping maintain public confidence that government officials remain subject to the rule of law, judicial review also bolsters the legitimacy of agency action. . . . Finally, judicial review can enhance the quality of administrative action by exposing partiality, carelessness, and perverseness in agencies’ reasoning.

Despite the policy reasons against doing so, over the years, in addition to being able to put an invisibility cloak around its actions due to the Anti-Injunction Act, IRS has claimed unreviewability based on the “committed to agency discretion” defense over a wide range of agency decisions. For example, prior to legislation, it argued with success that decisions to not abate interest and to not grant equitable relief from joint and several liability were exempt from court review, and it continues to assert unreviewability when taxpayers seek judicial review of IRS denials of collection alternatives outside of CDP.

The Discretionary Relief in the Swiss Treaty

As the opinion describes, Starr relocated its corporate headquarters to Switzerland from Ireland. It did so because of a highly-publicized split between former AIG CEO Ace Greenberg and AIG, and disputes over Starr funding AIG’s compensation plans. It alleged that its move to Switzerland was done to “protect its assets from an AIG lawsuit claiming that Starr was contractually obligated to fund the plan.”

That was significant because the US –Ireland treaty automatically provided that the rate on withholdings on dividends was 15% rather than the normal 30%. The US-Swiss treaty on the other hand provided for a reduced 15% rate if certain conditions were satisfied.

Because it failed to satisfy the conditions for the non-discretionary Swiss treaty benefit Starr did not qualify for the automatic reduction under the US-Swiss treaty. In the absence of qualifying for the automatic reduction, the US –Swiss treaty allowed for the discretionary relief that is at the heart of this dispute. The relief provision provides that a taxpayer “may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income arises so determines after consultation with the competent authority of the other Contracting State.” US Swiss Treaty, Art. XXII(6).

As the opinion explains, Treasury has published a Technical Explanation of the US-Swiss treaty; the Technical Explanation is as the opinion mentions roughly analogous to legislative history. That explanation provides that the reason for the limitation on benefits (that is, the reason why not every Swiss taxpayer was entitled to the reduced withholding) was to prevent “treaty shopping.” As the opinion sets out, treaty shopping is the practice of 
”moving … specifically to benefit from the lower U.S. tax rate offered by the U.S.-Swiss tax treaty.”

In 2007, Starr sent a request for discretionary reduced withholding as per the treaty to the US Competent Authority. Having not received a response in early 2010 it filed a protective refund claim. Starr forwarded the claim to the IRS analyst working the competent authority request. Shortly thereafter the competent authority denied the 2007 request for discretionary withholding relief, though interestingly it granted relief for the 2008 year.

Starr then sued for a refund in the fall of 2014. The complaint Starr brought claimed that the IRS abused its discretion for three reasons:

  1. Starr was not treaty shopping when it relocated to Switzerland,
  2. the IRS failed to consult with the Swiss Competent Authority before denying Starr’s request, and
  3. the IRS had no legal basis for issuing Starr a 2008 refund while denying its 2007 request based on the same material facts.

IRS filed a motion to dismiss on the grounds that its decision was unreviewable because it was committed to agency discretion. (alternatively, it also argued that the challenge raised an unreviewable political question, an issue that I will not discuss in this post but which the court found also did not apply to restrict court review).

How Did the Court Determine Whether the Matter Was Solely in the IRS Discretion?

As I discuss above, the court first disposed of Starr’s argument that only APA claims themselves are subject to the committed to agency discretion exception to judicial review. That IRS victory however was only short-lived though because the rest of the opinion discusses why in this case there was enough law for the court to apply, leading the court to the conclusion that it had the power to review the IRS’s decision to not grant Starr discretionary treaty relief. How does it get there? I suggest interested readers look at the opinion as there is lots there but I will hit a few of the highlights.

The court’s opinion goes through the black letter I also briefly describe above that generally asks if the applicable provision 
of law “is drawn so that a court would have no meaningful standard against which to judge the agency’s exercise of discretion,” or “in those rare instances where ‘statutes are drawn in such broad terms that in a given case there is no law to apply.’” (citations omitted).

In a footnote (note 7), the court notes the “strong presumption” that “Congress intends judicial review of administrative action” but also acknowledges that this case differs from many others given it was based not in a statute but a treaty provision. Despite the difference, it extends that presumption of reviewability to treaty provisions:

Federal courts “should normally apply the [background] presumptions supplied by American law” when ascertaining treatymakers’ intent in assessing entitlement to relief under a federal statute. One such presumption—an especially strong one—is that Congress intends for agency action to be reviewable. (citations omitted).

To look at the issue in question the court considered the prototypical agency matters that do get exempted from review, agency decisions whether to enforce or prosecute, and contrasted them with the IRS decision in this case. Despite accepting that distinction, IRS argued nonetheless that the treaty benefits’ decision warranted unreviewability because it implicated “complicated foreign policy matters” and courts have on occasion extended unreviewability to agency decisions sweeping in foreign policy.

The opinion distinguished a tax treaty’s benefits’ provision from those cases where courts found that the complex considerations in foreign policy matters rendered unreviewable, such as the State Department’s decisions to deny a consular visa or delegate a decision to control arms exports, noting that “reviewing a denial of benefits under the discretionary provision does not involve “second-guessing executive branch decision[s] involving complicated foreign policy matters.”

After disposing of the IRS argument that treaty benefit decisions were inherently nonreviewable the opinion undertook the task of discerning whether the “language, structure and history” of the benefits provision in the treaty supported nonreviewability. I hit some of the highlights of the opinion below.

The opinion started with a focus on the treaty language itself I quoted above, which provides permissively that the taxpayer “may” be granted relief. At first blush the use of the permissive “may” cuts in favor of absolute agency discretion, but the opinion notes that many cases have held that permissive language such as may was not determinative, leading the court to look to sources other than the text itself.

Its next stop was the treaty’s Technical Explanation, which as I mention above is like legislative history. Prepared by Treasury to assist the Senate in the ratification process, it reflects Treasury’s view and explanation of the treaty. That explanation includes a statement on the discretionary provision, stating that the Treasury would “base [its] determination . . . on whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of benefits under the convention.”

The opinion looked to testimony of Treasury officials, which like the explanation puts some context on the decision to grant discretionary benefits. For example, the Treasury Assistant Secretary stated that in determining eligibility for discretionary relief IRS would look for a “a substantial non-treaty-shopping motive for establishing themselves in their country of residence.”

While not part of the treaty itself, the explanation and testimony suggested a standard by which the IRS would evaluate requests for treaty relief. In fact, in denying Starr’s claim, the IRS applied that standard, informing Starr that it could not “conclude that obtaining treaty benefits was not at least one of the principal purposes for moving Starr’s management, and therefore its residency, to Switzerland.”

What was the IRS’s rebuttal? It pointed to Senate report accompanying the treaty ratification which stated that “the Secretary of the Treasury may, in his sole discretion, treat a foreign corporation as a qualified resident of a foreign country[.]” Tax Convention with Switzerland, S. Exec. Rep. No. 105-10, at 54 (1997). The opinion notes that this “does not explicitly discuss judicial review, but it nonetheless provides some evidence of an intent to preclude such review.” Despite what the opinion felt were the mixed messages, it felt that the report was not enough for the IRS to prevail:

IRS has not presented clear and convincing evidence that the discretionary provision was intended to preclude judicial review. Indeed, the structured guidance set forth in the Technical Explanation—a long with the lack of any express preclusion of judicial review—renders the issue sufficiently ambiguous that the presumption of reviewability controls?

IRS also argued that the “principal purpose” standard was too vague to afford a court meaningful review:

The IRS claims that this standard is not specific enough to permit review. What, asks the IRS, does it mean to conclude that a company’s “principal purpose” is to obtain the benefits of a tax treaty?

The opinion likewise finds this argument unavailing and notes that unlike IRS it was “not so daunted by the prospect of reviewing the IRS’s determinations. Courts routinely face somewhat amorphous and open-ended standards…. At the margins, it may be difficult to determine whether a company moved to Switzerland principally to lower its tax rate. But this does not mean there are no manageable standards to apply.”

Conclusion

Having survived a motion to dismiss, the case now will proceed to the merits. While the presence of the treaty provisions complicates the analysis, I think the district court got this one right on the law and on the policy. Courts are pushing back against IRS claims that its process or decisions should be insulated from judicial review. For the reasons Professor Levin succinctly mentions in his 1990 law review article, courts are rightfully skeptical of agency blanket calls for unreviewability. IRS has faced plenty of allegations of abuse of power, and it is rocked still by questions pertaining to its politicized review of applications for exemption. For an agency like the IRS, which administers a law which depends in part on continued public respect for the integrity of the tax system, IRS needs to choose its battles on this issue carefully.

Summary Opinions for the second half of May

Here is part two of the items from May we didn’t otherwise cover.  We’ll have the June items shortly, and then July.  Hopefully, I’ll get back on track for weekly summaries in the near future.

  • The Sixth Circuit in Ednacot v. Mesa Medical Group, PLLC affirmed the lower court tossing a physician assistant’s claim that an employer wrongfully withheld employment taxes.  The Court determined this was tantamount to a refund suit, which required the taxpayer to first file an administrative claim for refund with the IRS prior to bringing suit.  There seems to be a lengthy past between the parties in this case.  The petitioner brought up a valid seeming point that she did not know if the withholdings were paid to the IRS, and therefore wasn’t sure if the refund was appropriate, but the Court held that Section 7422 was designed to funnel these issues through the administrative process.
  • Couple interesting privilege cases recently, including the Pacific Management Group decision blogged by Joni Larson for us.  In a case that may have a somewhat chilling effect on making reasonable cause claims, the Tax Court has held that claiming reasonable cause to the substantial valuation misstatement penalty waived attorney client privilege and the work product doctrine for certain communications between the taxpayer and its lawyer and accountant.  See Eaton Corp. and Sub. v. Comm’r.  This holding was the affirming of a motion for reconsideration.  The Court found that although there was an objective determination under Section 6662(e)(3), whether relying on the advice on Section 482 was based on the facts and circumstances, including the advice of the lawyer.  By claiming reasonable cause, the privileges were waived for that issue.
  • Taxpayer was successful arguing against the substantial understatement penalty in Johnston v. Comm’r, but it was because the taxpayer didn’t actually owe the tax.  The IRS had argued that a debt between the taxpayer (an executive of a telcom company) and his company was discharged by his employer when he moved to a related entity.  There was credible evidence that it was not discharged and payment continued.  There was the pesky issue that the loan wasn’t paid until the IRS audited the individual, but the Court found that the audit prompted the company to do something with the loan and it hadn’t been tax avoidance…must have been persuasive testimony.
  • LAFA issued guidance on the effect on the limitations period on assessment for payroll tax when the wrong form is filed. (LAFA 20152101F).  Employers are generally required to file quarterly returns on Form 941 for employment taxes when they are paid in that period.  A different form, Form 944 is used for certain employers with little  employment tax liability, and that is required annually.  The statute generally runs from the date of the deemed filing of employment tax returns, which is April 15 the following year.  See Section 6501(a)&(b).  The LAFA reviews the following three situations:
  1. Employer is required to file Form 944, but instead timely files four quarterly Forms 941.

  2. Employer is required to file Form 944, but timely files Form 941 for the first and second quarters of the year instead, and files nothing for the third or fourth quarters of the year.

  3. Employer is required to file quarterly Forms 941, but timely files annual Form 944 instead.

 

The quick conclusions were:

  1.  Assuming the Forms 941 purport to be returns, are an honest and reasonable attempt to satisfy the filing requirements, are signed under penalty of perjury, and can be used to determine Employer’s annual FICA and income tax withholding tax liability, the Forms 941 meet the Beard formulation and should be treated as valid returns for purposes of starting the period of limitations on assessment.

  2.  An argument can be made that the Forms 941 for the first and second quarters of the tax year constitute valid returns under the Beard formulation since they purport to be returns and are signed under penalty of perjury. However, given that Employer’s FICA and income tax withholding tax liability for the third and fourth quarters will not necessarily be equal to that reported for the first two quarters, the Forms 941 arguably are not sufficient for purposes of the determining Employer’s annual FICA and income tax withholding tax liability and may not be honest and reasonable attempts to satisfy the tax law.

  3.  Assuming the Form 944 purports to be a return, is an honest and reasonable attempt to satisfy the filing requirements, can be used to determine Employer’s annual FICA and income tax withholding tax liability, and is signed under penalty of perjury, Employer’s Form 944 meets the Beard formulation and should be treated as a valid return for purposes of the period of limitations on assessment.

  • A taxpayer in a chapter 11 case, Francisco Rodriquez (not the current Brewers closer who pitched for the Mets before choking out his relative in the clubhouse) was successful in avoiding a lien under 11 USC 506 on property held by the taxpayer that was already underwater with three prior liens.  In re Rodriguez, 115 AFTR2d 2015-1750 (Bktcy D MD 2015).  Section 506 allows liens to be stripped if the property lacks equity, which was what the taxpayer was attempting.  SCOTUS in Dewsnup v. Timm held that  a chapter 7 debtor cannot “strip down” an allowed secured claim (clearly, I was not the debtor, otherwise SCOTUS would have tossed on some Its Raining Men, and granted my right to strip down—I only did it to pay for college, I swear—and yet, still so many student loans).  Various other cases have held that Dewnsup does not extend to other chapters in bankruptcy, and the District Court held that lien stripping was appropriate in chapter 11 under the taxpayer’s circumstances.
  • The Tenth Circuit continues its clear prejudice and hatred towards Canadians (I completely made that up and that link is NSFW) in Mabbett v. Comm’r, where it found the Tax Court properly tossed a petition as being untimely that was filed by a resident of the US, who was a Canadian citizen.  The Court found the Service had properly sent the stat notice to the taxpayer at her last known address (and even if that was not the case, her representative had forwarded her a copy well before the due date of the petition).  The taxpayer also claimed that she was entitled to the 150 day period to file her petition to the court under Section 6213(a) because she was a Canadian citizen.  The Court stated, however, that the statute was clear that the 150 day rule only applies when “the notice is addressed to a person outside the United States.”  The taxpayer had been traveling, and was Canadian, but failed to show she was outside of the United States at the time the notice was sent.
  • In case you haven’t seen, the Service has started a cybercrimes unit to combat stolen ID tax fraud.  In my mind, this is sort of like the IRS and Tron having a lovechild, which I would assume to look like this.  Jack Townsend has real coverage on his Federal Tax Crimes Blog.
  • Jack also has coverage of the new IRS FBAR penalty guidance, which can be found here

 

Summary Opinions for the week ending 3/27/15

How could I not start with John Oliver and Michael Bolton singing about the IRS.  This link is not really great for work, and to say it is sophomoric may overstate the sophistication and maturity.  Sexy singing is at the end of a fairly long clip, which is all pretty funny (on the IRS, “it combines two things we hate, people taking our money and math”).  This is probably the funniest Michael Bolton clip from the month, which is really impressive since it is about the IRS and he recently recreated the Office Space scenes with the character sharing his name – if you liked that movie, you should find the clip.  Equally as entertaining and enlightening were our guest posters during the week ending March 27, 2015.  Peter Hardy and Carolyn Kendall of Post & Schell did a two part post (found here and here) regarding the definition of willfulness in civil offshore enforcement cases.  First time guest poster, Bob Nadler, posted on the recent Sanchez case dealing with an interesting innocent spouse issue that hinged on whether a joint return was actually filed.  Thank you again for the great content.

I also need to thank our guest posters from the last week and a half.  Carlton Smith provided two of the three posts on the Godfrey case, the last of which can be found here and links to the first two.  Godfrey is an interesting case raising a couple issues regarding appropriate notice with collection actions.  We were also pleased to have Prof. Bryan Camp with a three part post on Eight Tax Myths, the last of which can be found here and links the first two.  Both sets of posts were very well received, and both generated a fair amount of discussion.  I would encourage everyone who has not read both sets to do so, and, for those who have, you might consider going back and reading the comments and responses.

To the other procedure: 

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  • In a FOIA dump, the Service has released PMTA 2014-015, which discusses the erroneous refund penalty under Section 6676.  The following points are discussed in the memo:

1. Does the Section 6676 penalty apply to refund claims made on Form 1040 and Form 1040X and does it matter whether the Service has paid the claim?

2. Does the nature of the item to which the excessive amount is attributable have any bearing on the penalty?

3. Is the Section 6676 penalty subject to deficiency procedures?

4. Are there any specific taxpayer notifications required for the penalty to apply?

5. Does the ‘reasonable basis’ exception to the Section 6676 penalty have the same general meaning as the reasonable basis exception to negligence found in Reg. 1.6662-3(b)(3)?

 I’m not sure there are any earth-shattering realizations to be found in the IRS response, but some points seem worth noting.  As to the first point, the Service stated the penalty can be imposed even when the IRS does not actually refund the amount requested.  For the second point, the Service discussed the various situations where other penalties would apply (reportable transactions, EIC, etc.).  As to the third question, the Service stated the general rule that the penalty is not subject to the deficiency procedures, but stated that for some refundable credit cases the penalty will have to be assessed pursuant to the procedures.  No court has apparently addressed either point.  The last thing that jumped out at me was that the Service stated the reasonable basis exception under Section 6676 has the same meaning as under the accuracy related penalty provisions found in Section 6662, which is not news, but good reinforcement of the prior position.

  • Harper Int’l Corp v. US is a case we (I) missed in January (see page 13 of this PDF for a more robust recitation of facts and holding).  In the case, the IRS denied a refund request.  On May 2, 2012 the IRS issued a Notice of Disallowance, which stated the taxpayer had two years to challenge the determination.  About a month later, another notice was received by the taxpayer, stating the claim was rejected and another formal Notice of Disallowance would be issued – but it never was.  Taxpayer petitioned the Court of Federal Claims in June of 2014, more than two years after the first letter, but less than two years after the second letter.  The Court of Federal Claims held that although equitable provisions might apply, it was not reasonable for the taxpayer to rely on the second notice (and they failed to comply even if using the date of the second notice because timely mailing was not timely filing for CFC).
  • Another sham(wow) partnership case in CNT Invest., LLC v. Comm’r, where the Tax Court has held that gain recognized in a collapsed step of a multi-step transaction was gross income for determining the extended statute of limitations under Section 6501(3)(1)(A).  Case also confirmed limitations period was the longer of the period found under Section 6229 or Section 6501.
  • Businessweek thinks the IRS sucks.  The reasons are largely outlined by the John Oliver video above.  I’m sure this has generated a lot of scoffs, but I honestly do try to keep this in mind as I sit on hold for 90 minutes.  Maybe it helps me from being a complete jerk to the person who eventually picks up.  Solid chance that person’s day is worse than mine. How much longer before this all implodes? Is that the goal?  Might work.
  • Kardash v. Commissioner was decided by the Tax Court on the 18th, and has a good discussion of transferee liability but a difficult result for taxpayer minority shareholders in a company where the Service found transferee liability for tax due that was the result of theft by the majority shareholders.  This is going to get a little longwinded, sorry.  In Kardash, a concrete company was largely owned by two shareholders, who controlled all aspects of the business.  Two other minor shareholders oversaw sales and operations; neither had any control over the overall management or finances of the company.  During the early 2000s, the company was very successful and the minority shareholders received huge additional compensation.  Unfortunately, during this time, the majority shareholders were plundering the coffers and not paying any taxes ( one of whom is in the clink and the other is no longer with us).  Here is some more background on that sad story.  The finances of this company were apparently open for the taking, as two other employees were jailed for stealing over $5.5MM from it before the IRS got involved.  On audit, for 2003 to 2007, the Service assessed over $120MM in tax, penalties and interest.  The company was insolvent at that point, payment was not possible, and the company and the Service entered into an installment agreement to pay $70,000 a year until the end of time.  The Service reached agreements with the two majority shareholders, but substantial amounts of tax were still outstanding.  The Service then attempted to recoup a portion of the remaining amount from the minority shareholders pursuant to Section 6901(a).  For Kardash, the amount was around $4MM.  There were a host of questions before the Court regarding the IRS’s collection actions against the company and majority shareholders cutting off liability, but what I found interesting was the issue about whether, under state law, the minority shareholders were responsible for the tax due to fraudulent transfers to them by the majority shareholders.

For the fraud, the Court looked to Florida law to determine the extent of the potential transferee liability.  As an initial point, the Court did not aggregate the transfers with those of the majority shareholders (contrary to the Service argument), and instead looked at each payment to the minority shareholders to determine constructive or actual fraud of each payment.  The FL statute provides that if the company did not receive “reasonably equivalent value” for the payments, they may be fraud if: “(1) the debtor was engaged…in a business…for which the remaining assets of the debtor were unreasonably small…;(2) the debtor intended to incur…debts beyond his ability to pay as they became due; and (3) the debtor was insolvent at the time of the transfer or became insolvent as a result of the transfer.”  Kardash argued his work for the company was reasonably equivalent value, and the Court agreed for certain “loans” in 2003 and 2004, which were really advanced on compensation.  For 2005 through 2007, the funds were provided to Kardash in the form of a dividend from the Company.  The Court noted the conflict in cases regarding the treatment of dividends as “reasonably equivalent value” as compensation for work done.  The Court seems to indicate the general position is that dividends are not compensation for services rendered and therefore not an exchange for value.  In the limited cases holding the opposite, the dividend has been directly tied to work provided.  See In re Northlake Foods, Inc., 715 F3d 1251 (11th Cir.) (holding dividend made as tax distribution to pay tax due on s-corp shares); In re TC Liquidations, LLC 463 BR 257 (ED NY 2011) (dividend made to shareholder to repay loans taken out to expand business).  Although I have not read these cases, this seems like a point that could be open to other interpretation in this case.  The dividends here effectively replaced a prior bonus program.  The program was stopped and the company made the loan/advances to the minority shareholders because the company knew the minority shareholders needed that level of compensation.  This was a temporary solution until the dividends were to start.  Since at least a portion was compensation provided in a different form, a finding that it was received in exchange for equivalent value would not seem unreasonable in this case.  The Court did address this by stating the company did not benefit from the dividends as clearly as in the above two cases, but I am not sure I agree.  Had the dividends not be issued to take the place of the prior bonus program and advances, the minority shareholders may have left.  During the period in question, the company was very successful, arguably because of the minority shareholders.  The second reason is that the company and shareholders treated it as dividend income and not compensation.  Although a factor worth consider, I am not sure it has to be dispositive.

The issue of insolvency was reviewed next, with a few pages devoted to the debts and income stream.  The Court relied on the IRS’s expert’s opinion that since there were no tax returns, no buyer would ever pay more than the gross value for the land and tangibles, and the company had no intangibles.  Based on that, the company was insolvent most of, if not the entire time.  Interestingly, the opinion includes the gross revenue, but I don’t think it includes the asset values.  Ignoring the various other ways to value a company, I think this is also open to other interpretation.  I am not sure the conclusion that no one would be willing to buy the company is correct—obviously that would be a substantial risk, but business people often take risk if the reward appears sufficient.  I am also not sure the value of the intangibles was $0, since the revenue for the years in question was north of $100MM, which was substantially more than the hard assets.  Clearly, the company, as a going concern, had some value that exceeded hard assets.  The company may have still been insolvent, I just wasn’t sold on those particular points.  An interesting case, and what seems to be a tough result for some transferees who were screwed by their employer.

  • The Service has issued internal guidance indicating that it will no longer allow taxpayers to enter into installment agreements for post-petition liabilities when the taxpayer has filed for Chapter 13 bankruptcy.  The guidance indicates that this was previously allowed in some jurisdictions, but that the Service believes this potentially violates the BR stay.
  • 2014 data book has been issued by the Service in electronic form, and can be found here.  Lots of interesting stuff.  Looks like 40% of penalties were abated in terms of amount.  Less business returns, but more individual in 2014 than 2013.
  • Barry and Michelle paid an effective tax rate of 18.8% (maybe slightly higher –I’m finding some conflicting reports and too lazy to do the math) for federal income tax purposes.  I think that is a little higher than mine…although we made slightly different amounts.

Summary Opinions for the weeks of 3/06/15 through 3/20/15

Image from https://storesafewasnotsafe.wordpress.com/

This will be the last post for the week, as we will all be busy with family activities (and taxes).  We should be back on Monday with some new content, and it looks like next week will cover some really interesting areas, including the recent Godfrey case, and sealing Tax Court records.

We have been very lucky over the last month to have a lot of really great guest posts.  We cannot thank those guest posters enough for the quality content, especially as the three of us have been very busy with our various other jobs (or appearing before the Senate–perhaps more on that next week also).  For the weeks that SumOp is covering in this post, we had Mandi Matlock writing on TPA Most Serious Problem # 17 on how deficient refund disallowance notices are harming taxpayers.  Peter Lowy wrote on the really interesting Gyorgy case, which deals with the taxpayer’s requirement to notify the Service on a change of address, but also highlights a host of other procedure items.   Patrick Smith joined us again, writing on Perez v. Mortgage Bankers Associate, and illuminating us on APA notice and comment requirements for different types of rules and the possible eventual reversal of Auer.  We also welcomed Intuit’s CTO, David Williams who wrote a response to Les’ prior post on H&R Block’s CEO indicating it should be harder to self-prepare (which Les was potentially in favor of).  And, another first time guest blogger, Patrick Thomas, joined us writing on the calculation of SoLs on collections matters.

We were also very lucky again to have Carl Smith writing for us, this time updating us on the Volpicelli jurisdiction case and the Tax Court pleading rules on penalties looking at the El v. Comm’r case.  A thank you to all of our guests over those two weeks, and a special thanks to Carl for his continued support.

To the other procedure items (if you keep reading, the image will make more sense):

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  • The Service released CCA 201510043, in which Chief Counsel stated a taxpayer is entitled to two sets of collection due process rights for the same period when there were two assessments; one for assessment arising out of a civil exam and the other from restitution-based assessment.  Section 6201(a) was recently (five years ago) amended to require assessment and collection of restitution in the same manner as tax.  The advice has a nice summary of cases outlining why this double assessment of the same tax is not double jeopardy.  Although the general rule is that a taxpayer is entitled to one CDP hearing with respect to tax and tax years covered by the CDP notice, there are situations where multiple hearings are appropriate.  The advice highlights Treas. Reg. 301.6320-1(d)(2) Q&A D1 and Treas. Reg. 301.6330-1(d)(2) Q&A D1 as examples of allowing two CDP hearings when there has been additional assessments of tax or new assessments for additional penalties.  The Advice determined that this situation was analogous and warrants two separate CDP hearings.
  • The Northern District of California in In Re Wilson held that penalties for failure to timely file were dischargeable when the original due date was outside of the three year look back under BR Code 523(a)(7)(b), but the taxpayer had extended the due date and the extended date was within the three years.  The Court indicated this was a case of first impression.  Another interesting BR Code Section 523 issue.
  • This clearly only pertains as a practitioner point, and not something any of our readers would personally need, but OPR has announced a standard information request letter to make a Section 6103 request for information maintained by OPR relating to possible violations of Circ. 230.  Info about the letter is found here, and you can get the actual letter here.
  • The Ninth Cir. affirmed the Tax Court in Deihl v. United States in finding a widow spouse did not qualify for innocent spouse relief.  In the case the Court did not find there was clear error by the Tax Court in reviewing the widow’s testimony and find it was not credible.  The surviving spouse provided testimony that conflicted with other evidence regarding the couples’ business, and she did not offer any third party testimony regarding the abuse.  The widow argued that since the Service did not offer contrary testimony regarding the abuse, the Tax Court had to accept her testimony, which the Ninth Circuit stated was incorrect.  Further, looking to Lerch v. Comm’r, a Seventh Circuit decision, stated that the Tax Court did not have to accept testimony that was questionable, even if uncontradicted (tough to overcome the presumption of guilt that comes along with a name like Lerch).
  • Gambling causes fits for the Service.  Tipped casino employees used to underreport frequently, but apparently casinos will provide estimates to the Service.  Gambling website accounts might be offshore accounts (even if sourced in US banks). Add to that list of problems how to treat bingo, keno and slot machine winnings.  This blurb will focus on slot machines.  New proposed regulations offered in a recent IRS Notice would provide a safe harbor to determine gains and losses from a slot machine.  The issue is that gains from “transactions” are included in income.  Losses are deductible to the extent of winning, but generally as itemized deductions.  For slot machines, a “transaction” is session based.  What is a session can be a point of disagreement between the Service and taxpayers.  This is apparently becoming more murky now that people don’t use actual coins.   So, what are those retirees on the bus trips to AC or Vegas to do?  The Service is soliciting suggestions, but the current proposed safe harbor states that a session of play:

A session of play begins when a patron places the first wager on a particular type of game and ends when the same patron completes his or her last wager on the same type of game before the end of the same calendar day. For purposes of this section, the time is determined by the time zone of the location where the patron places the wager. A session of play is always determined with reference to a calendar day (24-hour period from 12:00 a.m. through 11:59 p.m.) and ends no later than the end of that calendar day

The Notice then goes on to explain how to calculate gains and losses during the session.

  • Add this to the list of things that will not get you out of the failure to timely file penalties – taxpayer could not access tax records because his storage unite doors had frozen over.  The argument received an icy reception (oh, man that was bad) with both the Service and the Tax Court. See Palmer v. Comm’r., TC Memo 2015-30 (for some reason this isn’t up on the TC web page anymore – sorry).
  • If you are going to cheat on your taxes, you probably should do so using offshore accounts (I usually charge clients a .5 for that advice, and you all just got it for free!).  Check out Jack Townsend’s blog on US v. Jones, an “ordinary tax cheat”, as Mr. Townsend put it, who got dinged with 80% of the bottom of the guideline range for sentencing.  He was using “sophisticated means”, which seemed fairly run of the mill.  Jack compares this to the sentencing of another UBS client, who ended up getting 22% of the bottom of the guideline range.  Switzerland should use this in its promotional materials.
  • In MSSB v. Frank Haron Weiner, the Eastern District of Michigan found that Section 6332(a) did not establish priority for competing liens, and instead Sections 6321, 6322 and 6323 established the priority (in favor of the IRS in this case).  In MSSB, a debtor owed funds to the IRS and a lawyer named Frank.  The Service recorded four liens, each before December 3, 2012.  Around $1.6MM was owed.  On December 6, 2012, Frank sued the debtor to recover unpaid legal fees and won.  In 2013, Frank obtained a writ to garnish the debtors IRA (Michigan must not offer much in terms of creditor protection for IRAs).  The Service stepped in, arguing it had priority on the IRA.  Frank countered, arguing that Section 6332(a) would give him the money.  The Section states:

Except as otherwise provided in this section, any person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made shall, upon demand of the Secretary, surrender such property or rights (or discharge such obligation) to the Secretary, except such part of the property or rights as is, at the time of such demand, subject to an attachment or execution under any judicial process.

Frank’s position was that his claim was the type of claim referenced by the “subject to an attachment or execution under any judicial process.”  The Court, however, held that the language did not direct which claim (that of the IRS or Frank) had priority, and only stated that the financial institution did not have to turn the funds over to the IRS.  The Court then looked to the other lien provisions, and found the IRS had priority and directed payment.

  • I went to see roller derby one time, which was really entertaining.  A perfect mix of roller skating and WWF.  All of the young women have funny/clever names, and often have slogans.  The announcer said of one that she had “champagne for her real friends, and real pain for her sham friends.”  Unfortunately, this has really nothing to do with this next case, except the tax court was dropping some real pain on a sham partnership.  In Bedrosian v. Comm’r, the Tax Court held that whether legal fees paid by a sham partnership were deductible was an affected item subject to TEFRA, and the Court had jurisdiction to make such a determination.  This was not the Bedrosians’ first Tax Court rodeo, and they keep making new TEFRA law, which now comprises a substantial chunk of revised Saltzman and Book Chapter 8 dealing with general exam procedures and a growing subsection dealing just with the complex world of TEFRA.

What good is your right to challenge the IRS’s position if you have no idea what it is?!

Today we welcome first time guest blogger Mandi Matlock. Mandi splits her time between private practice where she is an associate at Mondrik & Associates and Texas RioGrande Legal Aid where she founded the low income taxpayer clinic. I know Mandi through her work in the clinic.  Because she has a significant background in consumer law, she brings a perspective to tax law issues informed by her other practice knowledge.  In addition, she is the chapter author in Effectively Representing Your Client before the IRS of the chapter on the special tax issues faced when disaster strikes.  This post picks up on an issue identified by the National Taxpayer Advocate in her annual report and examines the problems created when the IRS fails to explain why it is disallowing a claim for refund.  Keith

National Taxpayer Advocate Nina Olson released her Annual Report to Congress this January expounding on her oft-repeated mantra that the continued erosion of taxpayer service does not bode well for future tax compliance or for public trust in the fairness of the tax system. In this blog post, we take a look at the Annual Report’s Most Serious Problems #17, which focuses on how deficient refund disallowance notices are harming taxpayers.

The Service’s specific problem here starts with that tiny little subsection endcapping Section 6402. It says that when the Service disallows a refund claim, it “shall provide the taxpayer with an explanation for such disallowance.” IRC 6402(l). How hard could that be, right?

Well, scrutinizing the Service’s efforts closely through the lens of the Taxpayer Bill of Rights, as the National Taxpayer Advocate did in her Annual Report, it turns out the Service has more than a little trouble complying.

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How Does the Service try to Meet its Obligations?

The Service uses of a patchwork of over 50 different claim disallowance notices, some of which are required by statute, to notify taxpayers of its decision to deny or partially deny a refund claim. In an obvious attempt to comply with 6402(l), various subsections of the IRM require these claim disallowance notices to contain specific reasons for the disallowance and an IRC section where possible.

The Annual Report categorizes the claim disallowance notices it reviewed as either statutory or non-statutory. The statutory notices are those the Service is required by statute to send by certified or registered mail to commence the two-year statute of limitations for challenging the denial by filing a refund suit in a United States District Court or the Court of Federal Claims. They include stand-alone notices such as Letters 105C and 1364 as well as any number of so-called combo-notices, such as Letter 3219 or even a Statutory Notice of Deficiency issued during an examination in which a refund claim is pending.

The non-statutory notices alert the taxpayer that a refund claim was denied, but have no effect on the statute of limitations for filing a refund suit. They include Letter 569 (SC), the initial letter from Examination proposing to deny or partially deny a claim for refund, and Letters 2681 and 2683 from Appeals sustaining a prior decision to deny a refund claim. Non-statutory notices may be sent before or after a statutory notice a statutory notice of claim disallowance. For example, Appeals may issue a non-statutory notice informing a taxpayer of its decision to sustain the denial of a refund where Examination has already sent a statutory notice of claim disallowance. There are some instances where the non-statutory notice is the only notice ever sent (i.e., cases where the taxpayer has signed a waiver of his or her right to statutory notice of claim disallowance).

TAS also included in its review what it called “no consideration” letters, which notify a taxpayer IRS will not consider his or her refund claim because it is somehow deficient. It makes sense to include these no consideration letters in the review because they work to deny refund claims in cases where the no consideration letter itself is so deficient the taxpayer has inadequate information with which to respond and remedy the defects in the original refund claim.

The Treasury Inspector General for Tax Administration found in a recent report that half of IRS letters and nearly two thirds of IRS Notices were not clearly written and did not provide sufficient information. Need we invoke the horror of the old CP-2000 Notices that rambled on with multiple pages of irrelevant and confusing explanations for items of income and equally irrelevant and confusing exceptions to the irrelevant items of income? You get the picture. But do refund claim disallowance notices suffer from similar logorrhea?

The Annual Report Gives Appeals and Examination an “F”

The IRS falls short in its efforts to comply with the letter and spirit of Section 6402, according to the Report, thereby interfering with at least two of the rights guaranteed under the Taxpayer Bill of Rights: the right to be informed and the right to challenge IRS’s position and be heard. The Taxpayer Advocate Service reviewed a sample of refund disallowance notices and found shortcomings running the gamut from notices providing no explanation at all(!) to notices providing lengthy, confusing explanations that nevertheless failed to supply adequate specific information from which a taxpayer could determine how to respond. Oh my!

What good is the gleaming new guaranteed right to challenge the IRS’s position if you have no idea what that position is?! How will you prepare your reply and exercise your right to be heard if you can’t figure out what the issue is in the first instance? Don’t even think about calling IRS for clarification. IRS projects it will be able to answer fewer than half of taxpayer calls in FY 2015. Those taxpayers who do manage to get through will be speaking with an IRS employee who most likely has no access to a copy of the correspondence because IRS does not keep copies of the most frequently used claim disallowance letters.

What specifically did the Annual Report find with respect to refund claim disallowance notices? Letters 105C and 106C variously failed entirely to state the specific reason for the disallowance, failed to state clearly and understandably the specific reason for the disallowance, failed to provide information adequate to permit a taxpayer to dispute the disallowance, or some combination of the three. TAS determined 92% of 105C letters reviewed failed to satisfy the purpose of 6402(l). 65% did not provide information necessary to respond. More than half did not adequately explain the reason for the disallowance. Almost a third contained sections that were not written in clear, plain language. The Report also finds fault with Appeals’ use of Letters 2681 and 2683, neither of which is designed to provide an explanation at all.

Specific examples cited in the report include notices that provided inapposite information, failed to identify which item of income was being disallowed, failed to identify which dependent, credit, or other tax benefit was being disallowed, and failed to correctly state the amount of the claim being denied.

How Far Should the Service Go?

But how much disclosure is too much disclosure? This is the perennial struggle of consumer rights advocates. Have you tried to struggle through your Cardholder Agreement for one of your credit cards lately? How about your home loan closing documents? Now consider that these documents are the streamlined – yes streamlined – products of decades of legislation and regulation intended to benefit consumers by mandating clear and conspicuous information in a format that consumers can understand. In short, as disclosure experts lament, better writing on its own cannot simplify complex concepts.

While proponents of increased disclosure view it as a means to empower consumers and increase market transparency, detractors complain disclosures are inaccessible to uneducated consumers in any event, and still other commentators take the cynical view that businesses gleefully agree to increased disclosure to avoid substantive reform and lull consumers into complacency with white noise. A recent New York Times piece sheds some light on that interesting debate.

Thank goodness the issue of disclosure in this context presents a much simpler paradigm. For example, while the Annual Report highlights certain notices’ “complicated descriptions” of refund statutes, the criticism remains largely on the Service’s failure to provide the underlying dates the Service relied on to deny the refund claims as untimely. Thus a recipient of one of these notices who may understand the Service’s complex description of the law still cannot adequately respond because he or she doesn’t know what basic facts IRS relied on. While the underlying legal issue can at times be so complex as to frustrate efforts to explain it in clear language accessible to all taxpayers, the Service can start by always including the taxpayer’s specific facts that were operative in the IRS’s decision-making process.

The Report heaps praise on the Innocent Spouse Unit and holds up its denial and no consideration letters as models of clarity the Service should look to in revising the Examination and Appeals correspondence and procedures. I think we can all agree the innocent spouse law is complex. And yet the IS Unit manages to explain it while also providing adequate information for taxpayers to understand its decision and how to respond. A great example of the Service striking the right balance!

We agree with the NTA that IRS can get refund claim disallowance notices right the first time. In view of the statutory mandate and the equally important Taxpayer Bill of Rights, it must!

 

 

 

Summary Opinions for week ending 02/27/15

Before the roundup, a quick thank you to our guest posters from the week ending February 27th.  Michael Desmond joined us once again, posting on the likelihood of legislative responses to the court’s stopping regulation of paid preparers.  We also welcomed Marilyn Ames as a first time poster, writing about the binding effect of an OIC.

To the procedure from that week:

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  • The Service issued Rev. Proc. 2015-16, which provides updated guidance on adequate disclosure for reducing accuracy related penalties and the tax return preparer penalties under Section 6694(a).  The Revenue Procedure appears to be very similar to the prior guidance found in Rev. Proc. 2014-15, and reincorporates some examples from the guidance in 2013, which the Service decided it should not have removed.
  • The facts of a substantial valuation misstatement penalty case in Na v. Commissioner, which the taxpayer won, are fairly interesting.  In Na, the Service used the bank deposit method to recreate a taxpayer’s income.  Prior to the year in question, the taxpayer did not have much annual income and never gambled.  The taxpayer also spoke little English.  During the audited year, the taxpayer had income and deposits of over a $1M in gambling earnings, plus substantial distributions from her employer’s companies.  She explained that her employer used her personal accounts to run distributions from his companies and his gambling activity through.  The Court found her evidence and testimony credible, and greatly reduced her liability.  The Court did not address the specifics of the substantial valuation penalty, and instead said that was for the parties to review and calculate following the order.  Anyone want to give odds on the chances of seeing a TC case in the employer’s name in the near future?
  • The Service issued Rev. Proc. 2015-20, providing updated guidance for small businesses tying to comply with the final tangible personal property regulations issued in 2013 regarding capitalization of costs regarding TPP.  The Service has also promulgated some FAQs on the topic.  There has been a lot of consternation regarding whether or not these will require all businesses to request a change in accounting method and file Form 3115.  For some small businesses, the Form will not be required.
  • From the legal gossip blog, Above the Law, comes a glowing recommendation for the TV show Better Call Saul, stating that it is a far more accurate representation of the practice of law than most other legal shows.  I’ve watched the first few episodes, and am completely hooked.  In full disclosure, I was a huge fan of Breaking Bad, and this is a spin off.  Not particularly representative of my life though.  I had far less anguish over hush money and the persuasive power of violence.
  • The Tax Court held that state law applied in determining what the successor in interest was for an entity that transferred assets to a related taxpayer.  See TFT Galveston Port. LTD v. Comm’r.
  • IRS scams on the front page of CNN.
  •  Last August, we touched on FDIC v. AmFin in SumOp, which was based on a dispute over ownership of a refund issued to the parent of a consolidated group.  SCOTUS didn’t find the issue that interesting, and denied cert.
  • Do banks get title insurance before foreclosing on properties?  The District Court for the Southern District of Indiana in First Financial Bank v. US Dept. of Treas. tossed an action for quiet title filed by the bank where a subsequent title search turned up a tax lien after a deed in lieu of foreclosure.  The Court found that the Service met its burden under Section 7425 in that it had a valid lien, which was recorded at least thirty days prior to the sale, and the Service wasn’t given notice of the sale.
  • In the saga that is the Aloe Vera unlawful disclosure case, Aloe Vera won a significant (although not monetarily) victory last month.  The District Court for the District of Arizona found the IRS wrongfully disclosed to the Japanese taxing authority confidential return information, which was actually found to be false and the Service knew the same at the time of disclosure.  Unfortunately, for Aloe Vera, no actual damages were found, so the statutory damages were the extent of the recovery.

Summary Opinions for 11/21/14 to 12/5/14

Once again, trying to catch up and cover a few weeks in one SumOp post.  Before getting to the new items from the last three weeks, I wanted to give a short update on Hawkins v. Franchise Tax Board.  In September, A. Lavar Taylor wrote a two part guest post on the 9th Circuit’s holding, which can be found here and here.  The case deals with, as the guest post title indicates, “What Constitutes An Attempt to Evade or Defeat Taxes for Purposes of Section 523(a)(1)(C) of the Bankruptcy Code,” and a split found between the recent holding and other Circuits.  Carlton Smith shared with us last week that the Government sought en banc review, the debtor has responded, and the petition is now before the entire 9th Circuit to decide whether the review is appropriate or not.  Either way, some court may be reviewing soon, and we will let you know if we hear more.

GC

I also want to highlight some really strong guest posts over the last three weeks, and thank all of our guest posters again!  The aforementioned Carlton Smith wrote on the Lippolis Tax Court jurisdiction case relating to the $2MM Whistleblower amount limitation.  Professor Andy Grewal covered the recent Petaluma FX Partners oral argument in the DC Circuit, regarding the scope of TEFRA jurisdiction when the underlying partnership is a sham.

A few first time guest posters also contributed over the last few weeks.  Rachel Partain, an attorney at Caplin & Drysdale, wrote on the LB&I policy restricting informal refund claims for taxpayers in exam.  And, finally, Jeffrey Sklarz, of Green and Sklarz, touched on the interaction between Section 6020(b) and Deficiency Assessments in the recent Radar case.

To the other procedure.

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  • PWC provided a fairly comprehensive overview regarding the new information document request process.  The document outlines the history behind the changes, how the process works, and what occurs if the IDR is not responded to in a manner the IRS finds acceptable.
  • As I mentioned above, Carlton Smith had a write up on PT regarding the Lippolis case.  Tax Litigation Survey has added its thoughts here.
  • Two weeks ago, Jack Townsend on his Federal Tax Crimes Blog posted about a FOIA information dump regarding FBAR audits found on Dennis Brager’s web page.  You can find Jack’s post about it here.  The FOIA request resulted in over 6,500 pages of info.  Jack’s page has some good comments and responses.
  • Chief Counsel has taken the position that a company which acquired, pursuant to Section 381, another company that had taken TARP funds was subject to the same restrictions as the TARP company regarding NOL carrybacks.
  • Tax Girl has a well written story on Forbes about the Whistleblower case brought against Vanguard.  Vanguard is a huge financial company located in Chester County (same as me), which is known for its low cost investing options.  A prior in house tax attorney, David Danon, has brought an action under the New York False Claims Act regarding its internal transfer pricing for investment services, which he claims caused Vanguard to underpay its taxes substantially.  The New York statute was expanded in 2010 to include tax claims.  Last year, this expanded statute was discussed on the whistleblower panel at the VLS Shachoy symposium, although this case was under seal at that time (if it had been filed), and was not discussed.  There is probably a IRS and SEC action moving forward, although those were not highlighted in the story.
  • This story deals with a few Golden Corral restaurants.  Apparently the slogan there is “Help Yourself to Happiness,” which is a reference to its all you can eat buffet.  The one time I went to the Corral, that didn’t summarize my experience, but it seems like a popular chain, so others would probably disagree with me.  Also interesting, there is a lot of internet debate out there about the fact that Golden Corral no longer allows people to bring guns into its establishments.  This really pisses people off.

In Erwin v. United States, 114 AFTR2d 2014-6630 (MD NC), a general manager (a gent named Pintner) of a company that owned five GC restaurants (these are franchises) was found to be a responsible person for the TFRP.  He clearly handled day to day operations, oversaw payroll, could hire and fire, and could write checks.  The fact that the owners and officers indicated they would take care of the issue did not mitigate the responsibility.  There was an argument about whether he knew of the debt in June or October of the year in question, but the Court directed that did not matter, which is somewhat interesting because he left the company two months after finding out about the issue.  Tough holding for the manager, as the amount was substantial, and his knowledge may have been less than 60 days.  Should have left the Corral sooner.  Keith had a good post a few months ago about postponing the assessment of the TFRP when others might be liable (and hopefully pay), which can be found here.  I bet most folks in the manager’s position would be surprised to know this is how the law works.

  • Foundation was granted reasonable cause relief to abate first-tier excise taxes under Section 4943 by the Service.  The TAM found that the foundation had reasonably relied on a memorandum that incorrectly determined the attribution rules regarding excess business holdings, and how the percentage applied.  The memorandum was made by a qualified tax preparer.  The foundation realized the error and fixed the issue.  The Service determined there was not willful neglect, and the error was due to reasonable cause.
  • The Service issued Announcement 2014-34 discussing the realignment of technical work between TE/GE and Chief Counsel to shift authority for preparing revenue rulings, revenue procedures, announcements, notices, technical advice, and certain letter rulings relating to exempt orgs and certain qualified plans.
  • Occasionally, a nice woman from accounting-degree.org sends me a link to infographics they have created, which are usually interesting.  This one is a fairly simple chart regarding entity choice, including the tax impacts.  Unlike most similar lists, this one covers cooperatives…which are useful if you want to be a snooty building or start an organic farm in a vacant lot.

IRS May Restrict Informal Refund Claims for LB&I Taxpayers Under Exam

Today’s guest poster is Rachel Partain.  Rachel is of counsel at Caplin & Drysdale, Chtd. in New York, NY and her practice involves tax controversy matters for corporations, partnerships, and individuals.  Rachel was formerly an associate at Dewey & LeBoeuf LLP and a 2012-2013 Nolan Fellow of the ABA Section of Taxation.  In this post, Rachel explores a proposed change relating to refund claims for LB&I taxpayers.  Steve.

LB&I is considering sharply curtailing the ability of LB&I taxpayers under examination to submit informal refund claims and will be seeking comments on a claim cutoff from external stakeholders.  As informal claims are very common in LB&I (and other) examinations, there likely will be significant feedback to LB&I’s proposal.

On November 10, 2014, the IRS made available a draft of Publication 5125 dated as of July 2014 relating to the LB&I quality examination process.  See 2014 TNT 217-62 (Nov. 10, 2014).  Among other things, the publication indicates that LB&I is considering reducing the period in which taxpayers may submit informal claims to within 30 days after the examination opening conference.  After the expiration of the 30 day period, LB&I taxpayers would be required to submit documented and supported formal refund claims on Forms 1120X or 843 and, presumably, administrative adjustment requests for TEFRA partnerships and Form 1040X for Global High Wealth taxpayers.  Currently, LB&I asks that taxpayers submit refund claims, formal or informal, as soon as possible.  See I.R.M. 4.46.3.2.3.2.  In practice, it is common for exam to establish a deadline for the submission of informal claims.  LB&I’s proposal would apply an informal claim period uniformly to all LB&I taxpayers.

The Code furnishes the time in which refund claims must be filed.  See I.R.C. § 6511. The regulations provide additional requirements that refund claims must satisfy, including that claims must be filed on a tax return or Form 843.  See Treas. Reg. §§ 301.6402-2, -3.  Numerous court decisions have held that informal claims constitute valid refund claims, despite the requirements in the regulations.  An informal claim is any written document that provides the IRS with notice that the taxpayer is claiming a refund and the grounds for the taxpayer’s claim, and generally is not submitted with tax computations.  See Mobil Corp. v. Unites States, 67 Fed. Cl. 708 (2005).  There is precedent addressing informal claims in the context of an exam-imposed cutoff.  For example, in Mobil, the exam team set a date certain by which informal claims were to be filed.  The court held that the IRS has the ability to require taxpayers to follow the refund claim regulations, with the result being that one of the taxpayer’s informal claims submitted after the informal claim deadline did not constitute a valid refund claim.  As a result, under the proposed change and Mobil, LB&I taxpayers would be precluded from asserting that a submission to exam after the period for filing informal claims has elapsed constitutes an informal refund claim.

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The draft publication states that the purpose of informal claim end point is to “deploy resources efficiently.”  LB&I’s industry director of natural resources and construction stated that LB&I taxpayers submit a significant number of informal claims and that the informal claims impede the examination of issues identified on LB&I exam plans.  See 222 DTR G-2 (Nov. 18, 2014).  The publication indicates that LB&I wants taxpayers to submit fully documented and supported refund claims, which would enable exam teams to make determinations on refund claims without engaging in a lengthy examination process.  In fact, the LB&I Commissioner has publicly stated that exam will no longer be developing refund claims and instead will reject claims that are not fully developed.  See 2014 TNT 217-2 (Nov. 10, 2014).

Also, the LB&I document states, without explanation, that late informal refund claims “may result in unnecessary refund litigation.”  Perhaps the later an informal claim is filed, the more likely exam is to reject the claim in order to focus on wrapping up the examination.

It has been suggested that another purpose for LB&I’s proposed informal claim window may relate to the section 6676 penalty for erroneous refund claims.  However, the IRS’s position is that the penalty applies to both formal and informal claims.  See I.R.M. 20.1.5.16.  Therefore, the penalty may not be a driving factor behind LB&I’s proposal to require the filing of formal claims that otherwise would have been submitted as informal claims.

The LB&I Commissioner also announced that refund claims will be risk assessed, which means that claims will be preliminarily reviewed to determine whether to allow the claim or to initiate an examination of the issues raised in the claim.  See 2014 TNT 217-2.  LB&I’s considerations during risk assessment include the materiality of the issues in the claim, the time and resources needed to examine the issues and whether the issues in the claim may affect future years.  See I.R.M. 4.46.3.2.2.2.

The effect of an informal claim cutoff would be to shift the development and computation of claims more fully to taxpayers.  If implemented, the policy may result in an LB&I taxpayer delaying the filing of a formal claim until the end of the examination.  This would permit the submission of a comprehensive claim covering all of the taxpayer’s issues and their grounds and alternative grounds, and would require the taxpayer to prepare tax computations only once.  Where taxpayers submit formal claims towards the end of the refund limitations period, taxpayers will be under greater pressure, given the variance doctrine, to submit full and complete claims explaining all possible grounds for the taxpayer’s recovery as taxpayers will have a shorter window within which they can timely correct defective claims with amended or superseding claims.  Further, a formal claim requirement may deter taxpayers from filing smaller dollar amount claims if the time and expense of amending the return is more than the value of the refund claim.

Also, a policy limiting the period in which taxpayers may submit informal refund claims may lead to less collaboration between taxpayers and exam, which relationship has already become more formalized as a result of the recent changes to the LB&I information document request procedures.  See., e.g., LB&I-04-0214-004 (Feb. 28, 2014).

Given the IRS’s resource limitations resulting from budget constraints and exam’s objective of adhering to the LB&I exam timeline, it seems likely that LB&I will adopt an informal claim window.  However, many practitioners feel that 30 days is too short of a period.  I would expect an enlargement of the period in which LB&I taxpayers will be permitted to submit informal claims.  A more reasonable period would be at least 90 days, and perhaps a longer timeframe for TEFRA partnerships as opposed to other LB&I taxpayers.

Although the publication is in draft form and LB&I has not issued a notice announcing the proposed changes, it appears that LB&I has already determined that action should not be taken on late-raised informal refund claims.  I have seen LB&I exam respond to informal claims by directing the taxpayers to submit formal refund claims, or an administrative adjustment request in the case of a TEFRA partnership.