9th Circuit Finds No Conflicts of Interest or Duress in Taxpayer Challenges to Extensions of the Statute of Limitations

A recent published Ninth Circuit opinion, Twenty-Two Strategic Investment Funds v US, illustrates the difficulties taxpayers face when they argue that the courts should disregard a consent to extend the statute of limitations (SOL) on assessment due to an advisor’s conflict of interest or a taxpayer’s alleged duress.

read more...

Twenty-Two Strategic Investments involved an investment in the ill-fated KPMG BLIPs loss generating foreign currency investment tax shelter.

For those wanting a brief summary of the shelter, the opinion serves that up nicely:

In order to participate in the BLIPS program, a client would establish a single-member limited liability company (“LLC”), which would take out a specific loan with a participating lender and contribute all of the loan funds to a strategic investment fund, an LLC managed by Presidio, which would then purchase foreign currency assets. After a brief period, usually about sixty days, the client would exit the BLIPS program, the assets would be sold, and the loan would be repaid with interest and pre-payment penalties. The result of this series of transactions was a tax loss for the client approximately equal to the amount of the offset he or she was seeking.

Presto. Tax losses. The only problem was that IRS and DOJ got wind of the scheme, and civil liability and even criminal sanctions followed. This post, however, is not so much about BLIPs but the after effects for one of the unlucky investors who the IRS eventually came after in light of the BLIPs going bust.

The procedural issues in the case turned on the taxpayer arguing that extensions of the SOL on assessment were invalid. There were two reasons that the taxpayer argued the extensions were invalid: 1) the taxpayer’s accountant and return preparer Smith had a conflict of interest which the IRS knew about and 2) the individual taxpayer Gonzales left holding the bag on the consequences of the disallowed losses signed the extension under duress. If the extensions were invalid, the assessments were out of time.

This is a published Ninth Circuit opinion, and that is in part why it drew my interest (there are not so many published circuit court tax procedure opinions). Yet the taxpayer’s arguments were pretty thin.

On the conflict issue, the taxpayer had pointed out that his accountant Smith “instrumental in selling the [tax] shelter to Gonzales,” received a commission for involving Gonzales in BLIPS, and signed the 2000 tax return that the IRS was auditing.”

There are some cases in the TEFRA context (this is a TEFRA case but TEFRA discussions on the blog draw as much interest as last week’s PBS documentary on steel manufacturing in Warsaw Pact countries following the reforms of Soviet Premier Kosygin so I will skip those) where criminal investigations of the tax matters partner resulted in an impermissible conflict that the courts concluded prevented the TMP from binding the partnership.

Here, however, the issue related to the individual taxpayer binding himself, not from a TMP who the courts noted had incentives to extend the SOL that ran directly counter to the individual investors ultimately potentially liable for civil taxes and penalties.

Not enough for a conflict that would bring into question the extension’s validity:

Other than this vague implication of wrongdoing, Gonzales offers no evidence that Smith’s involvement in promoting BLIPS and his involvement in preparing Gonzales’s 2000 tax return combined to create a conflict of interest three years later when the IRS approached Gonzales himself about extending the limitations period. There is no evidence in the record that the IRS contacted Smith during the time he was advising Gonzales to request that Gonzales agree to extend his limitations period. Nor is there evidence that Smith ever provided any advice to Gonzales regarding extending his limitations period. Furthermore, as the district court observed, “[a]lthough Steve Smith represented Gonzales during the audit that flowed from his 2000 tax return, Gonzales had designated different representation before signing the consents.

The remaining issue concerned Gonzales’ argument that he signed the extensions under duress. Duress generally requires evidence of wrongful pressure to coerce someone into signing a contract or other agreement that they would ordinarily not sign. Duress in the tax context is an “action[] by one party which deprive[s] another of his freedom of will to do or not to do a specific act.” Price v. Comm’r, 43 T.C.M. 18 (T.C. 1981), aff’d, 742 F.2d 1460 (7th Cir. 1984).

Gonzales’ duress argument centered on two main events: IRS met with him without his legal representative and an IRS agent served a summons on him at his residence before asking him to extend the SOL. As with the conflict argument, the court had little problem disposing of it as a challenge to the extension.

Gonzales can recall no details of the meeting other than its location. He cannot remember any questions agent Doerr asked him or any particular things agent Doerr said that were intimidating or coercive. His testimony was that he was worried that he might be in legal trouble and that the IRS could ruin his life. His conclusion was founded on inference. However, the fact that the agent declined to assure Gonzales that the IRS would not be pursuing lawful action against him does not justify an inference that Gonzales was deprived of his freedom of will to such a degree that he signed the consents to the extensions under duress.

Similarly, the court noted that there was nothing out of the ordinary with the agent serving a summons at his residence; in fact, Section 7602 provides that it may be “delivered in hand to the person to whom it is directed, or left at his last and usual place of abode.” Simply put, that the summons caused Gonzales stress was not enough; stress or taxpayer fear following IRS agents taking legally authorized actions do not amount to duress.

Parting Thoughts

Taxpayers sign extensions of the SOL for many reasons. After the fact, it is difficult to unwind those extensions, just as it is difficult to unwind a stipulation, as Keith discussed last week here.

The duress issue in this case to me is the more interesting of the two. There are a handful of cases where the courts have found that IRS agents have impermissibly threatened taxpayers to sign documents. For example, in the 1973 TC memo opinion Robertson v Commissioner an agent’s specific threat to seize a taxpayer’s house if he did not sign a form constituted duress.

Duress also comes up in the context of determining whether a spouse agreed to file a joint tax return or other document (including an extension of the SOL) in light of pressure or abuse coming from the other spouse. There are a handful of cases as well looking into whether a spouse’s actions reach the level of duress. That is an issue we discuss in the Saltzman Book treatise; the upshot is that on occasion coercive forces both outside and inside the marriage have reached the level for a court to conclude that the document would not have been signed except for the constraint applied to the taxpayer’s will.

 

Having a Correct Statute of Limitations Date on the IRS System

Chief Counsel Advice 2017040416063446 points to an error in the current IRS calculation of the collection statute of limitations.  The advice concludes with a statement that the author of the relevant IRM provision is “open to revising” the IRM and related exhibit in order to clarify the correct time frame.  This is a rather casual statement regarding something that matters a great deal in certain circumstances.  While it’s nice to learn that the IRS is open to having the collection statute calculated correctly on its system, I would hope it would be desperate to ensure the accuracy of its systems, because otherwise many challenges to its calculations will result.

read more...

Guest blogger Patrick Thomas wrote about the collection statute of limitations previously and the difficulty in calculating this period.  His post includes links to studies by the National Taxpayer Advocate and the Treasury Inspector General for Tax Administration finding that the IRS regularly makes mistakes in calculating the collection statute of limitations.  Les wrote about a case the IRS lost because it incorrectly calculated the collection statute of limitations including the suspension triggered by installment agreements.  The recent CCA points to one of the difficulties and strongly suggests that the IRS current system incorrectly calculates the collection statute of limitations.  Yet, the author of the relevant section of the internal revenue manual governing the calculation of the statute of limitations is merely “open to revising” the manual.

The problem identified in the CCA concerns installment agreement; however, it is a potential problem for many of the IRS systems.  When a taxpayer requests an installment agreement, the statute of limitations on collection gets suspended for the period of time the IRS considers the IA because the IRS is prohibited by IRC 6331(k)(2)(B) from levying on a taxpayer’s property while the IA offer is pending and “if such offer is rejected by the Secretary, during the 30 days thereafter (and, if an appeal of such rejection is filed within such 30 days, during the period that such appeal is pending.)”

Because the IRS wants to make sure that it does not levy if the taxpayer has requested an appeal during the 30 day period, it builds 45 days into its system before it takes collection action after rejecting an IA.  This reasonable decision, which exists in other situations than just the IA, bleeds over into the way the IRS system now calculates the collection statute of limitations.  Instead of suspending the statute of limitations on its system for the period the IA is pending plus 30 days, the statutory time period of suspension, the IRS system suspends the statute of limitations for the period the IA is pending plus 45 days, which includes an extra 15 days for the administrative but not statutory period of suspension.  This extra 15 should not appear in the calculation of the statute of limitations but does.

Someone at the IRS noticed the problem and brought it to the attention of Chief Counsel’s office who, in turn, brought it to the attention of the person with the IRS responsible for setting the time frames on the collection statute of limitations.  The casual response does not leave me with a comfortable feeling that the problem will soon be fixed or that the person is scouring the system to find other instances of the same problem.  Yet, there are times when the IRS takes collection action at or near the last day of the collection statute of limitations.

The timing issue I encountered most often when working for Chief Counsel involved the filing of collection suits.  Department of Justice Tax Division attorneys burdened with many cases and accustomed to working with deadlines routinely filed collection suits very close to the statute of limitations on collection.  They rely, or at least pay attention to, the collection statute of limitations date provided to them in the suit letter by the Chief Counsel attorney who frequently relies on the collection statute of limitations date provided by the client.  Here is one example of how that date is routinely calculated incorrectly.  I suspect there are many others and the earlier work referenced by the NTA and TIGTA would attest to that fact.

The more suspension periods Congress creates the more difficult it is to correctly calculate the statute of limitations, but the IRS must build a proper system or it will routinely seek to collect from taxpayers who no longer owe the tax.  Doing so would violate the taxpayer bill of rights and just be wrong.  The IRS should not be casual about getting the statutory periods correct.  This should be a high priority.

9th Circuit Reverses District Court in Case Involving Exceptions to SOL For Failing to Disclose a Listed Transaction

We have often discussed statutes of limitation. Yesterday’s post discussed the government’s unlimited time period to assess civil penalties that are not based on the filing of a tax return. Today’s post discusses the consequences of a taxpayer failing to file a form that it is supposed to file when it engages in a listed transaction. In an opinion that surprised me, in May v US, (an unpublished opinion) the 9th Circuit reversed and held that the taxpayer’s failure to file the form resulted in the application of an extended SOL on assessment even when the IRS admitted that it had knowledge of the information that the form itself would have contained.

read more...

First some background: Section 6707A imposes a civil penalty for failing to include information pertaining to a listed transaction on a tax return. Under Section 6707A a listed transaction is “a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of [Section] 6011.”

Section 6501(c)(10) is an exception the general SOL rules and addresses a taxpayer who “fails to include on any return or statement (that Section 6011 requires to be included in the return or statement) for any taxable year any information with respect to a listed transaction.” If this information is omitted, the time for the assessment of any tax imposed by the Code arising out of the transaction, “shall not expire before the date which is [one] year after the earlier” of (A) the date the Service receives the information required to have been filed, or (B) the date that a material advisor complies with the Service’s request for the list the material advisor is required to maintain on the transaction in which the taxpayer has participated.

Treasury promulgated regs under Section 6011 that specify how a taxpayer is to disclose the transaction. Regulation § 1.6011-4 provides that “[a] taxpayer required to file a disclosure statement under this section must file a completed Form 8886, ‘Reportable Transaction Disclosure Statement’ … , in accordance with … the instructions to the form” and that “[t]he Form 8886 … is the disclosure statement required under this section.”

May involved a transaction that the taxpayer failed to disclose on his 2004 tax return, which he filed in 2005. The transaction at issue that he failed to include on his 2004 tax return was about $165,000 in pass through income. May eventually agreed that the transaction that gave rise to the omitted income was a listed transaction. At the district court, the Service argued that only the taxpayer’s filing of Form 8886 triggered the statute of limitations for purposes of Section 6501(c)(10)(A). The Service admitted that it had knowledge of the information that the taxpayer was supposed to report in the form but that May’s failure to file Form 8886 meant that the statute of limitation was still open (the trial court and appellate opinion do not specify how the IRS got the information but IRS conceded that it had it). May argued that the Service’s knowledge of the information in the form, rather than his filing the form, was the starting point for the one-year period.

 At the district court, May won, with that opinion stating that “common sense confirms that the statute of limitations does not open or close based on which piece of paper a taxpayer chooses to employ.”

Over a brief but spirited dissent, the 9th Circuit reversed. In finding for the government, the 9th Circuit tied the 6501(c)(10) exception to what it viewed as clear directive under the 6011 regulations to submit the 8886:

6501(c)(10)(A)’s reference to “the information so required” under § 6011 functions as an incorporation by reference of the disclosure requirements of Treasury Regulation § 1.6011-4(d), which requires that a taxpayer disclosing a listed transaction do so on Form 8886 and send a completed copy of that disclosure to the OTSA[Office of Tax Shelter Analysis]. It is undisputed that May neither filed a Form 8886 nor sent it to the OTSA. For that reason, May failed to do what was required to start the running of the § 6501(c)(10)(A) statute of limitations. Thus, the one-year limitations period of § 6501(c)(10)(A) did not commence, and the IRS’s assessment of the penalty was timely.

As support, the majority felt that looking to 6501(c)(10) in isolation was not coherent with the overall scheme, and it repeated the maxim from the 1984 Supreme Court case Badaracco v Comm’r that statutes of limitations “barring the collection of taxes otherwise due and unpaid are strictly construed in favor of the Government.”

The dissent viewed it quite differently, focusing on how Section 6501(c)(10) itself does not require the submission of any particular form and that the regulations under 6011 failed to clearly specify the SOL consequences of failing to submit information on any particular form:

It would have been simple to write a statute that stated that the limitations period starts to run on “the date when the taxpayer provides the information to the Secretary on the form specified by the Secretary,” but that’s not how Congress wrote the statute. Alternatively, it would have been simple for the Secretary to have promulgated a regulation that clearly informed all taxpayers that providing information to the IRS doesn’t count unless the information is provided on the specified form.

I must say I am surprised by the 9th Circuit opinion. As the dissent noted, it might have been appropriate to remand for the trial court to refine its standard to avoid a broad reading of the opinion that would invite questions and litigation in other circumstances as to whether IRS had sufficient knowledge:

I have no quarrel with the Government’s position that the taxpayer should be required to provide the relevant information in a coherent form to the appropriate tax agents. An interpretation that started the limitations period as soon as some IRS office, somewhere, had the information or as soon as IRS agents collectively had the information would be both illogical and open to abuse. I don’t disagree that it might be appropriate to remand this case to the district court to apply a more precise interpretation of the statute. But I am not persuaded by the Government’s interpretation, especially in the context of a civil penalty, and cannot join my colleagues in adopting it.

It seems to me if the IRS admits to knowledge of the information then in appropriate circumstances then to elevate the Form itself as the sole trigger elevates a literal form over substance.

Court Rules Abusive Tax Shelter Penalty Has No SOL; Laches Also Not A Defense

Groves v US involves a taxpayer who was assessed over $2M in penalties for failing to register transactions as tax shelters. The penalties stemmed from conduct in years 2002, 2004 and 2005, but the IRS did not assess the penalties until 2015. Groves argued that the IRS assessments, coming over a decade after the conduct that gave rise to the penalty, was too late. The federal district court for the Northern District of Illinois disagreed.

I will briefly explain the opinion below.

read more...

Under statutory procedures that allow for a refund claim following partial payment of the tax shelter penalty, Groves paid 15%, and filed a refund claim alleging that the penalty was assessed outside the normal three-year statute of limitations under Section 6501(a) or a 5-year SOL under Title 28 that applies to civil penalties. He also alleged in the alternative that the doctrine of laches barred the government from assessing the penalty for conduct that stretched back the better part of a decade.

After IRS denied the claim, Groves filed suit in federal district court. The court agreed with the IRS, holding that the penalty under Section 6700 for failing to register a tax shelter was not subject to the normal statute of limitation scheme and that laches was of no help.

We are in the process of finishing the new chapter in Saltzman and Book on statutes of limitation (SOL); it should be out in the fall (with this chapter will mark the rewriting of all original 18 chapters in the book, with a new 19th chapter on CDP). In the SOL chapter we discuss the odd intersection of civil penalties and SOL issues. Many penalties are not subject to readily observable statutes of limitations. For civil penalties that are not “return-based” penalties, courts have increasingly found that those penalties are not subject to any statute of limitations.

What are non return-based penalties? The key feature is that the conduct that gives rise to the civil penalty is not tethered to the filing of a tax return; in other words, as in Groves, what triggered the liability was the conduct of promoting tax shelters and failing to inform the IRS of his promotion rather than the filing of a return.

Groves argued that because the Code states that the 6700 penalty is to be assessed and collected in the same manner as taxes it should thus be subject to the general SOL rules as per Section 6501(a). The opinion disagreed:

Section 6700 assessments do not depend on the filing of a tax return,” but rather “occur … after the IRS becomes aware that an individual’s activities are prohibited by Section 6700.” The mismatch between the triggering event under § 6501(a)—the taxpayer’s filing a return—and the basis for liability under § 6700—being involved in a tax shelter and making false statements about its benefits—makes the § 6501(a) limitations period an inappropriate fit for the assessment of § 6700 penalties.

Groves countered that there was a return at issue, that is, the individuals who took up his advice and filed returns taking positions consistent with his shelter advice. The court emphasized that the penalty under Section 6700 only looked to whether promoter makes “a statement that falsely touts the shelter’s tax benefits.”

The court also addressed 28 USC § 2462, a non-tax law based SOL that applies to civil penalties. That statute states that “[e]xcept as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued ….”

The opinion concluded (as have other courts) that the IRS assessment of a 6700 penalty does not arise from “an action, suit or proceeding” because the IRS assessment arises from in the court’s view an ex parte act rather than an adversarial adjudication. Adjudicative action is a prerequisite to the 28 USC § 2462 SOL applying. As support, the court emphasized that Groves had no right to any pre-assessment administrative adjudication of the penalty, and a number of courts have held that the assessment itself was agency conduct not in the nature of an action or suit for these purposes. Groves served up a number of other creative § 2462 arguments, but the court rejected them, largely on the grounds that the IRS imposition of the penalty was not in any way based on a hearing or other adversarial procedures.

Finally, the court considered whether laches applied. Laches is an equitable defense that gives the court the power to hold that a legal right or claim will not be enforced if a party unreasonably delays in bringing the claim and the delay prejudices the other party. There is uncertainty as to whether a laches claim can be made against the government in tax cases. A Fifth Circuit case, Sage v US, after concluding that no SOL applied to the 6700 penalty, stated in dicta that the doctrine was the only curb on IRS assessment power.

Groves is appealable to the 7th Circuit, and the district court noted that the circuit had not held whether laches is available as a defense to a government tax suit. (for an interesting discussion of laches, including its history, see Judge Posner’s discussion in the 7th Circuit Lantz case from 2010). Groves concluded that laches is probably not a defense in tax cases, and that even if laches were an available defense it only applied in narrow circumstances that were not present in the case. One of the circumstances is when there is an egregious delay. On that point  the court pointed to a 2005 Second Circuit case, Cayuga Indian Nation v Pataki. In Cayuga, the US intervened on behalf of the tribe in an ejectment action that stemmed from conduct over 200 years old and pertained to actions surrounding a treaty signed in 1795. Unlike Cayuga, “this case, by contrast, involves a delay of just over ten years. Although ten years is not an instant, the difference between a ten-year delay and a 200-year delay is one in kind, not of degree.” Another circumstance where laches may apply is when the government action pertains to an adjudication of private rights. As to that circumstance, the court noted that “few areas of government activity are more canonically sovereign than taxation.”

Parting Thoughts

It does to me seem odd that the government has no limits on when it can assess these (and some other) penalties. Over the last couple of decades there has been a vast increase in the number of civil penalties in the Code. When Congress gets around to revising the civil penalty regime, it would be well served to look at these non return based penalties and impose some outside limits on when the government can  assess these penalties.

 

Tax Court Holds That Veteran’s Submission of Election to Exclude Foreign Earned Income is Too Late When Submitted After Service Issues a Substitute Return

This week’s Redfield v Commissioner illustrates the harsh and sometimes unfair results that sometimes attach when a taxpayer misses a deadline. The taxpayer in this case was a disabled 12-year Marine veteran who served in Afghanistan; he was suffering from PTSD and memory loss. After leaving the Marines he returned in 2010 to accept a civilian position at an airfield in Kandahar. Unfortunately his physical and mental condition worsened and he returned back to the States later in 2010. The case illustrates perhaps a gap in our tax system: the Service is required to enforce most deadlines without regard to whether the taxpayer’s disability contributed to the taxpayer’s delinquency.

Redfield’s tax troubles arose from his failing to file a tax return for the 2010 year, the year in which he had some foreign source income from the time he was working as a civilian in Kandahar. In 2014, IRS eventually prepared a substitute for return under Section 6020(b). Redfield did not respond to the stat notice that accompanied the SFR; instead he filed a delinquent 2010 return, which attempted to exclude the foreign source income from his shortened civilian gig in Kandahar.

Section 911 provides that citizens and residents living and working outside the US can exclude some of that earned income (the cap is adjusted for inflation and is about $100,000 these days). I will not spend much time on the nuances of the foreign earned income exclusion but Section 911 states that a taxpayer wishing to avail himself of the exclusion has to elect its application. The statute also directs the Treasury to issue regs to implement the regime. Treasury issued regs under Section 911 that fill in the details of that election: the when and the how are spelled out in detail.

The case considers whether Redfield satisfied the regulation’s timing requirement. The regs establish 4 methods of making the election 2 of them require the election to be made either with or in response to a timely filed return; a third requires that the election be made within one year of a timely filed return. That did not happen here.

The main issue revolved around the fourth method. It allows a taxpayer to file the election if it is made before the Service “discovers that the taxpayer failed to elect the exclusion.” In particular, the Tax Court considered whether the Service’s SFR amounted to its discovering that Redfield did not elect to exclude the wages he earned while working in Afghanistan.

Unfortunately for Redfield, in McDonald v. Commissioner, T.C. Memo. 2015-169 the Tax Court held that the Service discovers the failure to make the election no later than the issuance of the substitute for return. Redfield’s election was submitted years after the SFR, and the Tax Court held that he was out of luck.

The Tax Court acknowledged the harshness of the outcome, but felt that its hands were tied:

We acknowledge petitioner’s military service to this country and recognize that he emerged far from unscathed from his tours of duty in Afghanistan. We understand that the procedural requirements for making a timely [foreign earned income exclusion] election are not exactly intuitive and that the scars petitioner incurred during his military service may have contributed to the tax delinquency at issue.

While these facts may be relevant to the penalty and additions to tax that the IRS determined, they do not alter the requirement of a timely election. As to that requirement we must give effect to the regulations that the Secretary has issued under his delegated authority from Congress and to this Court’s prior construction of those regulations. That being so, we unfortunately have no alternative but to hold that petitioner did not make a timely and valid [foreign earned income exclusion] election for 2010. He is therefore not entitled to exclude from gross income any foreign earnings under section 911.

Some Parting Thoughts

Keith has written extensively on the impact of disability and time deadlines in the Code. An article he co-wrote a few years ago suggests that Congress should more directly apply the concepts of financial disability to other deadlines that taxpayers may not meet.

Deadlines by their nature may at times work and produce an unfair substantive result. The Service administers a complex tax system and processes many million tax returns. Yet it seems that for taxpayers who suffer from mental and physical disabilities, especially for veterans whose injuries arose in service for our country, there should be a safety valve for the Service or the court to provide relief when the failure to meet a deadline  is connected to the taxpayer’s disability.

Procedure Round Up(date):   Regulations, Mount Up! & State Law SOL Issue When Suing Promoters.

This will be a short post that touches on some temporary and final regulations that were issued in the last quarter of last year that impact tax procedure, specifically information reporting and the preparer due diligence rules, which we have previously covered.  The second portion of the post will deal with a state law statute of limitations issue from a tax shelter participant suing the promoter.

read more...

Regulation Update

What is Keno?

Back in March of 2015, I wrote about the temporary regulations dealing with reporting of winnings from bingo, keno, and slot machines.  The Service has finalized those regulations, which can be found here.  I believe the final regulations are similar to the temporary regulations (although aspects regarding electronic slot machines were not included in the final regs). These rules peg the required reported winnings at $1,200 for bingo and slot machines (but $1,500 for keno).  Anyone have any idea why those amounts are different (or what keno is, I don’t go to casinos much)?  The information on the information reporting must include the name, address, and EIN of the payee, along with a description of the two types of ID used to verify the payee’s address.

Discharge Reporting- Buy Now, Three Years, No Payments!

I thought I had written up the proposed regulations from 2014 relating to the rules on discharge of indebtedness reporting when a borrower had not paid for more than three years, but I cannot find the post (very possible I just read about it and found it interesting).  Under Section 6050P, prior regulations treated nonpayment of debt for 36 months as an “identifiable event”, which indicated formal discharge of indebtedness and required the issuance of a Form 1099-C.  This caused many borrowers to believe the debt had been discharged, but it was simply an IRS reporting requirement.  Tax professionals, lenders and borrowers did not like the rule.  The final regulations can be found here.  The regulations eliminate the passage of that time frame as a reportable event, which is a good result.  This change may have come from discussions started in the ABA Tax Section, Low Income Taxpayer Committee.

Preparer Due Diligence Regs Updated.

The Government has issued temporary/proposed regulations regarding the preparer due diligence rules, which can be found here.  We’ve talked about preparer due diligence repeatedly on the blog, including one of our first posts (and most popular), where Les extensively discussed peeing in pools.  That was re-posted earlier this year, and can be found here.  In both 2014 and 2015, Section 6695 dealing with preparer due diligence was amended.  The penalty was indexed for inflation, and the due diligence requirements were expanded to include the Child Tax Credit, the Additional Child Tax Credit, and the American Opportunity Tax Credit.  The proposed regulations update the provisions to take into account these changes.

Information(less) Returns

In late December 2016, the Service issued guidance (Notice 2017-9) regarding the new de minimis safe harbor provisions enacted under the PATH act.  In general, failure to include all required information on an information return or payee statement will result in a penalty being imposed on the issuer.  The penalty is dependent on various factors, including the amount incorrectly reported, when it was not reported, how quickly it is rectified, and potentially other factors.

The penalty under Section 6721 can be reduced or eliminated in certain circumstances.  There is a de minimis exception to Section 6721, which allows the penalties to be waived if the error is corrected on or before August 1st in the year it is filed.  This is limited to the greater of ten returns or .5 percent of the information returns filed.  For returns required to be filed after December 31, 2016, there is a safe harbor that applies, where, if the information return has an error of $100 or less, or involves less than $25 of withholding, then the safe harbor applies, and no corrected return is required.  The notice is clear that this does not apply for intentional acts or intentional disregard.  It also indicates that regulations will be forthcoming regarding the safe harbor.

The de minimis safe harbor will not apply, however, if the payee elects out of the safe harbor.  Under Section 6721(c)(3)(B) and Section 6722(c)(3)(B), the payee can make an election and the payor has thirty days to furnish a corrected payee statement to the payee and the IRS.  If it is not done within thirty days the penalties will apply (it is possible for additional time in limited circumstances).

The payor must provide the manner for making such an election, which can be any reasonable manner including by writing, electronically or by telephone.  The payee must be told in writing the fashion in which the election can be made.  The notice goes on to indicate the timing of when the election must be made, and indicates the election must: 1) clearly state the election is being made; 2) the payee’s name, address, and TIN; 3) the type of statements and account numbers; and 4) the years in which the election should apply.

So, if you are super angry that Gigantor Bank and Lack of Trust Company misstated your 1099 by $4.37, you now have your avenue for redress.

Shelter Participant SOL Against Promotor Runs From Final Tax Court Ruling, Not Notice of Tax Deficiency

I initially saw this suit, and thought some aspect pertained to federal law claims against the tax shelter promoter, but the claims were state law based.  It is, however, still an interesting statute of limitations issue, that could impact future rulings based on state law.

In Kipnis v. Bayerische Hypo-Und Vereinsbank, AG, the Eleventh Circuit, following direction from the Florida Supreme Court, has reversed the district court in holding the statute of limitation on state based claims against a tax shelter promoter by a participant were not time barred.

The particular holding is for a relatively straightforward issue.  After the defendant admitted fault, the IRS issued a notice of deficiency to the plaintiff for his involvement in the shelter.  This occurred in October of 2007.  On November 1, 2012, there was a final tax court order disposing of the case (90 days thereafter appeal rights expired).  On November 4, 2013, plaintiff filed suit against the defendant alleging various state law claims including fraud from the promoting and selling of the transaction.

The defendants moved to have the case thrown out as being outside of Florida’s four and five year statute of limitations for the claims made.  The issue was appealed to the Eleventh Circuit, which sought guidance from the Florida Supreme Court on the issue, specifically:

Under Florida law and the facts in this case, do the claims of the plaintiff taxpayers relating to the CARDS tax shelter accrue at the time the IRS issues a notice of deficiency or when the taxpayer’s underlying dispute with the IRS is concluded or final.

The Florida Supreme Court, which the Eleventh Circuit followed, determined that the claims accrued at the time the tax court order became final, which was ninety days after the order was issued when the appeals period had passed. See Kipnis v. Bayerische Hypo-Und Vereinsbank, AG 202 So. 3d 859 (Fla. 2016).  I think this is inline generally with what the federal law would be in most analogous situations, but would invite others to comment on this aspect if they have thoughts.

Mixing a Pro Se Taxpayer and Confusing Innocent Spouse Deadlines Leads to Bad Result

In Vu v Commissioner, a summary case from late last year, the Tax Court held that a pro se taxpayer did not establish the Tax Court’s jurisdiction to hear an appeal of an IRS’s denial of a request for innocent spouse relief. What makes the case unusual is that the taxpayer Amanda Vu did file a petition requesting relief but she did so before the IRS issued what it styled as a notice of determination and just prior to 6 months elapsing after her request to the IRS for relief was made. In other words, her petition jumped the gun on the two separate avenues needed to confer the Tax Court’s jurisdiction.

read more...

Before digging into the case I note that I came across the case and wrote a draft of this post without realizing that Carl and Keith are now representing the taxpayer Ms. Vu. As I discuss below, what intrigued me initially about the case was how the result was unfair. Carl and Keith and the Harvard Tax Clinic have filed a motion to set aside the dismissal and remove the case’s small case designation. I will discuss below why the Tax Court dismissed the case, and why I agree with the Tax Court judge that the outcome inequitable and hope that the legal argument Carl and Keith have advanced persuade the Tax Court to reconsider its approach.

I also note that we have discussed premature petitions before, albeit in the context of straight up deficiency cases. In Tax Court Order Finds Jurisdiction Even When Taxpayer Files a Petition Before the IRS Issues Notice of Deficiency a taxpayer filed a petition prior to the stat notice but in response to other correspondence IRS issued in its exam. I discussed how the Tax Court in Weiss v Commissioner went out of its way to confer jurisdiction, essentially allowing the taxpayer’s response to IRS motion to dismiss the case confer jurisdiction, so long as the taxpayer amended its petition and the IRS’s motion and the taxpayer’s response were issued prior to the actual 90-day period ran. I speculated that the problem of premature petitions filed in good faith was likely a common one, and that the Weisses were lucky in that the IRS motion, and their response, were within the 90-day period.

Vu was not nearly as fortunate as Weiss. I will simplify the facts to bring home the procedural conundrum Vu found herself in.

She, with a friend’s assistance, submitted a request for innocent spouse relief that she signed and dated February 28, 2014. IRS recorded it as received on March 24, 2014.

Vu testified that she received from IRS on June 12 an “Innocent Spouse Relief Lead Sheet” that was dated June 4, 2014. The document was designated Workpaper # 615 and reads in part:

Conclusion: (Reflects the final determination on the issue.)

Conclusion for 6015(b):

Note: A summary of your conclusion should go here. Ensure that reference is made as to what factors are met if allowing or granting partial relief, and what factors are not met

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(b).

*******

Conclusion for 6015(c):

Note: A summary of your conclusion should go here. Ensure that reference is made as to what factors are met if allowing or denying partial relief, and what factors are not met if disallowing or granting partial relief.

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(c).

*******

Conclusion for 6015(f):

Note: A summary of your conclusion should go here.

It was concluded that the Taxpayer does not meet innocent spouse relief under IRC 6015(f).

*******

Vu sent in a petition to Tax Court and it had a September 8, 2014 postmark, and Tax Court received it on September 12, 2014.

About one month after Vu filed her petition, on October 9, 2014 IRS mailed Vu a final determination denying her request for innocent spouse relief.

On November 3, 2014, IRS filed an answer. In the answer it denied issuing a notice of determination from New Mexico and indicated that it issued a notice of determination from Phoenix on October 9, 2014. IRS did not in the answer indicate that the petition Vu filed was premature; that was too bad because if it had flagged the issue, the taxpayer, like the early bird in Weiss, could have cured her defect and filed a petition that would have clearly been timely.

On January 27, 2015 Vu, more than 90 days after issuing what it called a final determination and over four months after Vu filed her petition, IRS filed a motion to dismiss Vu’s petition on the ground that she filed it prior to the time that the IRS issued its October 9 notice of determination.

Vu did not respond to the Tax Court’s order ordering a response to the motion. The motion was argued at a June 2015 calendar in New Mexico.

The Law

A petition to Tax Court is timely in innocent spouse cases if it is made (1) within 90 days of the mailing of a notice of final determination of relief, or (2) if the IRS has not yet mailed a notice of determination, at any point after six months has transpired since the taxpayer’s request for relief was made with the Commissioner.

Applying the above rules to Vu meant that the Tax Court would have had jurisdiction under two alternate theories:

  • if it considered the IRS’s Innocent Spouse Relief Lead Sheet IRS issued sometime in June a notice of determination and Vu filed a petition within 90 days of that determination, or
  • if at the time she filed her petition to Tax Court 6 months had elapsed following her request for relief and IRS had issued no determination in the case.

On both grounds the Tax Court held that Vu came up empty leaving the Tax Court to conclude that it had no jurisdiction in the case.

Both issues are interesting and walk us down some complicated procedural rules. First let’s look at issue 1. The opinion indicates that it likely would have been willing to conclude that the Workpaper #615 correspondence was a determination, noting cases such as Barnes v Commissioner that neither the statute or regs impose a specific form or spell out the content of what should be in a determination and the language of the workpaper led the taxpayer to conclude it was a final IRS determination. The problem for Vu was that there was no evidence in the record when IRS issued that correspondence, making it impossible to conclude that the petition she filed was within 90-days (and allowing the court to punt on concluding definitively that the Workpaper was a determination).

There were two possible dates: June 4, when the document was dated, or June 12, when Vu claimed to receive it. Determining which was correct was key, because if it were issued on June12th the petition she mailed on September 8 would have been filed within 90 days, using the mailbox rule that allows date of mailing to be the date of filing. If it were issued on June 4th the petition would have been filed outside the 90-days.

According to the Tax Court Vu did not offer any evidence as to why June12th was the correct date:

As for the June 12, 2014, date, petitioner however did not present any evidence whatsoever showing that any relevant action occurred on June 12, 2014, and has specifically failed to establish that respondent provided her the requisite final determination notice on that date.

What about issue 2, the 6-month rule? That issue turned on whether Vu’s request was considered made on February 28, when she signed, dated and testified that she mailed it, or March 24, when IRS records treated the request as received. If the operative date were February, then Vu’s petition would have conferred jurisdiction, as the petition she mailed on September 8 and which the Tax Court received on September 12 would have been filed after 6 months had elapsed from her administrative request for relief and prior to the IRS’s issuance of the October 9 final determination.

Vu came up empty here too. How it gets there requires a detour to Section 7502, the mailbox rule. The Vu opinion treats the statutory language “made” in the same manner as if it interpreted when the request were filed. The opinion treated the request for relief as having been filed or made in March (when IRS received it) and not when  mailed in late February. It does so because the mailbox rule under Section 7502 is actually an exception to the general rule that a document is filed when it is received by the IRS. Recall that the mailbox rule of Section 7502 only applies when documents are filed with and received after the expiration of a filing period. Here, the filing period limitation relates to the time period to bring an administrative request for innocent spouse relief, and that limitation was years in the future:

Because petitioner’s Form 8857…was filed before respondent initiated any collection action with respect to that year (indeed, before respondent even issued the joint notice of deficiency to petitioner and Mr. Nguyen with respect to that year), we find that respondent timely received the form on March 24, 2014; section 7502 therefore does not apply, and the relevant date for section 6015(e)(1)(A)(i)(II) is not six months after the alleged mailing date of the form but six months after the date of receipt of the form, or September 25, 2014.

The opinion made clear why Vu came up short:

Consequently, we can exercise jurisdiction over the petition herein only if it was filed “at any time after the earlier of” October 9, 2014 [the date of the formal notice of determination], or September 25, 2014 [six months after Vu’s request was made], see sec. 6015(e)(1)(A)(i), and “not later than” January 7, 2015, see sec. 6015(e)(1)(A)(ii). Because the petition was filed with the Court on September 12, 2014, it does not meet this requirement and we thus lack jurisdiction over it.

This opinion noted the unfairness of the outcome:

While we acknowledge that this is an inequitable result, as petitioner filed her petition believing in good faith that it was timely and her opportunity to file another petition has now expired, we are unfortunately constrained by the statute, and our role is to apply the tax laws as written.

Final Thoughts

This is a bad outcome. I do not understand why counsel for IRS did not alert Vu of the premature petition issue earlier in the process. It appears that counsel for the IRS did not appreciate the 90-day issue fully until it filed the motion; otherwise one would have hoped that counsel would have filed the motion in lieu of the answer. That would have given Vu time to file a petition within the 90-day window, as the taxpayer in Weiss did. I also note that the IRS only raised the 6-month issue at the hearing itself on the motion, which was many months after the IRS filed its motion to dismiss.

We have discussed before the difficulties associated with confusing IRS correspondence. When you add to the mix the reality that many taxpayers are pro se and not equipped to understand the nuances of differing IRS procedures you can get to a place where a taxpayer is denied her day in court despite efforts to have her case heard.

There is a possibility that the Tax Court will change its mind and the case will get heard. Keith and Carl in their motion to set aside the dismissal argue that the IRS forfeited the right to make an SOL argument by waiting too long in this case, as it should have been made in the answer. This is an argument similar to the way the Supreme Court in the 2004 case of Kontrick v. Ryan held that a bankruptcy debtor waited too long in his case to raise the untimeliness of a creditor’s filing because the time period was not jurisdictional, so had to be raised earlier in the case.  Kontrick is the Supreme Court opinion that first began the narrowing of the use of the word “jurisdictional”.

We have discussed the issue of jurisdictional deadlines repeatedly; the most recent was Carl’s discussion of Tilden earlier this week, an opinion that does not help the argument in Vu. Admittedly there is no direct precedent in support of Vu’s argument, and the Tax Court in Pollock v Commissioner has previously held that the deadline under Section 6015(e)(1)(A) was jurisdictional and not subject to equitable tolling. To be sure, there is no long line of Supreme Court precedent holding deadlines under Section 6015 jurisdictional, and the Tax Court’s opinion in Pollock was prior to the Supreme Court and other courts’ narrowing of the term jurisdictional. Moreover, the language in Section 6015(e) consists of a single sentence containing both jurisdictional grants and time periods to file a petition, a type of statute that the Supreme Court has previously held to be not jurisdictional.

Keith and Carl have a few cases other than Vu in the pipeline making this argument and I hope the courts at a minimum address the changing law and meaningfully apply those changes to these and other deadlines where IRS conduct has contributed to taxpayer confusion and the denial of a day in court.

USVI – Residing or Vacationing (and What if You Pay Income Tax While only Vacationing)

I am sitting in my dining room writing, and there is freezing rain outside, I’ve got a terrible cold, and my wife is cleaning up some child’s vomit.  I can’t help but think how nice it would be to live somewhere much warmer, that wasn’t as affected by these seasonal illnesses ….  And, wouldn’t it be all the better if I paid far less in taxes?  Maybe I should trade Love Park for Love City (nickname of St. John’s, USVI—which is apparently giving people money to come visit)?

The United States Virgin Islands have shown up in a lot of tax procedure cases over the last decade (like a ton!, there are only around 100,000 residents, and it seems like there is an important case every week).  So why is that the case?

Well, it is, for some, a legal tax shelter.  Normally, a US Citizen must file his or her return with the Service on a specified date, and the Service must assess tax within three years of filing a return, but if no return is filed the period of limitations remains open indefinitely.  See Section 6501.  To be filed, “the returns must be delivered…to the specific individual…identified in the Code or Regulations.” See Allnut v. Comm’r.  This normally means somewhere with the Service.  The USVI however operates a “separate but interrelated tax system.” Huff v. Comm’r.  Bona fide USVI residents are required to only file tax returns with the USVI Bureau of Internal Revenue (“VIBIR”).  See Section 932(c)(2).  If the taxpayer is not a bona fide resident, but has USVI source income, the taxpayer must file with the VIBIR and the Service.  In an effort to bring businesses to the USVI, an economic development program was implemented in USVI, which allows for a reduction of USVI tax on certain USVI residents up to 90% of their income tax.  Not sure how much economic development it has spurred, but a lot of rich people began trying to be bona fide USVI residents (or at least claimed they were), and the IRS took exception.

Below is a discussion of a few cases relating to claims of USVI residency.  One will review the requirements of residency, and why parking a boat may not be enough. It also highlights the interesting SOL issue of whether a USVI return starts the limitations period when the taxpayer is not a USVI resident.  The final case below investigates what happens if a non-resident pays tax to USVI (claiming to be a resident) and the refund statute of limitations has passed after there has been a determination that the person was not a resident.

read more...

Parking Your Yacht and Staying at Ritz–Not Residency

In Commissioner v. Estate of Travis L. Sanders, the Eleventh Circuit reversed the Tax Court and remanded for additional fact findings regarding whether or not the decedent had ever been a resident of the USVI (and from the tone of the case, the Court gave fairly clear indication that the Tax Court should find he was not a resident).    The Tax Court opinion in Sanders can be found here.  The issue in the case was whether the filing of a USVI return started the statute of limitations, which the Court decided hinges on whether he was a resident of USVI.  As stated above, this has been a hot topic over the last few years, which we have not covered much on PT.

In Sanders, the taxpayer made his money on surge protectors (I think high end, not the consumer ones your computer is plugged into).  The more protectors he sold, the more his balance sheet surged.  In 2002, Mr. Sanders began spending some (but not much) time in the USVI.  From ’02 to ’04, the years in question, Mr. Sanders stayed at the Ritz, and then parked his yacht on the islands and stayed on the boat.  He spent somewhere between 8 and 18 days on the islands in ’02, between 49 and 78 days in ’03, and between 74 and 109 days in ’04.  He kept his FL home, never established a personal mailing address in the USVI, his girlfriend (eventually wife) remained in FL, his minor child lived in FL, and he spent considerable time at the company HQ in FL.

As to his work at the surge company, he became a limited partner in a USVI company, which employed him, and then contracted his services to the company he had created.  Mr. Sanders took the position that this was USVI source income, and that he was a USVI resident.  He then claimed the income was exempt from United States taxes (and it was potentially entitled to a 90 percent tax credit under USVI tax laws – hence the set up).

The IRS said this Caribbean dream was a little too dreamy, and in 2010 issued a notice of deficiency, alleging Mr. Sanders was not a bona fide USVI resident and that the set up was, as Jack Townsend would say, a b@!! $&!1 tax shelter.  Unfortunately, our Captain Sanders died in 2012, and did not get to see if his scheming worked.  In August, the Eleventh Circuit didn’t weigh in on the BS’iness of the tax shelter, but did overturn the Tax Court as to whether the statute of limitations prohibited the assessment.  Why did the courts disagree?

How to qualify as a USVI resident has changed somewhat over recent years, and, the discussion to follow regarding the statute of limitations on filing with VIBIR may no longer apply, as the Service and VIBIR entered into an information sharing agreement in ’07, and following that the Service agreed to treat certain returns filed with VIBIR as starting the statute of limitations regardless of whether the person was actually resident of USVI.

This was prior to ’07, and the Service took the position that Mr. Sanders was not a bona fide resident of the USVI in the years in question, and therefore the return he filed with VIBIR did not start the running of the statute of limitations in the United States.  Mr. Sanders (and the USVI government) argued he was a bona fide resident, and the statute had run.

The Court did not determine whether Mr. Sanders was or was not a bona fide resident, and remanded for further fact finding.  It was clear from the tenor of the opinion that based on the facts before the Court it strongly (very, very, very strongly) disagreed with the Tax Court conclusion that Mr. Sanders was a resident.

The more important holding, although not new law, was that the statute of limitations for filing his US Federal tax return would only run due to the VIBIR filing if Mr. Sanders was a bona fide resident (requiring a substantive finding of fact), and there was no good faith exception to this requirement implied in the statute.

In discussing the good faith exception, the Eleventh Circuit reviewed the meaning and use of the term bona fide and found it required objective proof.  The Court did note there are some fairness concerns in not having such an exception, but said that was not sufficient to read such an exception into the statute.  In addition, it noted that “entwining of the merits of a case with the statute of limitations is not uncommon in tax cases.”  The Eleventh Circuit rejected the good faith exception, holding filing with VIBIR only triggers the statute if the taxpayer is a bona fide resident (not merely that the taxpayer believes he is).

As to the bona fide residency, as mentioned above, the Eleventh Circuit gave a pretty heavy indication as to its feelings as to residency.  The Court stated that “[b]ecause the Tax Court never decided the nature and extent of Sanders’s physical presence, it cannot have properly weighed this factor.”  Further, “[e]ven Sanders’s own estimate that he spent 18 days in the USVI…places him on the island for only a small portion of time,” and “he had no personal home on the islands for any part of [the years in question].”  And, “[l]iving in a condominium partially owned by one’s employer (and which is not even available for every visit) does little to evidence an intention to reside there indefinitely…”, but the Court did note that moving the boat to the island and connecting it to utilities was slightly more indicative of residence; although, noted this was less strong evidence than a fixed home.  There were various other similar quotes, making it fairly clear the Court did not think Sanders was a bona fide resident.

Although I’ve discussed this type of planning in the past with clients for both USVI and PR (and other more exotic jurisdictions), this type of planning has a more common analogous state level planning topic; which is selecting a state level income tax residence (in my practice, it is usually someone in NY, NJ, MA, and less often PA, considering a move to FL).  Obviously, the analysis is different, but the advice is the same; you can’t just say you think you are a resident, you have to take meaningful steps that can prove you are.

Also, interesting to note, at least to me, that the Chief Justice of the Eleventh Circuit was appointed by George H. W. Bush, who once claimed residency in Texas while staying a limited number of days per year in the Houstonian, which Texas accepted and Maine, DC, and other states never questioned.  Perhaps the Houstonian is more homey than the Ritz.

Where Does My Entity Reside?

The Third Circuit had an interesting, albeit unsurprising, holding in the end of October relating to USVI residency of entities.  In VI Derivatives, LLC v. United States, the Third Circuit affirmed the district court’s denial of the taxpayer’s motion to dismiss for lack of subject matter jurisdiction, holding that res judicata barred the challenge to subject matter jurisdiction.  In VI Derivatives, various LLCs were challenging their residency, but the lower court had previously already determined the residency of the entity owners (the Ventos, more on them in a minute).  In that holding, the Court indicated there was no separate determination to be made regarding the entities, “Because those partnerships are pass-through entities…, they do not have residencies separate from their owners.”  When the entities filed a motion to dismiss for lack of subject matter jurisdiction based on residency, the District Court denied the motions, holding res judicata barred the challenge because the residency decision on the owners constituted a final judgement on the merits, which was not appealed.  The Third Circuit agreed.

For those of you who follow tax procedure closely, especially offshore matters, the Ventos are turning into a familiar family.  Cases pertaining to the capital gains ($180MM) generated from the sale of Richard’s Vento’s business have generated interesting holdings regarding USVI residency, summons enforcement, and FOIA (and probably others that I am forgetting).

And…

VI Non-Residents Cannot Claim FTC For VI Income Paid

Not a shocking holding either.  In Vento v. Comm’r, the Tax Court reviewed the case of Renee Vento (daughter of Richard), who claimed foreign tax credits on her United States return for tax she paid in the USVI.  In the year the tax arose, Renee lived in the US.  For the tax year, she filed her income tax return with VIBIR including the payment of tax claiming to be a USVI resident, and the IRS transferred her estimated US payments to VIBIR.  Later, the IRS and Courts determined she was not a USVI resident, and a notice of deficiency was issued.  An agreed assessment was determined, with Renee treated as a US resident.  Renee apparently sought a refund on the VIBIR return, but this was likely denied due to the passing of the statute of limitations.  Renee then attempted to seek credits on her US return under Section 901 for payments she made to VIBIR (and the IRS payments that were converted to VIBIR payments) for the tax year in question.  Renee also claimed that for the IRS or the Court to hold otherwise would unfairly subject her to double taxation in the US and USVI.

The IRS responded by arguing that Renee was not a USVI resident, and therefore the payments were not compulsory, so no credits could be issued.

The Tax Court agreed with the Service.  It found that Renee had no USVI source income, and therefore there was no obligation to pay tax, so the payments to VIBIR were not “taxes paid”.  Section 901(b)(1) allows a credit for “the amount of any income…tax paid or accrued during the taxable year to any…possession of the United States.”  The Court found that the holdings regarding residency did not appear to give much credence to Renee’s position, which it found undercut her argument that she had a reasonable basis for paying VIBIR.  The Court also found that Renee had not exhausted all of her potential remedies to reduce her liability to USVI.  As such, the Tax Court found Renee did not meet her burden of showing that she had validly paid tax to USVI.

Before getting to the equity argument, the Court did note that Congress did not intend that taxes paid to USVI be eligible for the foreign tax credit.  The Court viewed the coordination rules under Section 932(c) as eliminating the potential for double taxation that the FTC usually solved.  Further, the Regulations specifically state that for FTC purposes, USVI income of a Section 932(a) taxpayer is treated as income from sources within the United States.  See Reg. 1.932-1(g)(1)(ii)(B).  The Court did also note that Renee’s situation may allow her to “slip through the crack in the statutory framework,” as under the literal terms she did not earn any USVI income, but it did not believe Congress would have intended that result.  The Court did not, however, hold on this rationale, as the “taxes paid” reasoning was sufficient.

The holding ends with some statements pertaining to the equity argument:

Whatever sympathy we might have for petitioners, however, does not compel us to allow them a credit against their U.S. tax liabilities to which they are not legally entitled.16 To the extent that petitioners pay tax on the same income to both the United States and the Virgin Islands, they must seek a remedy elsewhere; they cannot find it in section 901.

Foot note 16 states:

Our sympathy for petitioners would be tempered to the extent that tax avoidance motives prompted their claims to Virgin Islands residence. While the limited record before us is silent regarding petitioners’ motivations, our agreement to base our decision on the parties’ stipulations and admissions under Rule 122 does not require us to ignore the District Court’s observation in VI Derivatives, LLC v. United States…, aff’d in part, rev’d in part sub nom. Vento v. Dir. of V.I. Bureau of Internal Revenue… that “the timing of the [Vento] family’s decision to ‘move’ to the Virgin Islands is suspicious.” According to that court, Vento family members realized a significant gain as a result of a transaction that occurred at the beginning of 2001. Becoming Virgin Islands residents for that year held out the prospect of more than $9 million in tax savings to the family.

Sounds a bit like unclean hands.  Don’t argue equity after your tax fraud-ish behavior.  A bit harsher than the original taxpayer friendly Sanders holding before the Tax Court.

While reading the case, I wondered if the taxpayer could have made an argument about the amounts paid to the US that were “covered into” USVI (payments) pursuant to Section 7654.  That is the provision that makes the US pay over any tax collections it has to the possession.  I believe USVI intervened in this case (although I could be confusing my USVI residency cases), and the US was clearly a party.  It would seem both were on notice that their transfer of funds was potentially incorrect.  I have done no research on this, so the notion could be completely off base, but it was my initial thought while reading.