Summary Opinions for the week ending 3/27/15

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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.
Stephen Olsen About Stephen Olsen

Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.

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