Accepting Gifts from the IRS: Ethical Considerations (Part Two)

Previously, we discussed the two categories of IRS “gifts” that taxpayers cannot accept: clerical gifts and purely computational gifts. We left, however, with the cliffhanger that computational gifts may become “conceptual” gifts, which attorneys often can accept. Today, we’ll look closer at what a conceptual gift is and whether it is what was at issue in the Householder case (covered here).

read more…

Conceptual Gifts

Each step away from the strictly arithmetic computational gift takes you closer to the conceptual. Facts and circumstances are critical in determining which category the gift best falls into. So much of tax calculation involves the interplay of disparate statutes and facts, which may or may not have been explicitly covered in the settlement and negotiation. What first appears to be a matter of computation can often be a matter of concept: for example, the failure of the IRS to raise an issue that at first seemed ancillary but ultimately is determinative.

For example, imagine you are settling a deficiency case where your client filed their return late. Both parties have agreed on the deficiency amount, but never really discussed (or settled on) the exact date the return was filed. The IRS prepares a settlement document that reflects the deficiency agreed on but has a lower IRC § 6651(a)(1) late-filing penalty than you expected. Is this a computational error or a conceptual error?

At first blush, failure-to-file penalties seem like basic arithmetic: essentially, you look at the total amount of tax that should have been reported (and paid) and multiply that by 5% for each month the return is late. In the above hypothetical you’ve reached a determination of the amount of tax that should have been reported when you settled on the deficiency amount. But it isn’t clear that you ever discussed or determined exactly when the return was filed -that is, how late the return is, and by consequence how many months the penalty applies. That value could be subject to reasonable dispute. Exactly when a return is “filed” can be contentious. If the return was truly “late-filed” the issue would be when the IRS received it… but even that date isn’t always clear, especially post-Fowler (see coverage here).

Reverse engineering the late-filing penalty calculations may help in this case: how many months does the penalty amount proposed by the IRS equal? Is it a mathematically impossible number under the statute? (IRC § 6651(a)(1) rounds each fraction to a full month, so if you are 32 days late it is the equivalent of two months.) If so, it is likely a computational error.

Likely a computational error. But not definitely.

Again, conceptual errors may linger behind even the most seemingly mathematical mistakes. The IRS could conceivably have decided on a penalty amount that doesn’t immediately appear to add-up. For example, maybe the parties agree that the return was three months late, but the IRS believes there are significant hazards of litigation on a “reasonable cause” argument. In that case, the IRS may settle on a penalty that doesn’t otherwise make mathematical sense: a penalty of only 60% of the amount due for a three month-late return, accounting for the 40% chance that the petitioner may prevail on a reasonable cause argument in court.

The thing is, as a matter of negotiation the IRS pretty much always has discretion to settle on dollar amounts that won’t “make sense” in a winner-takes-all application of the Code. Left unbounded, the unscrupulous tax attorney could always say, “it wasn’t an arithmetic error: they were just scared I might win!” This line of argument should not always be availing. Whether an attorney can shoehorn a computational error into the conceptual category depends on the facts and circumstances of the case at issue, and the actual conduct of the parties in reaching their settlement.

First though, it is important to recognize why tax attorneys may be so tempted to categorize gifts as “conceptual” in the first place. The biggest reason? These are the gifts you can (in some sense, “must”) accept from the IRS. They are (generally) client confidences that do not raise to the level of misrepresentation to the court. Unless the client wants you to disclose the issue, you shouldn’t. Admittedly, different people in the tax world have different views on your responsibilities to the client and tax administration more broadly. The 2020 Erwin Griswold Lecture gives an interesting overview of the opinions of some prominent tax personalities on that point.

ABA Statement 1999-1 uses the example of a Schedule C deduction to illustrate. In the example the parties eventually agree that the deduction should be allowed, but counsel for the taxpayer believes (secretly) that the deduction likely should be due to passive activity under IRC § 469, and therefore wouldn’t benefit the client. The IRS doesn’t raise this issue, and neither does counsel. ABA Statement 1999-1 advances this as a “conceptual” error: counsel must not disclose unless their client expressly consents to their doing so.

To me, this is a roundabout way of asking whether the conceptual error might not be an “error” at all. As the ABA Statement notes, passive activity issues are highly factual and “subject to some reasonable dispute.” That seems less like a conceptual “error” on the IRS’s point, and more like a conceptual “weakness.” In the ABA’s example the wiggle room is in the reasonable dispute on a highly factual question of law. But that isn’t always how conceptual errors work, particularly when you “know” the key facts at issue.

For example, imagine the IRS audits your client claiming their niece as a qualifying child for the Earned Income Tax Credit. All the IRS is putting at issue is whether the niece lived with your client. Later in the process, you learn that the real problem with your client’s return is that they are legally married and needs to file married filing separate (which disallows the EITC). The IRS, however, doesn’t think to raise this issue. Note that this is essentially what happened in Tsehay v. C.I.R., discussed here. Even though that may be a “conceptual” error you still are not completely off the hook. I would argue that you cannot enter a decision with the court failing to correct that mistake. Recall your obligations to the court under MRCP 3.3 and note especially Rule 3.3(a)(2): the prohibition on failing to disclose adverse controlling legal authority.

In sum, the only time you may be completely free is where it is a conceptual “weakness” rather than an outright error: those instances where you could argue “maybe, just maybe, it wasn’t a mistake at all.” Let’s see if that’s what happened with the Householders.

As Applied to the Householders

The gift to the Householders was in the form of a very messy Notice of Deficiency. Most pertinently, it involved the transformation of a gain (reported by the taxpayer) into a rather large, favorable loss that never seems to have been claimed by the taxpayer at all. The Notice of Deficiency explanation illustrates the confusion: “It is determined that the amount of $317,029 claimed on your return as a loss resulting from the sale of your business is allowable.” The problem is that loss was not claimed on the return.

How did this mistake come to be? Was it from dueling legal theories for calculating the gain on the sale? I am operating from imperfect information, but the order would suggest otherwise. The working theory is that the IRS revenue agent was looking at an unsigned Form 1040 that had been submitted during examination negotiations, and not the actual Form 1040 that had been filed.

One may be tempted to call this a “clerical” mistake: a typo transposing numbers from the actual filed return and one that was just floating in the revenue agent’s file. But one can also imagine facts that would shift this into the world of “conceptual” errors. If there was a return floating around the revenue agent’s file that took the position there was a $317,029 loss, it is conceivable that the IRS simply agreed with that position. How are you to know if the IRS agreement was inadvertent? More facts would certainly be needed surrounding the transaction at issue to determine if it were a conceptual or clerical error.

A core question Householder raises is whether by filing a petition and invoking the power of a tribunal (and thus MRPC Rule 3.3), you are under any sort of obligation to correct errors on a Notice of Deficiency: computational, clerical, or otherwise.  A secondary question is whether silence on such a mistake is the same as prohibited “misrepresentation” to the court. I don’t think it is always so simple as to say “it’s not my job to fix the IRS’s mistakes.”    

In any event, by the time Householder gets to the Tax Court, Judge Holmes is essentially handcuffed in getting to the right number. Particularly where settlement is done on issues rather than bottom line numbers, it appears that silence on an error concerning how those issues will ultimately “add up” under Rule 155 computations is not going to be upset by the court. See Stamm Int’l Corp. v. C.I.R., 90 T.C. 315 (1988).

But that’s not what this foray into ethics is all about. This is not about what the Tax Court can do, but what a tax attorney should do under their professional obligations. I certainly do not have enough facts to know whether Householder involved conceptual, computational, or clerical mistakes. I do know that these sorts of gifts raise all sorts of ethical issues and are not as fun to receive as one may think.

Accepting Gifts from the IRS: Ethical Considerations (Part One)

Previously, I wrote about the strange case of Householder v. C.I.R (here). As a refresher, the Householders tried to take about half-a-million dollars in nonsense deductions for their horse breeding/leasing “business,” and the Tax Court disallowed them. This, of course, resulted in a $0 deficiency after running Rule 155 computations.

Wait, what?

Yes, that’s right: there was no deficiency for the Householders even after “losing” on a half-million dollar deduction because the IRS made a serious mistake in their Notice of Deficiency. Essentially, the IRS “gifted” the Householders a tax loss unrelated to the one at issue before the court. In the previous post we mostly looked at whether the IRS could take back or otherwise undo their gift. This time, we’ll look at ethical considerations for counsel in accepting these gifts.

read more…

It took all my willpower not to name this blog “Emily Post’s Guide to Accepting Gifts From the IRS.” However, the real concerns for counsel in these situations are less matters of etiquette and more the competing obligations of confidentiality with your client and candor to the court.

As a human in the world, I might think morality dictates I should tell the IRS of an erroneous “gift” so they can (presumably) rescind it. But as a lawyer in the world, professional rules dictate otherwise- something that may be thought of as a “loophole” in morality. (I can’t help myself: I was a philosophy major with a focus on applied ethics and I’m still paying off those loans. Any reference I can make to something I learned in undergrad eases the pain.)

Without being able to heavily rely on our gut moral compass, it can be difficult to know what is required of you as a lawyer on ethical issues. Lawyers have to think in terms of what “is or isn’t” in accordance with the Model Rules of Professional Conduct (MRPC). And even within the constrained universe of the MRPC it can be difficult to know what your ethical responsibilities are: as the Minnesota Rules of Professional Conduct state, these are “rules of reason.” See MRPC “Scope” [14]. In most situations attorneys must work backwards from the general principles of the MRPC to arrive at an answer.

Fortunately, there is an ABA Statement almost directly on point for the sorts of issues at play in Householder. This is ABA Statement 1999-1.The money quote from that statement is as follows:

“A client should not profit from a clear unilateral arithmetic or clerical error made by the Service and a lawyer may not knowingly assist the client in doing so. This is not the case, however, if the computational error is conceptual, such that a reasonable dispute still exists concerning the calculation.”

The ABA Statement creates a typology of “gifts,” each with different characteristics and ethical considerations. The differences are important primarily in how they determine what duties you owe the client, the IRS, and the court. Those different varieties are (a) computational gifts, (b) clerical gifts, and (c) conceptual gifts. Let’s take a look at each before figuring out which one the Householders received.

Clerical Gifts

Let’s begin with the easiest one to classify and respond to: clerical gifts. These can be thought of as typos, and they are not the sort of gifts you are allowed to accept. If my client and the IRS settle on a refund of $1,000 and the IRS types up a decision document accidentally listing a refund of $100,000 my role is clear: Let the IRS know of the mistake. I don’t even need to consult my client on that. The decision document would be entered in court and failing to correct this mistake would be in violation of my duty of candor to the court. MRPC 3.3.

You might be thinking to yourself, “but what about your duty to the client? Shouldn’t they get the final say as to whether to accept this payday since the mistake is a client confidence?”

Not so. Where the court is involved, such client confidences are explicitly overruled by MRPC 3.3(c). In fact, because you’d already reached a settlement amount with the client and IRS, you don’t even need to disclose the issue to your client: you have implied authority to make the fix on your own. See MRPC 1.6(b)(3). As we’ll see with the other varieties of gifts, this issue of maintaining a client confidence can be a serious sticking point.

If the matter didn’t involve entering a decision document in court (and therefore candor towards a tribunal), the answer may be different. In that case, you’d want to have a long chat with the client about the criminality of cashing a government check they aren’t entitled to. And as a tax lawyer you’d probably want to drop the case because of Circular 230 concerns. But that isn’t what we’re dealing with for the purposes of this blog. For now, playing the role of Emily Post, if the IRS gives you a clerical gift, one must politely say “I could never accept such generosity.”

Computational Gifts

Computational gifts may be “squishier” than clerical gifts and entail a broader range of mistakes. On one end of the spectrum the mistake may be simple arithmetic: 2 + 2 = 5. This isn’t a far-cry from a clerical mistake, and identical ethical considerations apply: you cannot accept such generosity, and you must disclose (if in court). Most of the time, however, the arithmetic isn’t so cut-and-dry. What if the issue isn’t failure to correctly add two numbers, but failure to consider a code section that would introduce another variable to the equation? In other words, what if the correct computation is 5 + 3 x 0 but the IRS doesn’t recognize a law providing the zero multiplier, and only adds 5 + 3? Computational, to be sure, but not strictly so…

Which leads us to the final category: “Conceptual Gifts.” These are the gifts attorneys want to receive from the IRS, because in some circumstances they can actually accept them. Was the Householder’s erroneous Notice of Deficiency one such conceptual gift? We’ll take a deeper look at what exactly distinguishes conceptual gifts from purely computational ones in the next post.

Counsel Clarifies the Limited Rights of Unenrolled Preparers in Tax Court Cases

Taxpayers who have filed a petition in Tax Court often still rely on their tax return preparers to help try to resolve the matter. Most unlicensed tax return preparers are not admitted to practice before IRS Counsel attorneys. Despite that, in a 2014 Chief Counsel notice the IRS emphasized that Counsel attorneys should interact with a taxpayer’s representative if there is a valid POA on file authorizing the representative to act on the taxpayer’s behalf.

Last week, in  Notice CC-2017-007 Counsel clarified its earlier procedure and discussed issues relating to a representative who is an “Unenrolled Return Preparer.”

read more...

As we have discussed before, following the judicial rejection of the Service’s plan to require unlicensed preparers to pass a test and complete continuing education requirements, the Service launched a voluntary testing and education program called the Annual Filing Season Program (see for example Some More Updates on IRS Annual Filing Season Program and Refundable Credit Errors). Under that program, unlicensed preparers take 18 hours of continuing education and take a test on federal tax law. The return preparer seeking to obtain certification of compliance with the annal filing season program must also renew their preparer tax identification number (PTIN) and consent to adhere to and be subject to the obligations in Circular 230 addressing duties and restrictions to practice before the Service and Circular 230 § 10.51, which addresses sanctions and disreputable conduct. The benefits of opting in to the Annual Filing Season Program include becoming part of a searchable database of preparers and the right to represent taxpayers in examinations, though not before Appeals, Counsel or Collection.

That representation ability is a key perk for unenrolled preparers; it generally was available to all signing preparers before 2015 though by now limiting representation to the unenrolled preparers who comply with the Annual Filing Season Program, the Service has hoped to generate interest in and demand for what it required through its ill-fated mandatory testing and education regime.

Form 2848 specifically now has a designation for the class of unenrolled preparers who opt in to the Annual Filing Season Program; designation “h”, which is for “Unenrolled Return Preparer.”

Last week’s Chief Counsel notice discussed the limits of these representational rights for Unenrolled Return Preparers. Most importantly, representation is still limited to matters involving examination of a tax return. A challenge for the Service is drawing the line between assistance in an exam matter and in a matter that progresses beyond an exam because the taxpayer, often with shadow assistance by an unlicensed preparer, has filed a petition in Tax Court. Despite the limits of the representational powers of unenrolled return preparers, in the current Chief Counsel Notice the Service clarified that “if the involvement of an unenrolled return preparer is beneficial to the resolution of the case, Counsel attorneys may work with the unenrolled return preparer, in a non-representative capacity, to develop the facts of a case.”

In the Notice, Counsel thus takes a practical approach to the issue. Most cases in Tax Court involve pro se taxpayers, and many disputes in court revolve around facts. My experience is that in many instances the involvement of a third party can assist in the resolution of the case. The 2017 Chief Counsel Notice states that the preparer may assist the taxpayer in gathering information or in substantiation of items on the return, and that Counsel attorneys may permit the preparer to attend meetings.

The Notice does remind its attorneys to clarify with the taxpayer and the preparer that for the unenrolled return preparer there is no general authority to represent taxpayers in Tax Court cases, and that Counsel has no obligation to communicate with the preparer or even include the preparer in meetings if the preparer is abusive or if the interests of the preparer conflict with the interests of the taxpayer.

There are a couple of points worth highlighting in the Notice. First, with the increased reach of special due diligence penalties applying to more refundable credits, it is becoming somewhat more likely that a conflict between a preparer and a taxpayer may arise. In addition, as with other third parties who are not representatives of a taxpayer, Counsel’s communications with unenrolled preparers could expose the Service to possible 6103 violations if the communications proceed without the involvement of the taxpayer. As such, the Notice reminds its attorneys that it should communicate with the unenrolled preparer only if the taxpayer “is present, either in person or on the telephone, or in the unenrolled return preparer’s capacity as a third party record keeper or a potential witness.” In addition, because I suspect that taxpayers may not fully appreciate the limited powers of unenrolled preparers, the Notice states that to “avoid confusion Counsel attorneys should clarify with both the petitioner and the unenrolled return preparer that unenrolled return preparers do not have the authority to represent petitioners in dealings with Chief Counsel, even if the petitioner purports to consent to the representation.”

Conclusion

In sum, the Notice seems helpful for all parties. As taxpayers become more familiar with the limits associated with preparers who have not opted in to the Annual Filing Season Program, the Service encourages what it could not mandate; that is, the use of preparers who in fact have demonstrated some minimal level of competence and who demonstrate the additional accountability and visibility associated with the annual filing season program. I think that the approach of providing the incentive to use some preparers as compared to others, so long as that incentive is tied to furthering the goal of good tax administration rather than lining the pockets of some preparers over others, is a good model for IRS oversight over an industry that plays a key role in tax administration.

Fee Arrangements are a Matter between Taxpayers and their Advisors

We welcome back guest blogger G. Brint Ryan, Chairman and CEO of Ryan, LLC. Brint wrote a guest blog post for us at the end of 2014 about a case we described then as perhaps the most important procedural case of the year combined with the Loving case.  He has continued to litigate concerning the issue of fees for service and the ability of the government to control the fee arrangement between parties.  The most recent case involves litigation with the state rather than the IRS but has implications that go beyond just the laws in California.  Keith

In an important win for business against government encroachment, a California Superior Court recently invalidated a rule restricting taxpayers from paying performance-based fees for professional services.  In this case, Ryan, LLC (“Ryan”) filed suit challenging the legality of an emergency rule promulgated by the California Governor’s Office of Business and Economic Development (“GO-Biz”) in August 2014, which sought to restrict performance-based fee arrangements for companies applying for the California Competes Tax Credit.  California Superior Court Judge Timothy M. Frawley ruled in favor of Ryan, stating that the “cost of a consultant’s services is a matter between the taxpayer and the consultant.” He found that the state had failed to show any link between these costs and the economic development goals of the program.

read more...

This ruling is a win for businesses and the professionals who assist them in making their growth and investment decisions.

Federal, state, and local governments in the U.S. offer tens of billions of dollars annually in credits and incentives (like the California Competes Program) to businesses to promote job creation and economic development. However, due to the complexity of uncovering and applying for available credits and incentives, half of them go unclaimed each year. Firms like Ryan provide the advice needed to ensure that these incentives aren’t missed by growing businesses that are generating local jobs and economic opportunities.

Of the nearly six million employer firms in this country, companies with fewer than 500 workers accounted for 99.7% of those businesses. In other words, the businesses that make up the very backbone of the U.S. economy are the ones likely to engage a credits and incentives consultant. They are small to medium-sized and unlikely to have the experience, expertise, or bandwidth needed to properly research, identify, and negotiate business incentives. These smaller organizations are the most likely to need external counsel to assist them in unlocking incentives that will help expand their businesses by impacting their bottom line.

Adopting a performance-based fee structure, which pays a consultant only if that consultant successfully procures useful business incentives, is a “win-win” situation, especially for firms who can’t afford to pay these fees upfront. This is precisely why a ban on fee arrangements makes no sense. Restricting taxpayer contracts for professional services would only hamper the appetite and ability of businesses to apply for tax credits—producing a self-defeating result for any economic development program.

Judge Frawley agreed with this argument, writing that banning performance fee arrangements “does nothing to stimulate ‘new employment’ or ‘economic growth,’ and does nothing to encourage businesses to invest in California. The only thing the ban is likely to accomplish is [to] discourage businesses with contingent fee arrangements from participating in the California Competes tax credit program.”

Thus, ironically, losing this lawsuit is actual a “win” for the California economy. Removing this ban puts California back in line with the way other states operate. It opens the market back up for California as a business-friendly state and promotes the California economy.

In addition, the nature of the ban was inherently flawed and lacked a fundamental understanding of how performance-based fees work with regards to incentives. It restricted the fee structure for one particular tax credit. But companies that are considering expansions and relocations typically are not focused on a specific tax credit or incentive in a single state. For example, Ryan works on behalf of its clients to research and pursue any and all potentially available credits and incentives for each potential site so that the client can take all of them into account in determining the return on investment for a project. In general, because the services Ryan provides to its clients are interconnected, span multiple years and locations, and encompass a variety of different tax credits and incentives (national, state, regional, and municipal), the fees it charges cannot be isolated on a “per credit” basis.

Underscoring these arguments is the basic notion of fairness. It is unjust for government to intrude into a company’s business judgments to the point of dictating how a company pays its consultants. Ryan levied a similar blow to Internal Revenue Service (IRS) business regulatory overreach in 2014 in Ridgely v. Lew, which invalidated restrictions prohibiting attorneys, certified public accountants (CPAs), and other practitioners from entering into performance-based fee arrangements for services before the IRS (known as Circular 230 provisions).

This ruling on the California GO-Biz case is a win for businesses as well as economic development in the state of California. Ryan will continue to lead the charge against unfair and illegal government interference that infringes on the rights of taxpayers and inhibits economic growth.

 

 

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:

read more...

  • 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.

Legislative Authority to Regulate Paid Tax Return Preparers: The Focus Turns to Congress to Act

In this post, Michael Desmond of The Law Offices of Michael J. Desmond, APC discusses the prospects for a legislative response to recent court decisions enjoining the IRS from regulating paid tax return preparers and, more broadly, calling into question the scope of the IRS’s authority to promulgate practice standards under Circular 230.  This follows up on prior posts Mike has written on related topics: Is there a Future Role for Circular 230 in the IRS’s Efforts to Improve Compliance and one of PT’s most-viewed posts, Final Circular 230 Written Tax Advice Regulations. Les

Background

Section 330 of Title 31 (“Section 330”) provides the statutory basis for the Treasury Department and the IRS to promulgate the practice standards set forth in Treasury Department Circular 230. In its present form, 31 U.S.C. § 330(a)(1) authorizes the Secretary to “regulate the practice of representatives before the Treasury.” For decades, Treasury and the IRS have relied on this statute as authority for the regulation of a wide variety of “practitioner” conduct ranging from the due diligence standards in Circular 230 § 10.22, to the fee practices in § 10.27, to the conflict of interest rules in § 10.29 and the “written advice” standards in new § 10.37. Section 330(a)(2) of Title 31 complements Section 330(a)(1) by authorizing the Secretary to sanction (including by suspension or disbarment from “practice”) a “representative” who is incompetent, disreputable, violates regulations promulgated under Circular 230 or, in certain cases, misleads or threatens a “person being represented” or “prospective person to be represented.” Treasury and the IRS have relied on this authority to regulate a list of “incompetent” or “disreputable conduct,” ranging from conviction of certain crimes to “willfully” failing to electronically file a tax return when otherwise required to do so. See Circular 230 §§ 10.51(a)(1) through 10.51(a)(18).

read more...

Both subsection (a)(1) and subsection (a)(2) of Section 330 are linked to the “practice” of a “representative,” terms that are not defined by the statute and, until recently, had not been interpreted by the courts. In 2004, Congress amended Section 31 to add a new subsection (d), which provides a negative grant of authority for the Treasury Department and IRS to regulate the rendering of written tax advice with respect to certain potentially abusive transactions. American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418, §§ 822. Neither the 2004 statute nor its legislative history address the definition of “practice” or “representative” as those terms are used elsewhere in Section 330.

Although Section 330 and its predecessor statutes have been in place largely unchanged for over a century, the government’s reliance on the statute to regulate as “practitioners” individuals who directly and indirectly interact with the federal tax system had not been subject to serious challenges until recently. Amendments to Circular 230 finalized in 2011 attempted to regulate as “practitioners” persons whose only connection to the tax system was the preparation of tax returns for compensation changed that.

Loving and Ridgely

The D.C. Circuit’s decision in Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014) and the D.C. District Court’s decision several months later in Ridgely v. Lew, 2014 U.S. Dist. LEXIS 96447 (D.D.C. July 16, 2014) have introduced a new paradigm to Circular 230, calling into question key portions of the regulations and creating a watershed moment for the regulation of a broad range of tax advisor conduct. With the decisions in both cases now final, attention has shifted from the courts to Congress to address what are generally agreed to be serious compliance problems created by a system where hundreds of thousands of unregulated, unlicensed and in many cases untrained professionals assist tens of millions of taxpayers in paying and obtaining refunds of billions of dollars in taxes each year.

Summarizing Loving and Ridgely:

  • In Loving, the D.C. Circuit considered the “precise question” of “whether the IRS’s statutory authority to ‘regulate the practice of representatives of persons before the Department of Treasury’ encompasses authority to regulate tax-return preparers.” Finding no ambiguity in Section 330, the court held that it did not, walking through “six considerations [that] foreclose the IRS’s interpretation of the statute.”
  • While in Loving, the D.C. Circuit focused narrowly on newly promulgated provisions in Circular 230 that imposed testing and continuing education requirements on paid tax return preparers, the District Court’s decision in Ridgely v. Lew extends the D.C. Circuit’s holding in a context with potentially far broader consequences. While the only aspect of Circular 230 directly at issue in Ridgely was the limitation on contingent fees in Section 10.27 as applied to a CPA’s preparation of “ordinary refund claims,” the rationale of the case has wider application. The District Court equated paid tax return preparation to the preparation of “ordinary” refund claims and held that if—under Loving—the former does not constitute “the practice of representatives,” neither does the latter. And, if regulating the preparation of “ordinary refund claims” is beyond the scope of the IRS’s regulatory authority, so is regulating fee practices with respect to that activity.
  • While Ridgely was, by its terms, limited to contingent fee practices for refund claims, its rationale can be applied broadly to a wide range of conduct that Circular 230 has long purported to regulate, including due diligence, standards for written tax advice and conflicts of interest – none of which necessarily arise in the context of direct representation of taxpayers before the IRS. In sum, were it passed in its current form, S. 137 would address Loving and authorize the IRS to regulate paid tax return prepared, but it would not address Ridgely or future cases that can be expected to arise attempting to extend Ridgely to other conduct that is only indirectly related to an interaction with the IRS.
  • Although the Ridgely Court’s rationale may be a lineal extension of Loving, it does not necessarily hold up against the “six considerations” the D.C. Circuit walked through in Loving. For example, unlike paid return preparation, the IRS has historically taken the position that it can regulate a CPAs’ fee practices. Moreover, Loving does not specifically address the secondary argument rejected in Ridgely that the IRS has derivative authority to regulate all aspects of conduct for persons who are, in other contexts, admittedly agents or “representatives” of taxpayers before the IRS (i.e., lawyers, CPAs and enrolled agents who at some point have filed an IRS Form 2848, Power of Attorney). This raises an interesting theoretical question as to whether the outcome might have been different had Ridgely reached the D.C. Circuit before Loving. Regardless, the Ridgely court did extended Loving to invalidate the limitation on contingent fees in Circular 230 § 10.27 and no appeal was taken.

With the government having folded its tent, at least for the moment, on further litigation over the scope of authority under Section 330, the focus now shifts to Congress for a solution.  While the prospects for expanding the IRS’s regulatory authority in the current political environment are unclear, the need for an updated statute – even before Loving and Ridgely is not.

The Horse Act of 1884

A downside to using a statute enacted 130 years ago as the basis for any modern day regulation, much less regulation of a multi-billion dollar industry, is that the language of the statute may not be up to the task at hand. When the predecessor to Section 330 was enacted, the United States did not have a generally applicable income tax, much less an entire industry focused on paid return preparation. Reading the original statute, it is difficult to imagine that in 1884 Congress thought that it was authorizing anything remotely close to the regulation of tax return preparers. Rather, when the original statute was enacted as part of the Horse Act of 1884, Congress was focused on funding claims brought against the War Department “[f]or horses and other property lost” during the Civil War. In authorizing that funding, Congress qualified it with the proviso:

 

That the Secretary of the Treasury may prescribe rules and regulations governing the recognition of agents, attorneys, or other persons representing claimants before his Department, and may require of such persons, agents and attorneys, before being recognized as representatives of claimants, that they shall show that they are of good character and in good repute, possessed of the necessary qualifications to enable them to render such claimants valuable service, and otherwise competent to advise and assist such claimants in the presentation of their cases.   And such Secretary may after due notice and opportunity for hearing suspend, and disbar from further practice before his Department any such person, agent, or attorney shown to be incompetent, disreputable, or who refuses to comply with the said rules and regulations, or who shall with intent to defraud, in any manner willfully and knowingly deceive, mislead, or threaten any claimant or prospective claimant, by word, circular, letter, or by advertisement.

Act of July 7, 1884, ch. 334, 23 Stat. 236, 258-59.

Submission of claims to the Treasury Department having evolved in the past 130 years from dead horses to home buyer, health insurance and earned income tax credits, among myriad other tax expenditures, the statutory grant of authority is in dire need of an update. As the D.C. Circuit stated in Loving in holding that Section 330 did not authorize the regulation of paid preparers, “we are confident that the enacting Congress did not intend to grow such a large elephant in such a small mousehole.” 742 F.3d at 1021.

Prospects for a Legislative Response

The judicial framework of Loving and Ridgely and the historical background of the Horse Act of 1884 provide context for evaluating recent legislative proposals to amend Section 330 to authorize the regulation of return preparers. Legislation introduced in prior Congresses focused on mandating regulation where historically the IRS had been unwilling or unable to do so. See, e.g., H.R. 1528, The Tax Administration and Good Government Act , § 4 (108th Cong.).   Those earlier legislative efforts met resistance on several fronts, including a concern expressed by the IRS that it lacked the resources to effectively regulate hundreds of thousands of paid preparers, a concern expressed by existing “practitioners” that the market value of their credentials not be eroded by a regulatory stamp of approval for all paid preparers, and a concern by unregulated paid preparers over the burden that would be imposed by any regulation. With no traction on the legislative front and a growing concern over unregulated preparers, Treasury and the IRS acted on their own with the promulgation of the 2011 amendments to Circular 230 making all paid return preparers “practitioners.” This shifted the target from Congress to the IRS, but did nothing to eliminate the underlying concerns. In short order, those concerns gave rise to litigation.

In the early days of the 114th Congress, legislation was again introduced to authorize the Treasury Department and IRS to regulate paid return preparers, now with the contextual benefit of Loving and Ridgely.   On January 8, 2015, Senators Wyden (D-Ore.) and Cardin (D-Md.) introduced S.137, which would amend Section 330 to supplement the current authorization for regulating “the practice of representatives of persons before the Department of Treasury” by adding a new subsection specifically authorizing regulation of “the practice of tax return preparers” as defined in Code section 7701(a)(36). If enacted, S. 137 would overturn Loving and authorize (presumably on a prospective basis) the changes to Circular 230 finalized in 2011 that attempted to fold paid return preparers into the definition of “practitioners.” The Obama Administration takes a similar albeit less detailed approach in its Fiscal Year 2016 Revenue Proposals, which call for legislation that “would explicitly provide that the Secretary has the authority to regulate all paid return preparers.” Similar legislation was also introduced in the 113th Congress without any meaningful action being taken on it. H.R. 4470, Tax Return Preparer Accountability Act of 2014, (113th Cong. 2014); H.R. 4463, Tax Refund Protection Act of 2014, H.R. 4463, 113th Cong. (2014); H.R. 1570, Taxpayer Protection and Preparer Fraud Prevention Act of 2013, 113th Cong. (2013).

While S. 137 responds to Loving,it does not address the broader challenge to the authority of the Treasury Department and IRS to regulate conduct beyond return preparation that was called into question by Ridgely. This is a somewhat ironic result, given that the district court in Ridgely purported to simply apply the holding in Loving, interpreting the meaning of “practice of representatives of persons before the Department of the Treasury.” By adding a new subsection to Section 330 providing targeted authority for Treasury and the IRS to regulate paid return preparers, S. 137 would appear to leave untouched the Ridgely court’s holding (applying Loving) that “the practice of representatives” under current law is limited to persons having direct “representative” interaction with the IRS and does not extend broadly to fee practices for preparing amended returns even with respect to persons who, like the plaintiff in Ridgely, are admittedly “practitioners” in other contexts.

S. 137 follows a discussion draft of legislation released by then Senate Finance Committee Chairman Max Baucus in 2013 as part of a broader package of proposals to reform the administration of federal tax law. That draft “clarifies” Section 330 by adding a reference to “preparing and filing . . . tax returns” to subsection (a)(2)(D). The draft assumes the threshold conclusion that “practice of representatives” includes return preparation, an issue that would have to be addressed in light of Loving. Moreover, like S. 137, the draft legislation does not address the narrow interpretation of “practice of representatives” in Section 330(a)(1) adopted by the District Court in Ridgely.  Despite these issues, inclusion of a proposal to amend Section 330 in the prior discussion draft suggests that the issue will be addressed again by the Finance Committee as Chairman Hatch continues to push for broader tax reform in the current Congress.

Also on the legislative front, the ABA’s Section of Taxation recently issued a Report supporting a legislative response to Loving, although the Report has yet to be adopted by the ABA’s House of Delegates. Like S. 137, the Report recommends that Section 330 be amended to include “tax return preparers” (as defined by Code section 7701(a)(36)) within the scope of Sections 330(a) and (b). While the Report does not propose specific legislative language, its recommendation could be implemented by expanding the definition of “practice of representatives,” which would address the holdings of both Loving and Ridgely. The Report also recommends amendments to Section 330(d), originally enacted in 2004, to expand it beyond a negative grant of authority applicable only to written tax advice rendered in the context transactions that have the potential for abuse.

Conclusion

Although the near-term prospects for legislation expanding the IRS’s regulatory authority may be remote, there does seem to be a broad consensus that paid tax return preparers should be subject to some form of uniform regulation and that the IRS should be able to promulgate practice standards applicable to a broad range of advisor conduct.   Loving and Ridgely make clear, however, that the Horse Act of 1884 is not up to the task of supporting that regulatory initiative. Whether it comes as part of a broader tax reform effort, or with narrower legislation targeted at improving the administration of the tax law, legislative action at some point in time seems inevitable. Legislation introduced in the current and past Congresses provide a good start and, with some refinement, should help to ensure the shared goal of improving compliance and tax administration. Only the minor challenge of moving tax legislation stands in the way.

 

 

Who’s Afraid of the IRS? When Business Fights Back Against Government Overreach and Wins

Today we welcome first time guest blogger G. Brint Ryan, Chairman and CEO of Ryan, LLC . This is the tax advisory firm in which Gerry Ridgely, Jr., is a Principal and Executive Vice President and Vice Chairman Emerging Businesses.  Mr. Ridgely was the plaintiff in Ridgely v. Lew, which invalidated the regulations under 31 C.F.R. sec. 10.27 restricting contingency fees.   

Looking back over 2014 there are no more important cases involving federal tax procedure to come out this year than the ones decided in Loving v. IRS, invalidating regulations under 31 C.F.R. secs. 10.3 to 10.6 as to return preparer regulation and Ridgely v. Lew.  Because of their importance, we have blogged both cases extensively and expect to continue to blog on the issues raised by these cases for quite some time.  See, e.g., Initial Reactions to the Government’s Loss in Loving (Feb. 11, 2014); DC District Court Following Loving Takes Down Part of Circular 230 Contingent Fee Rules (July 18).  We have been fortunate to have outstanding guest bloggers from the perspective of a leading academic with Steve Johnson’s outstanding post that he wrote almost immediately after the decision in Ridgely v. Lew and from top practitioners Michael Desmond and Chris Rizek.  Following the Loving decision, we were fortunate to have Dan Alban, counsel for plaintiffs, blog on his perspectives on that case.  Today, we are glad to have Brint Ryan provide inside perspectives on the Ridgely case as we close out the year. 

We wish you a happy new year from Procedurally Taxing and many happy returns in 2015.  Keith 

2014 wasn’t the best year for the IRS, which came under fire for wasteful spending, missing e-mails, and allegedly targeting conservative groups.  While most of the attention is focused on the partisan nature of these claims, the business community is also waging critical battles against the IRS—and more importantly, winning.  Business leaders are crying foul in an ongoing mission to overturn burdensome business regulatory overreach designed to create an unfair IRS advantage.

read more...

The most recent blow to IRS business regulatory overreach came through a favorable ruling this past July, which invalidates restrictions prohibiting attorneys, certified public accountants (CPAs), and other practitioners from entering into performance-based fee arrangements for services before the IRS (known as Circular 230 provisions).  In the consulting industry, many clients prefer “performance-based” pay arrangements to an hourly rate.  Any rule prohibiting performance-based fees would not only hinder companies from taking advantage of state incentive programs, for example, but also alienate smaller firms who might be interested in moving or expanding, but can’t afford to pay fees upfront.  Yet this is precisely what the IRS attempted to do.

Thankfully, the resulting court order from the United States District Court in Ridgely vs. Lew invalidates and permanently enjoins the IRS from enforcing the restrictions under the Circular 230 provisions.  This is a tremendous result in a long-fought battle to protect taxpayers and their representatives from the IRS’s efforts to limit their ability to pursue valid claims.  Without question, the Court reached the correct result.

Now, taxpayers—not the IRS—will have the right to determine the fee arrangement between themselves and their representatives.

While this case is not as high-profile as IRS official Lois Lerner’s efforts to cripple conservative non-profits, it will have a profound impact on a company’s ability to drive economic growth, job creation, and innovation.

A perfect example of how this ruling frees companies to invest, grow and thrive lies in the Research & Development (R&D) tax credit.  This program has wide bipartisan support and is backed by the Obama Administration.  Eighty percent of the R&D tax credit benefits directly support jobs in the United States, creating $2 of economic benefit for every $1 spent.

Yet even the Court in the Ridgely case stated that these tax incentives can be complex.  The IRS has thousands of employees and a seemingly unlimited budget.  On the other hand, companies don’t have the vast financial resources afforded the IRS through the hard-working US taxpayer.  The recently overturned Circular 230 regulations made life easier for the IRS but more difficult for businesses to hire professional services firms to navigate the stringent federal compliance requirements of programs like the R&D Tax Credit.

A level of fairness has been restored, and companies now have the ability to retain professional services on a performance-based agreement, mitigating the financial risk and unlocking their ability to take advantage of the many benefits these programs provide.  It’s a victory for innovation, job creation, and economic growth.

However, Big Government continues to fight for the ability to control and overregulate.  In August, the California Governor’s Office of Business and Economic Development (Go-Biz) exploited emergency rulemaking procedures by capriciously inserting a requirement to regulate the fee arrangements between taxpayers and their representatives when allocating the California Competes Tax Credit (“Tax Credit”)—essentially creating California’s version of Circular 230.  These fee provisions limit the availability of the Tax Credit by allowing GO-Biz to deny the Tax Credit to taxpayers.

Despite the fact that the California Legislature has recently and repeatedly demonstrated that it does not intend to impose limits on fee arrangements between taxpayers and their consultants, Go-Biz passed.  At a time when California is bleeding jobs, regulatory overreach by GO-Biz is impacting the ability of taxpayers to obtain representation to pursue their right to a tax credit for driving economic growth and job creation job.

Ryan is now leading the charge against Go-Biz, challenging the legality of the California rule restricting taxpayer contracts for professional services under the Tax Credit program.  We will continue to aggressively defend the rights of taxpayers against burdensome regulations that inhibit job growth and economic development.  A Government that so egregiously meddles in fair business practices cannot be tolerated.

As James Madison so famously said in 1788, “There are more instances of the abridgment of the freedom of the people by gradual and silent encroachments of those in power than by violent and sudden usurpations.”

Summary Opinions for 11/07/14 & 11/14/14

Trying to get somewhat back on schedule with the SumOp’s, so we are covering two weeks of material in this post.

First, I want to note that Keith has a really interesting post up on Forbes regarding Microsoft filing a FOIA suit yesterday against the IRS to determine the extent to which the IRS is using an independent contract (here the law firm Quinn Emanuel) in its examination.  This is going to be a very hot  topic moving forward.  That post will find its way to PT later today, but probably not until late in the afternoon.

Before getting to the items we missed over the last few weeks, we had a very strong guest post by Christopher Rizek on the Sexton v. Hawkins case, which was very well received two weeks ago. You should check it out if you didn’t read it when we originally posted.  In October, we had a somewhat related post from Michael Desmond on the future role of Circular 230 in tax compliance, which can be found here.  The comments to that post, which are found here, have recently expanded significantly, as various Villanova LLM students were asked to respond as part of their professional responsibility class.  The students provide some quality feedback, astute observations, and ask some good follow up questions.

To the other procedure.

read more...

  • Veolia Environment is still fighting with the IRS over document discovery.  We touched on this last year around this time.  The case again discusses privilege regarding various draft reports by experts, and other lawyer communications.  For one draft valuation, which was then shared with the company’s accountants at PWC, the Court found privilege had not been waived, stating, “PWC is not an adversary nor a conduit to an adversary.”  That seems like a favorable view on what is required to blow privilege.  The case goes through many other specifics as to the types of documents that remained privileged.
  • Jumping to a case from early October that we (I) missed in Comparini v. Comm’r, where the Tax Court determined it had jurisdiction to review an IRS determination to deny the taxpayers’ whistleblower claim.  The letter was not formatted as a determination, and prior letters had been sent to taxpayers; however, letter was the first one to use term “determination”, stated the matter was closed, and did not indicate any further administrative procedures were available.  The Court found that prior letter could have been a determination, but this later letter was also a determination (there is an interesting back and forth in the concurring and majority opinion about the basis for jurisdiction).  The concurring opinion, and Judge Holmes in comments to the CA Bar Association, both noted that the Court is having to spend a lot of time on procedural matters and jurisdictional questions due to the Whistleblower Offices’ habit of issuing various statements that seem to be determinations, and not having set forms for indicating when a determination had been made.  Tax Litigation Survey has coverage here.
  • Another older item that I didn’t catch.  The Service issued an Action on Decision  with regard to the Dixon case from last September, which we wrote about here.  The case had to do with an employer’s ability to designate employment tax payments that were not withheld at the source.  The Service believes the Tax Court was wrong in Dixon in deciding such payments can be designated against a taxpayer’s specific liability.
  • From Jack Townsend’s Federal Tax Crimes Blog, a discussion of the jury instructions in the Weil case as regard the good faith defense.  Not a long post, but interesting summary of this attack on the government’s case, and how the instructions could have influenced the jury.
  • Earlier this year, Google killed off one of its coupon saving sites, Zavers (reminds me of Zima’s “zomething different” slogan—don’t use Z’s where they are not needed—your company will fail), but the remains of the aggressive tax planning of Zavers’ chief technology officer have been resurrected by the Tax Court in Brinkley v. Comm’r.  As a side note, it is nice to be Google, who bought Zavers for close to $100MM in 2011, probably spent a bundle more on it, and are now walking away, as it was not growing fast enough (so says the article linked above).  The underlying matter has to do with Mr. Brinkley’s characterization of his income as capital gains, whereas the Service and Tax Court thought a portion should be ordinary income.  He had apparently been very clear that his ownership should never dip below 3% of the stock, which Zavers agreed to; however, at the time of the Google purchase, he owned around 1%.  In the end, he was paid as though he still held 3%.  The two tax procedure items involved the shifting of the burden, and reliance on a practitioner as reasonable cause.  Neither treads new ground.

On the shifting of the burden, the taxpayer argued that he offered reasonable evidence that an item of income reported on an information return was incorrect, shifting the burden under Section 6201.  The Court, however, was relying on other evidence submitted by the IRS, and not the information return, so the burden did not shift.  Mr. Brinkley also argued that he complied with Section 7491, and produced “credible evidence to support his position as to a factual issue, complie[d] with substantiation requirements, and cooperate[d] with the Secretary with regard to all reasonable requests for information,” but the Court found that Mr. Brinkley failed to offer any credible evidence of his position.

As to the reliance, the Court found that Mr. Brinkley failed to disclose his percentage of the stock to his advisers, how much that was valued at, and  did not provide them with all the documents from the deal.  It is clear law that where the adviser is not informed of all pertinent information, the taxpayer cannot rely on the adviser’s advice or work to get out of a penalty.

  • Susquehanna Bank, which was purchased last week by a North Carolina bank, recently won a lien priority case in the Fourth Circuit.  The Court held the district court incorrectly determined a trust deed, which the bank received prior to the IRS lien, but failed to record, was entitled to priority under Section 6323(h) based on Maryland law relating the recording of the trust deed back to the execution date.  However, the holding was affirmed because the bank was protected by Maryland’s equitable conversion law, which directs that when a taxpayer executes a deed in exchange for a loan prior to a lien filing, the deed took priority.
  • Kurko v. Comm’r is packed with tax procedure.  Lew Taishoff’s blog has some coverage here.   The cases discusses credit elect overpayment jurisdiction before the tax court, tolling for financial disability under Section 6511(h), how those interact, and the Court’s “next friend” rules under Tax Court Rule 60(d).  The Court encouraged Ms. Kurko, who suffered from substantial mental health issues, to have someone file a Motion to Be Recognized as Next Friend.  The Court said such motion should recite that:

o   The person filing would like to be recognized as Ms. Kurko’s next friend and would represent her best interests;

o   That Ms. Kurko cannot prosecute the case without help;

o   The person has a significant relationship with Ms. Kurko; and

o   There is no other person better suited to serve as next friend.

  • The Tax Court had occasion to review the 2006 changes to Section 6664, and the removal of the reasonable cause defense to the gross valuation misstatement penalty in Reisner v. Comm’r.  Prior to 2006, old Section 6664(c)(2) allowed the reasonable cause defense to the penalty when value was provided by a qualified appraiser and the taxpayer made a good faith attempt to determine the value.  That was tossed in the 2006 amendment for gross valuation misstatements (those with only substantial valuation misstatements can still show reasonable cause).  In Reisner, the taxpayer received a charitable deduction for a façade easement.  A portion carried forward to 2005 and 2006.  The Service determined the donation was valueless, and no deductions were allowed.  The gross valuation misstatement penalty was not imposed in 2004 or 2005 because the taxpayer was able to show reasonable cause.  For 2006, the return was filed after the changes to the statute, and the Service imposed the penalty on the carryover charitable deduction.  The Court held the penalty was correctly imposed, stating:

Because their 2006 return was filed after the effective date of 2006 amendments to I.R.C. sec. 6664(c)(3), Ps are precluded under that section from raising a reasonable cause defense to imposition of the gross valuation misstatement penalty for the underpayment on their 2006 return attributable to the carryover of their charitable contribution deduction.

An interesting result, where the action was protected in the initial year, but the statutory change resulted on penalties in future years based on the same transaction.

  • The Ninth Circuit reversed the Tax Court in JT USA, LP v. Comm’r, holding Section 6223(e)(3)(B) was clear and unambiguous and did not allow a partner in a partnership to elect out of the TEFRA proceedings unless the partner elects to have all his or her partnership items treated as non-partnership items.  For the majority, that was all partnership items, regardless if those were owned through other entities.  From the case:

 

26 U.S.C. § 6223(e)(3)(B), entitled “Notice to Partners of Proceedings,” reads in pertinent part, “In any case to which this subsection applies, if paragraph (2) does not apply, the partner shall be a party to the proceedings unless such partner elects – . . . (B) to have the partnership items of the partner for the partnership taxable year to which the proceeding relates treated as nonpartnership items.

In the prior proceeding, the tax Court held that that “§ 6223(e)(3)(B) permits taxpayers to opt out of the partnership proceeding with respect to their indirect interests but to leave in that proceeding their alleged remaining direct partnership interests.”  The Ninth Circuit disagreed, and said that the plain language states it is all or nothing when it comes to opt out.  The opinion was split, and the dissent stated the taxpayer should have the ability to completely elect out with regard to their direct interests in the partnership, but not do so with the indirect interest in the partners (and/or the other way).  I found this surprising, and my initial (somewhat uninformed) thought is that the tax court had this right.