Notes from the Fall 2019 ABA Tax Section Meeting

From October 3 to 5 Les, Christine and I attended the tax section meeting in San Francisco.  We were each on different panels and we each enjoyed a delightful dinner cruise on the bay Friday night courtesy of tax procedure guru, Frank Agostino.  During the cruise the three of us had an in depth discussion with Frank about his latest ground-breaking tax procedure initiatives which we hope to highlight in coming posts.

For this post I intend to provide some of the information passed out during the update sessions in the Administrative Practice and Court Procedure Committees.  For anyone interested in more depth or more precision, it is possible to purchase audio tapes of the committee meetings from the tax section.

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Administrative Practice Committee

The discussion initially focused on Appeals and the Taxpayer First legislation seeking to create a more independent Appeals.  Apart from the legislation, Appeals issued a new conferencing initiative on September 19, 2019.  A request for comments on the new process went out. 

The presenter discussed the change to IRC 7803(e)(5)(A) and the right to a hearing in Appeals.  This change resulted from the Facebook case discussed here.  For those who do not remember the Facebook litigation, Chief Counsel denied Facebook the opportunity for a conference with Appeals after Facebook filed its Tax Court petition — even though Facebook had not met with Appeals prior to filing the petition.  The new provision will make it more difficult to deny a taxpayer the opportunity to meet with Appeals in this circumstance.

Another provision of the Taxpayer First Act, IRC 7803(e)(7)(A), grants taxpayers the right to their file 10 days in advance of a meeting with Appeals.  This provision has some income limitations but will generally benefit the vast majority of individual taxpayers.  It seems like a good step forward, though I would like the file much earlier than 10 days before the meeting, and I have had trouble getting it from Appeals in the past.  Some Appeals Officers (AOs) have denied my request for information in the administrative file, even though taxpayers have always had the right to this information.  If the case is in Tax Court, a Branerton letter to the Chief Counsel attorney will almost always result in that attorney calling the AO to tell the AO to send the material.  If you go to Appeals prior to Tax Court and have no Chief Counsel attorney to make this call, I wonder if the legislation will cause Appeals to take the position that a taxpayer cannot receive the material until 10 days prior to the meeting.  This would be a shame, because meetings are much more productive when parties can properly prepare.

The Taxpayer First Act also made changes to the ex parte provisions, set out in 7803(e)(6)(B), first enacted in 1998 as a means of insulating Appeals from the corrupting influence of other parts of the IRS.  The ex parte provisions were previously off-code but picked up by the IRS in a pair of Revenue Procedures describing how they would work.  The new provision allows Appeals to communicate with Chief Counsel’s office in order to obtain a legal opinion as it considers a matter, as long as the Chief Counsel attorney providing the advice was not previously involved in the case.  I don’t think this changes much.  Rev. Proc. 201218 already allowed attorneys in Chief Counsel to provide legal advice to Appeals.  Maybe this makes it clear that Appeals is not so independent that it cannot receive legal advice when it needs it, but it seemed that Chief Counsel and Appeals had already figured that out — even if some taxpayers criticized Appeals for obtaining legal advice.  Of course, when obtaining advice Appeals needs to seek out someone other than the attorney who was providing advice to Examination, in order to avoid having the attorney be the Trojan horse improperly influencing Appeals.

The panel mentioned Amazon v. Commissioner, 2019 U.S. App. Lexis 24453 (9th Cir. 2019). This is an important transfer pricing case clarifying what constitutes an “intangible” that must be valued and included in a buy-in payment to a cost-sharing arrangement between a parent company and its foreign subsidiary entity. The 9th Circuit panel affirmed the Tax Court, declining to apply Auer deference and holding that certain of Amazon’s abstract assets, like its goodwill, innovative culture, and valuable workforce, are not intangibles.

The committee also discussed Chief Counsel Notice CC-2019-006 “Policy Statement on Tax Regulatory Process” (9-17-2019).  A copy of the complete policy statement can be found here.   Each of the four points is important in its own way.  I find number three to be especially important.  We discussed the notice previously in a post here.

A few recent cases were mentioned as especially important to administrative practice:

Mayo Clinic v. United States, 124 AFTR2d 2019-5448 (D. Minn. 2019) provides the most recent interpretation of Mayo and what it means, in the context of whether Mayo Clinic was entitled to an exemption as an “educational organization” under Treas. Reg. § 1.170A-9(c).

Baldwin v. Commissioner, 921 F.3d 836 (9th Cir. 2019) is a mailbox rule case in which the taxpayer seeks to overrule National Cable & Telecommunications Association v. Brand X Internet Services, 545 U.S. 967 (2005).

Bullock v. IRS, 2019 U.S. Dist. LEXIS 126921 (D. Mont. 2019) is a pre-enforcement challenge to Rev. Proc. 2018-38 which relieves 501(c) organizations of the obligation to disclose the names and addresses of their donors.

Court Practice and Procedure Committee

Robin Greenhouse, who now heads Chief Counsel’s LB&I office, gave the report for Chief Counsel’s office.  She read from her notes and provided no PowerPoint presentation or handout material, so this time I cannot FOIA the PowerPoint presentation to provide the data.

She discussed two financial disability decisions which seems like an interesting place to begin.  First she mentioned Carter, as representative for Roper, v. United States, 2019 U.S. Dist. LEXIS 134035 at( N.D. Ala. 2019) in which the court determined that an estate cannot use 6511(h) to assert financial disability because an estate is not an individual.  I wrote a post on this case earlier in the fall.   Next she mentioned the case of Stauffer v. Internal Revenue Service, which I recently wrote about here.  I failed to make notes on the other cases she discussed and I cannot remember why.

Judge Marvel talked about the new Tax Court announcement on limited scope representation and the Chief Counsel Notice, CC-2020-001 on that issue.  During the first month of the fall Tax Court calendar four persons entered a limited appearance, including our own Christine Speidel.  The limited appearance ends when the calendar ends, making it not entirely clear what to do with a decision document.  Some suggested getting the decision document signed by the petitioner was the way to go.

So far the Tax Court has 18 pending passport cases.  Judge Marvel indicated that we might see the first opinion in a passport case soon.

Effective on September 30, 2019 the Tax Court has begun accepting electronic filing of stipulated decisions.  The practical effect of this is that because the IRS always signs the decision document last, it will be the party to submit the document.  I doubt this change will have a profound impact on Tax Court practice but, in general, more electronic filing is better.

Development of the Tax Court’s new case management system is moving quickly.  The court expects it to go online by Spring of 2020.  When implemented, this system will allow parties to file petitions electronically.  Judge Marvel expects that practitioners will like the new system.  The new system may allow changes to the public’s access to documents; however, whether and how that might happen is unclear.

Gil Rothenberg, the head of the Department of Justice Tax Division’s Appellate Section gave an update on things happening at DOJ.  He said there have been 75 FBAR cases filed since 2018 with over $85 million at issue.  Several FBAR cases are now on appeal – Norman (No. 18-02408) (oral argument held on October 4th) and Kimble (No. 19-1590) (oral argument to be scheduled) both in the Federal Circuit; Horowitz (No. 19-1280) (reply brief filed on July 18th) in the 4th Circuit and Boyd (No. 19-55585) (opening brief not yet filed) in the 9th Circuit.

Over 40 bankers and financial advisors have been charged with criminal activity in recent years and the government has collected over $10 billion in the past decade.  I credit a lot of the government’s success in this area to John McDougal discussed here but the Tax Division certainly deserves credit for this success as well.

DOJ has obtained numerous injunctions for unpaid employment taxes in the past decade.  It has brought over 60 injunction cases against tax preparers and obtained over 40 injunctions.  These cases take a fair amount of time and resource on the part of both the IRS and DOJ.  They provide an important bulwark against taxpayers who run businesses and repeatedly fail to pay their employment taxes.  Usually the IRS revenue officers turn to an injunction when the businesses have no assets from which to administratively collect.  We have discussed these cases here.  I applaud DOJ’s efforts to shut down the pyramiding of taxes.  Congress should look to provide a more efficient remedy, however, for addressing taxpayers who engage in this behavior.

He said that while tax shelter litigation was generally down, the Midco cases continued.  He mentioned Marshall v. Commissioner in the 9th Circuit (petition for rehearing en banc was denied on October 2nd) and Hawk v. Commissioner in the 6th Circuit (petition for certiorari was denied by the Supreme Court on October 7th).  We have discussed Midco cases in several posts written by Marilyn Ames.  These cases arise as transferee liability cases.  See our discussion of some past decisions here and here.  My hope is that the government will continue to prevail on these cases as the scheme generally serves as a way to avoid paying taxes in situations with large gains.  I wonder how many of these cases the IRS misses.

In Fiscal 2019 there were 200 appeals.  The government won 94% of the cases appealed by taxpayers and 56% of the cases appealed by the government.  I was naturally disappointed that he only talked about cases in which the government prevailed and did not discuss some of the larger losses such as the one in Myers v. Commissioner discussed here.

He briefly discussed the Supreme Court’s decision in Taggart v. Lorenzen, a bankruptcy case, in which the court held that the proper standard for holding the government in contempt for violating the discharge injunction required mens rea.  This followed the position of the amicus brief submitted by the Solicitor General. The Court declined to adopt the petitioner’s position, which would permit a finding of civil contempt against creditors who are aware of a discharge and intentionally take actions that violate the discharge order. The Court found this proposal to be administratively problematic for bankruptcy courts, distinguishing between the purpose and statutory language of bankruptcy discharge orders (which require mens rea) and automatic stays (which do not).

He ended by announcing that he will retire on November 1, 2019.

11th Circuit Reverses and Imposes an Injunction Against a Corporation for Failing to Pay

We have discussed before the increasing practice of the Department of Justice Tax Division to seek an injunction against an operating business that pyramids its tax liabilities.  Pyramiding is the term used for taxpayers who keep building higher and higher tax liabilities by failing to pay period after period.  Usually, it applies to a company that fails to pay employment taxes by failing to withhold the income and employment taxes from its employees and pay the taxes over to the IRS.  Pyramiding typically occurs when a company lacks sufficient cash flow but sometimes it results simply from greed and a belief that the IRS will not catch the person and make them pay.

If a company pyramids its employment taxes and the IRS has no practical means of collecting from the company, the IRS, many years ago, would shut the company down, or attempt to do so, by issuing levies or seizing property even though the company had no equity in seized assets or funds in the bank.  By seizing assets of the business the IRS could effectively close the business temporarily and that might cause it to close permanently.  Other levies would frequently stop suppliers from supplying or banks from lending even if they produced no dollar return.  The goal of these seizures and levies was not to get money but to keep from losing more money.  The practice of no equity seizures went away over 30 years ago.  After the demise of no equity seizures, revenue officers longed for a tool to shut down the taxpayers in situations in which the taxpayer continued to run up liabilities no matter what the revenue officer tried to do. 

Finally, the government, after many years of discussing the possibility, decided that it could bring an injunction action seeking to stop the pyramiding taxpayer from running up additional liabilities.  Doing this through an injunction takes longer and cost more money from the perspective of the time and effort of the Department of Justice trial attorney but can prove an effective method of shutting down a business that continues to ignore the requirement to pay payroll taxes.  In United States v. Askins and Miller Orthapedeatrics, D.C. Docket No. 8:17-cv-00092-JDW-MAP (11th Cir. 2019), the 11th Circuit agreed with the IRS that an injunction of the business was appropriate remedy to stop a business from continuing to incur employment taxes.  In ruling for the IRS, the 11th Circuit reversed the decision of the district court which had denied the IRS injunctive relief.  The case represents an important circuit level discussion of what the IRS needs in order to succeed in obtaining injunctive relief.

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 The business at issue was run by two brothers.  The brothers had caused the business not to pay its employment taxes, both trust fund and non-trust fund, since 2010.  The brothers also created trust and other entity accounts in order to hide the assets of the business.  In many ways the case read as a textbook case for a criminal prosecution against the brothers. A high percentage of injunction cases seem to fit the bill for criminal prosecution and DOJ does prosecute people for failing to pay employment taxes – something it almost never did three decades ago.  I do not know what causes the decision to fall into the injunction box rather than the prosecution box, but here the government chose the civil route.

The court described the situation as follows:

“The IRS has tried several collection strategies over the years. It started with an effort to achieve voluntary compliance: IRS representatives have spoken with the Askins brothers “at least 34 times” since December 2010, including 27 in-person meetings. Twice they entered into installment agreements that set up monthly payments to bring Askins & Miller back into compliance, but the company defaulted both times. Two other times, they warned Askins & Miller that continued noncompliance could prompt the government to seek an injunction.

The IRS has employed more aggressive means as well. It served levies on “approximately two dozen entities,” but most “responded by indicating that there were no funds available to satisfy the levies.” Three entities paid some money, but not nearly enough to satisfy Askins & Miller’s debts or to keep pace with its accrual of new liabilities. Additionally, the IRS’s ability to collect payments through levies has been hampered by the defendants’attempts to hide Askins & Miller’s funds and to keep the balances in Askins & Miller’s accounts low. Between 2014 and 2016, the Askins brothers transferred money from Askins & Miller to “RVA Trust,” which operates a private hunting club for the brothers, and “RVA Investments,” an accounting business associated with their father. The IRS also discovered additional accounts at BankUnited and Stonegate Bank. It did not seek to levy RVA Trust, RVA Investments, or the bank accounts because it discovered them after this case had been referred to the Department of Justice and because the IRS believed that “there is a substantial risk that any new levy would result in opening new undisclosed accounts and moving the money there.”

When the IRS finally gave up on its administrative collection efforts and referred the case to the Department of Justice for the pursuit of an injunction, it met another obstacle.  The district court denied the motion without prejudice finding the declaration conclusory, and finding that the proposed injunction was “effectively an ‘obey-the-law’ injunction.”  The IRS filed a new declaration with the district court trying again to convince it to enjoin the taxpayer’s actions.  The district court again reached the conclusion that the requested injunction served as an order to obey the law.  After the second attempt at the district court, the IRS appealed.  While the case was pending in the district court, the taxpayer ran up even more liabilities.

To obtain a preliminary injunction under “the traditional factors,” the IRS must demonstrate 1) a substantial likelihood of success on the merits, 2) that it will suffer irreparable injury unless the injunction is issued, 3) that the threatened injury to the IRS outweighs whatever harm the proposed injunction might cause the defendants, and 4) that the injunction would not be adverse to the public interest.  The district court noted that the parties essentially agreed that three of the four traditional elements for an injunction case were met by the facts of the case, but felt that the IRS could obtain a judgment for damages and, therefore, did not face irreparable injury.  The IRS argued that such a judgment was meaningless under the circumstances since it had exhausted its administrative efforts with its powerful administrative tools in trying to collect the outstanding debt.

Taxpayers raised a question of whether the closure of their business rendered the case moot.  The court went through a thorough analysis of factors of mootness factors and determined that remanding the case to the district court for a determination of mootness would serve no purpose but delay stating:

“Given the undisputed facts before us, we do not believe that the defendants can satisfy their “heavy” and “formidable” burden of making it “absolutely clear” that their behavior will not recur. And “we are unpersuaded that a remand would further the expeditious resolution of the matter.” Sheely, 505 F.3d at 1188 n.15 (conducting mootness analysis without remanding for further fact finding). The district court already concluded that the defendants have “a proclivity for unlawful conduct” and are “likely to continue ignoring” their tax obligations. The record demonstrates a near-decade-long saga in which the IRS has pursued Askins & Miller time and again. Over that time span, the defendants have funneled money to new accounts and entities as the IRS closed in on the old ones. For at least the time between November 2015 and mid-2018, Askins & Miller continued as a going concern despite reporting “no investments, no accounts or notes receivable, no real estate, and no business equipment.” Against that backdrop — and in light of the defendants’ admissions that Askins & Miller “continues to exist” and that one of the brothers continues to practice medicine — “we can discern no reason for sending the question of mootness back to the district court for further review or fact finding.” Id.

Then the circuit court moved on to examine the issue of whether the IRS had an adequate remedy of law.  Addressing that issue, the court acknowledged that it had not addressed the issue in its past ruling.  It found that prospect of even more losses in the future made a compelling case for granting the injunction stating:

“The fact that the IRS is attempting to avoid future losses is key. As the IRS notes, it “is an involuntary creditor; it does not make a decision to extend credit.” In re Haas, 31 F.3d 1081, 1088 (11th Cir. 1994). As long as the brothers continue to accrue employment taxes, the IRS continues to lose money. This sets the IRS apart from the position of other creditors (who can cut their losses by refusing to extend additional credit), and — crucially — means that the injunction sought is not simply an attempt to provide security for past debts. Rather, the proposed injunction here would staunch the flow of ongoing future losses as the brothers continue to accumulate tax liabilities — unlike in cases where the loss has already been inflicted or would be attributable to a single event, where we have stated that injuries are irreparable only when they “cannot be undone through monetary remedies.” E.g., Scott, 612 F.3d at 1295 (quoting Cunningham v. Adams, 808 F.2d 815, 821 (11th Cir. 1987)).

Indeed, the record and the district court’s own findings demonstrate that the government’s proposed injunctive relief is “appropriate for the enforcement of the internal revenue laws,” 26 U.S.C. § 7402(a), and that the government will likely suffer irreparable injury absent an injunction. Among other things, the district court noted that Askins & Miller had “a proclivity for unlawful conduct,” had “diverted and misappropriated” the employment taxes it had withheld from its employees’ wages, and was “likely to continue ignoring” its employment tax obligations. The IRS’s declaration demonstrates that, over a period of several years, it expended considerable resources making numerous — and unsuccessful — attempts to collect Askins & Miller’s unpaid taxes. And in the face of all that, as the declaration explained, Askins & Miller is effectively judgment-proof. In short, the record amply demonstrates that, absent the requested injunction, the government will continue to suffer harm from Askins & Miller’s willful and continuing failure to comply with its employment tax obligations — including lost tax revenue and the expenditure of a disproportionate amount of its resources monitoring Askins & Miller and attempting to bring it into compliance — and that, in all likelihood, the government will never recoup these losses.”

Having determined that the IRS did not have an adequate remedy at law, the circuit court ended by addressing the district court’s concern that the IRS merely sought an obey the law injunction.  Here, it stated that:

“Finally, the proposed injunction goes well beyond merely requiring compliance with the employment tax laws. In fact, it lists numerous concrete actions for the defendants to take — to name only a few, segregating their funds, informing the IRS of any new business ventures, and filing various periodic affidavits — well beyond what a simple “obey-the-law” injunction would look like. In short, this case does not raise the sort of fair notice concerns that Rule 65(d) is designed to address.”

The Askins and Miller case represents a major victory for the IRS.  The problem with pyramiding business taxes needs a solution.  After many years of floundering to find a solution, the IRS has combined with the Tax Division of the Department of Justice over the past decade (or more) to pursue injunctions against the most egregious taxpayers engaged in pyramiding in situations in which the decision is made not to prosecute.  This is a great development for everyone except the taxpayers who pyramid.  The government needs to aggressively pursue these taxpayers.  Doing so requires significant resources, but success can stop taxpayers who fail to pay year after year.  The 11th Circuit provides a great discussion for how to stop this action.  The effort expended in succeeding here shows the difficulty the government encounters as it seeks to stop this type of taxpayer action and the amount of resources it must expend to do so.

Who Owes the Tax – Blue Lake Rancheria

In the case of Blue Lake Rancheria Economic Development Corp. v. Commissioner, 152 T.C. No. 5 (2019) the Tax Court determined that only one of the two corporations against whom the IRS was pursuing collection owed the tax. I hope that we will one day receive a guest post from petitioner’s counsel, Bob Rubin, who started two weeks before me at Chief Counsel’s office in March of 1977 and occupied the office adjacent to mine, but in the meantime I want to write a short post to provide the facts and outcome on a case featuring the unique legal issues presented by tribal entities.

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The primary issue in this case focused on tribal law and the powers granted to corporations chartered under the federal statutes governing these entities. Blue Lake Rancheria Economic Development Corporation (BLREDC) is the real petitioner in this Collection Due Process (CDP) case and the parent corporation in the structure created by the tribe. The second corporation, Mainstay Business Solutions (MBS), presents as a subsidiary of BLREDC.

MBS ran an employment and temp agency. During and after the recession, it experienced significant business challenges and ultimately closed its doors. Before it closed up, it incurred huge 941 liabilities for failure to pay over employment taxes for numerous quarters. MBS agrees that it owes the money but that does the IRS little good since it has no assets. The IRS seeks to also hold BLREDC liable for the unpaid taxes and BLREDC has assets.

The IRS argues for the application of state law and under state law it would have a relatively easy time tagging BLREDC with the liability. BLREDC argues that state law does not apply. The court recites the relevant statutes and notes that although MBS is structured as a division of BLREDC the form of a division is a creature of federal, and not state law, created as a result of the issuance of a federal charter to the tribe by a federal agency in a dispute over federal taxes. Under the circumstances the court states that it fails to see why state law matters.

Next, the IRS argued that the power to create legally distinct corporate divisions is not an ordinary corporate power and, therefore, it follows that the granting of such a power is outside the scope of the federal statute. As with the first argument, the court disposes of this one noting that the federal statute at issue here grants broad authority. It rejects the narrow interpretation of the scope of authority available under the statute.

Additionally, the court notes that the canons of construction at play in this this situation favor the tribe. It cites to a couple of canons it deems applicable and points out that they call for interpreting statutes in a manor favorable to the interests of the tribe.

The court closes with the following quote:

The plain terms of IRA [the federal statute at issue here] sec. 17 clearly bestow broad discretionary power on DOI to issue Federal charters of incorporation to Indian Tribes. The powers that may be conferred on a tribal corporation under IRA sec. 17 are not limited to those held by State corporations nor are they limited by State law.

As a result the Tax Court determines that BLREDC does not share the employment tax liability with its former division. On the way to this result the court had also determined that BLREDC did not have a prior opportunity to contest the merits of the employment tax liability. The court also distinguished the case of First Rock Baptist Church Child Dev. v. Commissioner, 148 T.C. 380, 387 (2017), discussed in a prior post here, as it went through its analysis concerning its jurisdiction. The court also pointed out that this case involved employment taxes and not income taxes stating that a different analysis applied in the case of employment taxes.

The tribal law that underpins the court’s decision here will not come into play in most of the cases litigated regarding related corporations and their common liabilities for tax. For that reason this taxpayer favorable opinion here will not easily translate to more common situations. Tax practitioners who do represent tribal interests will find the opinion useful not only in the way the court approached its analysis of the statute but also because of the canons it applied. Congratulations to my friend Bob Rubin for winning an unusual case and providing PT with the opportunity to explore the intersection of tribal law and tax procedure.

TIGTA’s Report on the Growing Gig Economy

Today we welcome guest blogger Joseph C. Dugan. Joseph is a 2015 graduate of Indiana University Maurer School of Law. During law school, he coordinated IU’s IRS VITA program and worked part-time at a Low-Income Taxpayer Clinic. After graduating, Joseph clerked on the U.S. District Court for the District of Maryland and the U.S. Court of Appeals for the Seventh Circuit before assuming his present position as a trial attorney with the Federal Programs Branch of the Department of Justice, Civil Division. Joseph lives in Maryland with his wife and four-month-old son. Joseph writes in his individual capacity and does not purport to represent the views of the Department of Justice or any of its components.

 This post originally appeared here on the Surly Subgroup blog. We highly recommend adding it to your regular blog reads. Christine

On February 14, 2019, the Treasury Inspector General for Tax Administration (TIGTA) released a Valentine’s Day treat: a comprehensive report following a TIGTA audit concerning self-employment tax compliance by taxpayers in the emerging “gig economy.”

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As Forbes noted last year, over one-third of American workers participate in the gig economy, doing freelance or part-time work to supplement their regular incomes or stringing together a series of “gigs” to displace traditional employment. Popular gig services include ride-sharing giants Uber and Lyft; arts-and-crafts hub Etsy; food delivery services GrubHub and Postmates; and domestic support networks Care.com and TaskRabbit. Even Amazon.com, the second-largest retailer in the world and a traditional employer to many thousands of workers in Seattle and at Amazon distribution centers worldwide, has gotten in on the gig economy with its Amazon Flex service. And for those interested in more professional work experience to pad their resumes, Fiverr connects businesses with freelance copywriters, marketers, and graphic designers. The power of smartphones and social media, coupled with flat wage growth in recent years, makes the digital side hustle appealing and, for many households, necessary.

From a tax revenue perspective, the gig economy is great: it is creating billions of dollars of additional wealth and helping to replenish government coffers that the so-called Tax Cuts and Jobs Act (TCJA) has left a little emptier than usual. From a tax compliance perspective, however, the gig economy presents new challenges. Gig payers generally treat their workers as independent contractors, which means that the payers do not withhold income tax and do not pay the employer portion of FICA. Instead, the contractor is required to remit quarterly estimated income tax payments to the IRS and to pay the regressive self-employment tax, which works out to 15.3% on the first $128,400 in net earnings during TY2018, and 2.9% to 3.8% on additional net earnings. That self-employment tax applies even for low-income freelancers (i.e., it cannot be canceled out by the standard deduction or nonrefundable credits).

While the proper classification of gig workers is a legal question subject to some debate, platforms hiring these workers generally treat them as independent contractors. Taxpayers new to the gig economy and unfamiliar with Schedules C and SE may not be aware of their self-employment tax obligations. If they are aware, they may not be too eager to pay, especially if back-of-the-envelope planning during the tax year failed to account for this additional, costly tax.

In light of this emerging economic narrative and evidence that the portion of the Tax Gap attributable to self-employment tax underreporting is on the rise, TIGTA undertook an audit. TIGTA identified a population of 3,779,329 taxpayers who received a Form 1099-K (an information return commonly used by gig economy payers, as discussed below) from one of nine major payers between TY2012 and TY2016. The audit found that 25% of those taxpayers did not report income on either Schedule C (where self-employment income should be reported) or Form 1040 line 21 (where self-employment income is often incorrectly reported). The TIGTA audit further found that, after adjusting for taxpayers who filed Schedule C with a profit of less than $400 (who may not owe self-employment tax) and taxpayers who earned less than $400 on combined Forms 1099-K received by the IRS, 13% of taxpayers did not file a Schedule SE and did not pay self-employment taxes.

These TIGTA findings are revealing. As Leandra Lederman and I discuss in a forthcoming article, Information Matters in Tax Enforcement, there is a host of evidence that information reporting increases tax compliance. As a suggestive starting point, according to IRS statistics, the voluntary individual compliance rate for income subject to substantial information reporting is 93%, while the voluntary individual compliance rate for income subject to little or no reporting is under 37%. TIGTA’s report does not provide percentages that permit a direct comparison with overall IRS compliance estimates. However, the high rates of complete failure to report income tax and employment tax by gig workers receiving a 1099-K seem to suggest that the 1099-K requirement is not as effective as its drafters hoped. Given the transparency of the earnings to the IRS, a likely explanation for this failure is that some gig workers simply do not understand their tax obligations.

But there’s another problem: a substantial amount of gig income is not clearly subject to an information reporting requirement at all. Back in the day, if a payer hired an independent contractor and paid the contractor over $600 during the tax year, the payer was required under Code section 6041(a) and IRS guidance to file Form 1099-MISC, an information return that put both the IRS and the taxpayer on notice of the income. In 2008, however, Congress enacted Code section 6050W, which, upon its effective date in 2011, required “third-party settlement organizations” (TPSOs) to report payments on what is now Form 1099-K, subject to a generous $20,000/200 transaction threshold. A tiebreaker rule set forth in Treas. Reg. § 1.6041-1(a)(1)(iv) provides that a payer subject to reporting requirements under both Code section 6050W and Code section 6041(a) should comply with the former provision only. As a practical matter, this means that payers who consider themselves to be TPSOs (the definition of which is ambiguous and obviously drafted without reference to the emerging gig economy) can report payments for their higher-earning contractors while leaving contractors with under $20,000 or under 200 transactions invisible to the IRS. What are the chances that an Uber driver who earns a few hundred bucks a month in compensation for rides might genuinely, or conveniently, forget to report those receipts come tax time if she hasn’t received a 1099? Pretty good, if prior Tax Gap research is any indication.

My coauthor, Leandra Lederman, presaged some of the problems with Code section 6050W and Form 1099-K reporting in a 2010 article, in which she identified factors that inform the determination whether additional information reporting might be successful. As Leandra and I observe in Information Matters, Form 1099-K held little promise from the outset. And the problems inherent in the TPSO reporting regime have only worsened as the worker economy has transitioned more and more toward lean, diversified gigs.

As if all of this weren’t concerning enough, TIGTA also found serious problems with the way the IRS goes about assessing self-employment tax compliance. Due to resource constraints, the IRS’s Automated Underreporter (AUR) program, the first line of offense against noncompliant taxpayers subject to information reporting, only selects and works a fraction of returns flagged for discrepancies by the Information Reporting and Document Matching Case Inventory Selection and Analytics (IRDM CISA) system (an acronym that only a bureaucrat could love). The idea is for AUR examiners to focus on cases that may yield the highest assessments while also pursuing repeat offenders and providing balanced coverage across AUR inventories. Yet, even as the discrepancy rate involving Forms 1099-K issued by the nine gig economy companies at the center of the TIGTA study increased by 237% between 2012 and 2015, the AUR program selected just 41% of these cases for review.

That review is not necessarily robust. TIGTA found that, for TY2011 through TY2013, 57 percent of all self-employment cases selected to be worked by AUR examiners were screened out—that is, closed without further action. Yet for cases not screened out, 45% were assessed additional self-employment tax; and TIGTA estimates that about $44 million in further self-employment tax could have been assessed during TY2013 alone if the screened-out cases had been worked and resolved similarly to those that were not screened out.

TIGTA also found that, while the IRS has implemented several tiers of quality review within the AUR program, little action is being taken to identify and correct error trends, and the review processes themselves are prone to error and mismanagement due in part to a lack of centralized coordination. One unfortunate consequence of these shortcomings in the AUR program is that gig workers who are already confused about their obligations are receiving inaccurate CP 2000 notices (the standard notice that informs a taxpayer of an error detected through AUR). In fact, TIGTA estimates that the AUR program sent taxpayers 23,481 inaccurate CP 2000 notices about their self-employment taxes in FY2017. That error rate is not only bad for taxpayers, it is bad for the government: if self-employment tax is inadvertently omitted from a CP 2000 notice, as a matter of policy the IRS is generally unable to correct that omission even if the IRS later detects the mistake. That additional revenue is simply forfeited.

So, despite all its wonderful potential to increase both economic opportunity for hard-working Americans and access to valuable services for those willing to pay for them, the gig economy has created some new challenges for tax administration. Gig workers are unsure of (or noncompliant with) their self-employment tax obligations; gig payers are unsure of (or taking advantage of) their status as TPSOs; and the AUR program is not keeping up with the changing times. TIGTA proposes a host of corrective actions in the February 14 report, most of which the IRS has endorsed. Among these corrective actions, three that strike me as particularly important are Recommendation 3 (revise the Internal Revenue Manual to clarify those circumstances in which an AUR examiner should enter a note justifying a screen-out decision); Recommendation 10 (develop IRS guidance on how taxpayers should classify themselves under Code section 6050W); and Recommendation 11 (work with Treasury to pursue regulatory or legislative change regarding the Code section 6050W reporting thresholds). The IRS disagrees with Recommendation 10, asserting that the problem is better addressed through a Treasury Regulation than IRS guidance and complaining that the IRS is preoccupied with issuing guidance under the TCJA and reducing regulatory burdens pursuant to E.O. 13,789. That may well be the case, but revenues are being lost every year that gig payers and workers misunderstand, or misapply, their reporting and payment obligations. There is no reason to suppose that the gig economy will start contracting any time soon, so it would be prudent for the IRS and Treasury to allocate resources to address this problem expeditiously. (Yes, I appreciate that the IRS is chronically underfunded and forced to make very difficult choices about how to staff projects. This is a problem that Congress largely created and Congress alone can fix.)

Ultimately, the best course here might be for Congress either to tailor the definition of TPSOs to a narrower subset of payers for whom the higher thresholds actually make sense (e.g., platforms like eBay, whose casual sellers may not net any income through their online rummage sales) or to lower those thresholds to make gig earnings more transparent to the IRS. So long as we maintain the regressive self-employment tax, we ought to ensure that all taxpayers liable for the tax—even tech-savvy taxpayers Ubering their way through the emerging economy—pay their fare share.

Misclassified “Independent Contractor” Succeeds in Using Tax Code to Get Damages from Employer

We have nearly finished information return filing season. This is the time of year when Americans get their W-2s and 1099s, stuff them in folders and drawers, and hope that when it comes time to prepare their tax return they remember where the papers are. Information returns often lie forgotten until it’s time to answer questions from software prompts or from long-suffering preparers who play detective to ferret out a taxpayer’s economic life.  Some taxpayers can access their information returns seamlessly, but for most this is still a 20th century process that contributes to the huge costs of filing compliance. To be sure, information returns are the backbone of “voluntary” compliance—it is no surprise that when income is not subject to reporting taxpayers have a tendency to not include those items on their 1040s—and that will be true whether the 1040 is postcard size or in the form of a Hallmark Valentine’s Day card professing the IRS’s undying love for taxpayers who file and pay timely.

I digress—today’s post is about people who intentionally file incorrect information returns.

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We have discussed this issue before, and Stephen and I have just heavily tweaked this issue in the Saltzman and Book IRS Practice and Procedure treatise. The cases tend to crop up when someone seeks to make someone else’s life miserable by fling a phony return to generate IRS attention in the form of underreporting letters and possible tax assessments. What could be more middle-finger flipping then sending the IRS an information return showing a former partner or significant other with all kinds of income supposedly but not really earned?

To deal with this, Congress added Section 7434 which provides that

[i]f any person willfully files a fraudulent information return with respect to payments purported to be made to any other person, such other person may bring a civil action for damages against the person so filing such return.

There are a surprising number of interesting legal issues that spin off this provision. One of the issues concerns whether the statute provides a remedy for someone who is truly an employee but is treated as an independent contractor and who then receives a 1099-MISC rather than a W-2. The cases are split, some saying that the statute only provides a remedy when an improper amount is reported, and other courts holding that the statute provides a remedy for any fraudulent action in connection with the information return, including filing the wrong form. Another key issue that the courts are wrestling with is whether liability is limited to the person who was required to file the information return under federal law. For example, some courts have declined to find personal liability if the filer was not the party required to file the information return. See e.g., Vandenheede v. Vecchio, a 2013 case from a federal district court in Michigan declining to hold liable two co-trustees who prepared and caused a false information return to be filed on another’s behalf.

This takes us to a case from last year that I read as I prepare the updates for the next round of the treatise. The case is Czerw v Lafayette Moving and Storage. In the case, a federal district court in NY considered the claims of Joseph Czerw, who worked over twenty years as a mover for the same employer. In prior years, Czerw received W-2s and was treated as an employee, which was consistent with his actual arrangement with the employer. In 2015 his employer had major financial difficulties, with checks bouncing. Unlike in past years, when he got W-2s, for that year Czerw received a 1099-MISC for over $5,000. Not only was the information return the wrong type, but Czerw had only been paid about $4,000. Even though Czerw contacted his employer to get him to treat him as an employee and reflect the proper amount he was paid, his employer declined to fix things.

Czerw sued his corporate employer and Matthew Ferrentino, the corporation’s sole owner and president, alleging that his employer and Ferrentino had actual knowledge that a W-2 form was the correct form to submit and that the 1099-MISC reflected the wrong amount he received. Czerw alleged that the defendants willfully, purposely, and fraudulently filed the false Form 1099-MISC as part of a scheme “to defraud state and federal taxing authorities . . . by lessening [] Lafayette’s tax obligations and the amount of its worker’s compensation insurance premiums.” The complaint sought $5,000 in damages—the statutory amount provided in the absence of actual damages or discretionary legal fees.

The defendants defaulted, but before the court granted damages it had to explore whether the statute provided for relief in Mr. Czerw’s situation. The first issue the court considered was whether liability extended not only to the corporation but also to Ferrentino individually. The order briefly explores the split in cases on the issue, and lines up squarely with the cases that extend liability “on any person who willfully causes a fraudulent information return to be filed.” Thus it found that Ferrentino in his individual capacity was also potentially on the hook for damages.

As to whether section 7434 can be used in misclassification cases in the absence of an incorrect amount reported, the order notes that the law is developing on this issue. The court was able to avoid coming down on any side because the 1099-MISC that was filed overstated the amount that Czerw received:

As Plaintiff concedes, however, some courts have held that “§ 7434(a) creates a private cause of action only where an information return is fraudulent with respect to the amount purportedly paid to the plaintiff.” Liverett v. Torres Advanced Enter. Solutions LLC, 192 F. Supp. 3d 648, 653 (E.D. Va. 2016) (emphasis added). Under that interpretation, the statute “provides no remedy for a person incorrectly classified as an independent contractor.” Tran, 239 F. Supp. 3d at 1298. But because Plaintiff alleges that the Form 1099-MISC incorrectly states the amount paid to him, the second element is satisfied regardless, and the Court need not address whether the alleged misclassification supports a claim under § 7434.

Conclusion

Employee misclassification is a major issue. Employers who misclassify employees are failing to provide unemployment insurance and workers’ compensation. Those employers can also leave workers with large employment tax liabilities. Advocates who work in this field have Section 7434 as a possible mechanism to ensure fair treatment for workers and punish those who do the wrong thing. The Czerw order is helpful but as briefly reflected in this post there are some key legal issues that await further development.

 

 

 

 

 

 

Tax Court Judicial Conference Kicks Off Tonight: A Brief Take On Exotic Jurisdiction

Keith and I are both in Chicago to attend the Tax Court’s Judicial Conference. I am looking forward to seeing some old friends and colleagues, attending panels on a range of topics, and speaking on a panel with Keith, Nina Olson and Judge Peter Panuthos about the role that taxpayer rights play in representing taxpayers.

One of the panels I will attend is called “A Trip Through the Tax Court’s Exotic Jurisdiction.” I am especially looking forward to that, as I have been writing lately about the role that administrative law generally and the APA in particular plays in cases that are not traditional deficiency cases. Last week in updating the Saltzman Book treatise as part of our regular three times a year update I have revisited Kasper v Commissioner, a case we on PT discussed briefly when it came out and which is one of the more interesting procedure cases of the past year. As readers may recall, that case held that the standard of review in whistleblower cases is arbitrary and capricious and the scope of that review is limited to the administrative record.

In reaching its conclusion, Kasper revisits and places in context the Tax Court’s approach in other cases that are not traditional deficiency cases. Tax procedure can be complex enough when dealing with straightforward deficiency cases (consider for example the Borenstein case that PT discussed which Keith and Georgia State Tax Clinic Director Ted Afield have just filed an amicus brief that looks at an odd situation when a taxpayer filed an original return with a refund claim just prior to filing a petition). Congress over the past few decades has added to the Tax Court’s basket a number of other types of cases, including the whistleblower provisions Kasper addressed, CDP which 20 years on still presents a steady stream of tough issues (see Lavar Taylor’s latest guest posts on alter egos) and the rules relating to employment tax determinations under Section 7436.

All of this is preface for a recent Program Manager Technical Advice  that discusses the limits of Section 7436. Readers may recall that 7436 provides that the Tax Court has jurisdiction to determine in employment tax audits whether someone is properly classified as an employee or whether the employer is entitled to so-called 530 relief (essentially a safe harbor allowing escape from liability if certain conditions are satisfied). There have been a bunch of interesting procedural issues spinning off 7436; for example I discussed last year the Tax Court order that concluded that Section 7436 did not provide it jurisdiction to determine whether an S corp’s wages were artificially low:

Section 7436(a)(1) only confers jurisdiction upon this Court to determine the “correct and the proper amount of employment tax” when respondent makes a worker classification determination, not when respondent concludes that petitioner underreported reasonable wage compensation, as is the case here.

The PMTA involves a similar legal issue in a different context. In the PMTA, the IRS considered a non-US corporate taxpayer with a US Sub. The overseas parent sent its employees into the US to provide computer and engineering services to US clients. The overseas parent paid the employees for the engineering and computer work they did in the US. The overseas parent did not withhold on the payments it made to its employees for the work those employees performed in the US, essentially arguing that it was not engaged in business in the US and was able to rely on statutory and regulatory exceptions on overseas employers who have temporary employees working in the US and who earn limited salaries (while some treaties have specific rules on this the PMTA indicates that the parent resided in a jurisdiction that did not have a treaty with the US).

IRS examined and concluded that the parent should have withheld on the wages that were paid to its employees. The PMTA concludes that its conclusion regarding the withholding liability would not be a determination under 7436 and the parent was not entitled to go to Tax Court:

[T]here is no dispute that the [nonresident alien(NRA) parent corp] performing computer and engineering services on behalf of the foreign corporation are employees, that the services were performed within the United States, and that such NRAs received compensation from the foreign corporation for those services. Rather, the foreign corporation is asserting that it is not liable for income tax withholding because it was not engaged in a trade or business within the United States. This argument is not based on a position that the NRAs are not employees. Thus, there is no actual controversy over the worker classification of the NRAs. Rather, the foreign corporation’s disagreement is premised on the position that the NRAs are employees, but that because the employees worked for a foreign corporation while temporarily in the United States and were compensated less than a threshold amount the foreign corporation did not have a trade or business within the United States

Conclusion

Of course the IRS does not get to decide the contours of the Tax Court’s jurisdiction but as the PMTA discusses IRS employment tax audits can raise issues not squarely within the language of 7436. Absent Tax Court jurisdiction, taxpayers can get court review in the federal district courts or the Court of Federal Claims. That comes after assessment, and some payment of the tax, triggering other issues and perhaps more litigation costs.

NTA’s Reaction to Today’s Post on Misclassified Workers

Keith’s post this morning referenced the National Taxpayer Advocate Nina Olson’s blog post discussing the Mescalero case; her office reached out to us to provide some additional information that she had intended to share in a future blog post of her own.  Below is the latest, straight from the NTA:

After my blog posted, an analyst from TEGE contacted my senior research advisor, asking how we had come up with the estimate that it took only 1 or 2 hours to identify the workers and their tax payments.  My research advisor explained that there is a systemic way of searching and compiling the records.  Apparently the IRS had been searching each worker’s record manually, which took hours and hours…..This made me feel very sad, because clearly this analyst cared deeply and wanted to do the right thing.

It appears to me that the CCA may have been driven by the IRS’s concerns that is it “did not have the resources” to do these manual searches.  My office has committed to working with TEGE to show them how to do systemic searches, and then my office will go back to Chief Counsel and ask them to reconsider its CCA.

What is most disturbing about all this is that no one took seriously enough the taxpayer’s right to pay no more than the correct amount of tax, such that someone would think to explore whether there was a systemic way to pull this information.  This shows that there is still much work to do to embed the Taxpayer Bill of Rights in every aspect of IRS activity.

Thanks to the NTA for reaching out to Procedurally Taxing, and allowing us to publish her views.

For an index to all of the NTA’s blog posts see here

The NTA plays an important role in highlighting when tax administration neglects to take into account fundamental taxpayer rights, as well as highlighting ways that tax administrators can embrace and promote those rights.

Relatedly, the NTA is convening the third international taxpayer rights conference in the Netherlands on May 3rd and 4th. I attended the first two conferences, and I learned a great deal about tax administration generally and how other countries (and the US) are faring in incorporating taxpayer rights into all facets of tax administration. Information about the conference, including an agenda and registration, can be found here.

Misclassification of Workers and its Aftermath

Last spring we reported on the Tax Court decision in Mescalero Apache Tribe v. Commissioner, 148 T.C. No. 11 (2017), in which the Tax Court determined that the taxpayer could obtain information about tax reporting by its former employees. The tribe did not classify these individuals as employees during the period of employment; however, the IRS determined that the individuals who worked for the tribe were employees and not independent contractors. Where an employer has misclassified its employees, the employer is liable for certain taxes that would have been paid through proper withholding of employees unless the employer can show that the employees paid the taxes.

The tribe tried to track down the employees to determine if they properly reported the taxes. It could not reach most of them and sought through discovery in Tax Court to find out from the IRS whether the employees paid. The IRS resisted citing the disclosure provisions; however, the Tax Court ordered the IRS to turn over information which would allow the tribe to calculate its liability after taking into account the employee payments. This post is about the rest of the story because, not too long after the opinion came out, the IRS issued CCA 201723020 limiting the scope of the opinion in the view of Chief Counsel’s office. For those interested in this issue, you should also look at the blog post by the National Taxpayer Advocate on this subject.

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The CCA takes the position that a taxpayer that has misclassified employees cannot obtain information about the employees from Exam or Appeals but can only obtain the information through the discovery process in court. In a resource starved agency, it seems counterproductive to drive taxpayers into court just to obtain information that will allow the taxpayer to determine the correct liability. No one has this information other than the IRS and the individual employees who are typically scattered to the wind. If the misclassification only involves one or two employees, maybe the employer can readily find the misclassified employees; however, if the number of employees is substantial the employer will almost certainly encounter problems tracking down the all of the employees at the time of the misclassification. The CCA will cause employers in these larger cases to petition the Tax Court just to use discovery.

The opinion provides that:

“It is important to note that the court’s determination that the workers’ return information was discoverable was based largely on the representation by the Tribe that it has already made a significant effort to locate the workers and that it had failed only with respect to a relatively small number.  It is also important to note that IRC 6103(h)(4) authorizes disclosure, but does not require it; thus the court’s determination that the workers’ return information “is disclosable under section 6103(h)(4)(C)” does not create a requirement that the Service disclose the information.

Thus, Mescalero does not stand for the proposition that taxpayers and/or their representatives are entitled to workers’ return information during the conduct of an employment tax audit or at the Appeals consideration level. Instead, the Mescalero decision is limited to discovery requests made by a taxpayer during the pendency of a Tax Court proceeding, where the Tax Court has the ability to determine hether the requested information is disclosable pursuant to IRC 6103(h)(4), AND has balanced the relevancy of the requested information against the burden placed on the Service pursuant to Tax Court Rules 70(b) and 70(c).”

Since section 6103(h)(4) permits disclosure, it seems a better way may be to give the information to taxpayers at the examination level but charge them for the cost of obtaining the information so that the IRS is not the loser in this situation. Charging a reasonable search fee allows the taxpayers to obtain the information early in the process, saves resources of both parties inherent in the use of Appeals and the Tax Court. The decision expressed in the CCA makes a loser out of everyone when a much easier solution seems available. The National Taxpayer Advocate is rightfully critical of the decision in her blog post. Once the attorneys in Chief Counsel’s office opine that the decision to disclose is up to the IRS and not barred by section 6103, the door is open for the IRS to make a reasonable decision. The path suggested in the CCA should be ignored by those entrusted to administer the law.