Summary Opinions for June

Before covering the June tax procedure items we didn’t otherwise write on, I wanted to highlight that Keith was quoted in a Seattle Times’ article about the IRS/Microsoft litigation, where MS is questioning the length of its audit and the Service’s hiring of Quinn Emanuel to investigate its tax obligations.  Other tax procedure luminaries Stuart Bassin (who is working with Les on rewriting part of SaltzBook addressing disclosure litigation) and Professor Andy Grewal (a PT guest poster) were also quoted.   Keith’s last post on the topic can be found here, where he discusses Senator Hatch’s letter to the Commissioner questioning the use of an outside law firm on audits.

  • The 2015 IRS annual Whistleblower Report to Congress was released in June and can be found here.  In 2014, the Service paid out around $52MM in awards, representing about 17% of the tax it claims was collected due to WB’s information.  Submissions to the WB group were up in 2014, with over 14,000 claims being filed.  Of those, about 8,600 were opened.  The report paints a slightly rosier picture of the program than what may be practitioners’ perceptions of the program.  It does note issues with taxpayer confidentiality, and whistleblower protection. The report also provides a spreadsheet of the reasons for closing cases and the time most cases have been in the program (which tends to be fairly long).
  •  This Tax Court case has a fair amount of tax procedure packed into it.  In Webber v. Comm’r, the Court found a taxpayer had retained control and incidents of ownership over life insurance held in a trust, which caused some negative tax  consequences.  In coming to this determination, the Court found that the IRS Revenue Rulings dealing with the “investor control” doctrine were entitled to Skidmore deference under the “power to persuade” standard.  The Court also found reasonable cause due to the taxpayer’s reliance on his advisor.  In the case, the advisor was an expert and was paid hourly to review the transaction, and had the pertinent information.  We just wrote this case up for SaltzBook, so I won’t go into too much detail (don’t want to give all the milk away, as we definitely want to keep selling cows).
  • Agostino & Associates has published its July Monthly Journal of Tax Controversy.  Frank and his associate Brian Burton have a nice piece on the public policy of OICs.  As always, it is interesting and essentially a mini law review article.
  • BMC Software v. Comm’r is a Fifth Circuit case we (I) missed in March that was potentially significant in how closing agreements are interpreted.  Miller & Chevalier’s Tax Appellate Blog has coverage here.  The facts are fairly specific, and the applicable Code sections do not pertain to many taxpayers.  What is important is that the Fifth Circuit reversed the district court, and held that the boilerplate in the opening paragraph stating, “for income tax purposes” did not cause the agreed treatment of a tax item for one purpose as applying for all purposes under the Code.  The Court would not read that into the agreement of the two parties, who had meticulously spelled out the specific tax treatments for one purpose.
  • Another case with multiple interesting tax procedure items.  In Riggs v. Comm’r, the Tax Court ruled on 1) whether a bankruptcy stay for the taxpayer’s successor-in-interest applied to the taxpayer, and  2) whether the IRS had to follow the taxpayer’s instructions about which debts its payment should be applied to when the Bankruptcy Court directed the payment generally.  As to the first point, the court found there was not sufficient “identity between the debtor and the [taxpayer] that the debtor may be said to be the real party defendant”, so the stay did not apply.  As to the second point, the Court found the payments were not voluntary, and therefore it did not have to follow the taxpayer’s instructions under Rev. Proc. 2002-26.  I would assume the Court would have specifically directed the payment application in the order had it been requested.
  • Hard to talk to an accountant these days and not discuss the tangible personal property change of accounting method.  The Service has provided additional time to file Form 3115 and modified some procedures.  See Rev. Proc. 2015-33.
  • For those of you who do work with Section 6672 penalties, you know the definition of willfulness and actually running a business can be in conflict.  Often, a business that is light on cash has to make a decision about which bills to pay, and sometimes the business thinks that suppliers need payment to keep product flowing.  If a responsible person makes such a decision and knows the withholding taxes are delinquent, Section 6672 penalties will almost certainly apply.  See Phillips v. US, 73 F3d 939 (9th Cir. 1996).  The Court of Federal Claims had occasion to review one such case in Gann v. US, and dismissed the government’s motion for summary judgement.  It held that determining when and whether the responsible person had knowledge of the company’s failure to pay taxes was a disputed issue of fact.  The Court found that simply showing that cash inflows and outflows indicating someone wasn’t going to get paid weren’t enough for summary judgement, and some level of actual knowledge was needed by the responsible person.  There was also some question as to whether the person was a “responsible person”, which was covered by Professor Timothy Todd on Forbes and can be found here.
  • Another attorneys’ fees case that probably would have ended differently had the client made a qualified offer.  In Mylander v. Comm’r, the Tax Court found that the taxpayer prevailed in the amount in controversy and the most significant issue, but the Service’s position was substantially justified.  The reasoning for this was because the case was complex and the taxpayer didn’t share all relevant facts or the case law for their claims.  I’m not sure how I feel about the complexity aspect or the onus being on the taxpayer to provide the applicable law  to the Service.  If the taxpayer’s position was clear, and reasonable research could have turned up the correct law, it seems unfair to make the taxpayer outline all relevant cases.  I hope those were only considered in conjunction with the missing facts, and wouldn’t have been sufficient on their own.  The Court did also mention that the current case was arguably distinguishable from the applicable prior holdings, so the Service’s position could have been somewhat reasonable no matter what.  All of this probably wouldn’t have mattered if the taxpayer had taken advantage of the qualified offer provisions (although if you make an offer, and fail to provide the IRS with the facts and the law, can you still prevail?).
  • SCOTUS has denied cert for Ford in its interest payment case involving the treatment of an advanced remittance.  Les has blogged this case twice before, most recently here.  In addition to the interest question, there was also a jurisdictional issue about whether the district courts could hear an interest disagreement or if it had to be determined by the Court of Federal Claims.  Les’ post outlines the issue and eventual court holding.
  • In Slone v. Comm’r, The 9th Circuit has decided another case on the two prong test necessary to establish a transferee is liable for the predecessor’s tax liability.  The court remanded for the tax court to review the transaction as to the first prong on federal law, but also held that the Service had to show it was a fraudulent transaction under the federal law and also had to independently show that the transferee was liable under the applicable state law.  This holding is in line with the various other recent cases, including Stern, Salus Mundi, and Diablod, which we most recently covered here.
  • Would you like to know how to file delinquent FBARs and not pay a penalty (i.e. are you mega rich and hiding money in some country with shady banking laws)?  Well, this probably doesn’t apply to you because you likely did not pay the tax due on those assets.  For those folks who paid the tax, but inadvertently failed to file the FBAR the IRS has issued updated guidance on filing late without penalties.
  • A res judicata case, which should have a familiar name for tax procedure junkies.  In Batchelor-Robjohns v. US, the 11th Circuit held the feds were barred by res judicata from raising the dead taxpayer’s income tax issues in an income tax audit when the same issue was previously litigated in an estate tax refund relating to same issue.
  • Just about a year ago, we covered Heckman v. Comm’r, where the Tax Court found the six year statute of limitations under Section 6501(e)(1)(A) applied to ESOP distributions that were not properly disclosed.  The Eighth Circuit has affirmed that ruling.  This is the link to the prior SumOp where we discussed the case.  In Heckman, the courts (Tax Court & 8Th Cir.) declined to incorporate other related entity returns to show disclosure for the individual’s return of the ESOP distribution.  It is interesting to compare that language to CNT Investors, another recent Tax Court statute of limitations case, which seemed to indicate the tax court would consider all the filings of the taxpayer and his related entities.  Although the tones are different, I do not think the holdings are necessarily in conflict.  In Heckman, there was not much disclosed that would adequately apprise the Service of the connection.  In CNT, a few key items were left off, but overall the filings painted a fairly full picture.

Summary Opinions through 02/20/15

A special thanks to our frequent guest blogger, Carlton Smith, who over the last few weeks has provided us with quite a few posts.  Les, Keith and I have been extremely busy with various projects, which Carl knows, and he offered to do some extra writing to ensure the blog had quality content over that period. The posts have all been wonderful, and we are indebted to him for that.

Before getting to the other tax procedure, we wanted to provide an interesting update on a case we have been following.  Frequent readers of our blog are familiar with our coverage of the Kuretski case, which questioned the President’s power to remove Tax Court judges under Section 7443(f). As Mr. Smith stated in his December 2nd post on the topic,

This past June, the D.C. Circuit ruled that there was no separation of powers issue because (1) the Tax Court, while defined as an Article I (Congressional) court in section 7441, was really, for most constitutional purposes, an Article II Executive Agency exercising executive functions, and (2) there is no problem in the President, who heads the Executive Branch, ever having the power to remove officers of an Executive Agency.

The taxpayer has filed for cert., which has not yet been reviewed.   Miami attorney, Joe DiRuzzo (who seems to get his hands on cases with most interesting procedure issues), in late December and early January, filed Kuretski-like motions in various Tax Court cases appealable to various Circuits asking the Tax Court to declare the 7443(f) removal power unconstitutional.  In a couple of those cases, the Service was given a healthy amount of time to respond, until March 9th.  The Service has requested another sixty days to coordinate its response at the highest levels of Counsel’s office (not a direct quote, but pretty close–we can provide a copy of the motion, if you are interested).  That is a lot of time to coordinate a response, and it would be reasonable to assume this has something to do with what is or is not happening with the Kuretski.  I’m sure we will have continuing coverage as this moves forward (or doesn’t move forward).

To the other procedure:

  • Agostino & Associates have published their February 2015 Newsletter.  It is great, as normal, and congrats to Jairo Cano on being named a Nolan Fellow!  I particularly liked the first part of the article regarding the “Service’s Duty to Foster Voluntary Compliance Through IRC Sections 6014(a) and 6020(a).”
  • Do you hate it when your clients fail to pay your bills? Want to stick it to them, and force them to pay tax on the discharge of that indebtedness by issuing a Form 1099-C.  OPR thinks that might reflect negatively on your character and fitness to practice before the Service.  OPR did not provide an opinion, but found that only an “applicable entity” had to file such a form, which is defined as various government entities, “applicable financial entities” or other organizations that engage in lending.  Further, whether a debt can be discharged is a question of fact, and it “generally occurs when a taxpayer receives funds that are not includible in income, because the taxpayer is obligated to repay the obligation,” not when there is a disagreement about fees for services owed.  OPR stated that if a practitioner was not following these substantive rules, that could be problematic for the practitioner under Circular 230, as the practitioner would have a duty to know those laws before issuing an IRS form.  See in particular Circ. 230, Section 10.22(a).
  • The District Court for the Western District of North Carolina, in Carriker v. United States, has partially dismissed an accountant’s attempt to collect attorney’s fees for the accountant defending his CPA license before a state board that he claimed was related to an IRS controversy.  The Court found these were not proceedings “by or against” the United States under Section 7430.  Similarly, the Code did not provide for fees for the accountant’s time helping his lawyer on the project.  The claims related to fees for the underlying IRS controversy were not dismissed.
  • The Service issued a taxpayer favorable PLR on seeking discretionary relief for late recharacterization of a Roth IRA conversion back to a normal IRA in PLR 201506015.  Under the PLR, the taxpayer converted his IRA to a Roth, and a few weeks later invested in a company on his financial advisor’s advice.  That company, through other investments, either stole or lost the money, and fraudulent provided incorrect statements regarding the investment’s value.  Because of this, the taxpayer had no reason to recharacterize his IRA back to a Roth.  After the period for making such an election, the taxpayer found out about the fraud.  Taxpayers are, under certain circumstances, allowed to convert their traditional IRA to a Roth IRA.  This requires the taxpayer to pay the income tax due on the distribution, but no penalty.  If the value of the account decreasing significantly immediately after the conversion, taxpayers may want to recharacterize and obtain a refund of the tax due.  There are certain time limits within which the election must be made.   Under Treas. Reg. § 301.9100-3(b)(1), the Service has discretion to allow late relief in certain circumstances.  One of which is when the taxpayer “failed to make an election because, after exercising due diligence, the taxpayer was unaware of the necessity for the election.”  The Service found the fraud caused the taxpayer to be “unaware of the necessity for the election” and allowed the late election.  This is arguably a broad, taxpayer friendly, view of when a taxpayer will be aware of something and what is a necessity.
  • The Service has issued its internal guidance regarding Letter 5262-D in estate and gift audits.  This guidance discusses how the auditor should handle a case that was not settled based on how cooperative the taxpayer was.  It covers when a 30 day letter can be issued, how additional information must be requested, and when a 90 day letter must go out.  If you don’t respond to those IDRs, you are probably getting a ticket to Tax Court.
  • Next time the ABA Tax Section meets in San Francisco, we may need to take a field trip to the bar from this next case.  In Estate of Fenta v. Comm’r, the Tax Court found the taxpayer was not entitled to litigation and administrative costs, as the IRS was substantially justified (too bad, because I think the fees would have gone to a low income taxpayer clinic).   The action in this case surrounded the Lakeside Lounge, which might be this joint.  The Lounge appears to be a dive bar, that earned a substantial portion of its income from the sale of booze, largely in cash transactions.  In a fact pattern that would not be surprising to any IRS agent, it was believed that the bar was not reporting all of its income.  Below is a quick note on how the Service calculated the deficiency and on why no costs were awarded.

The taxpayer wasn’t excited to hand over the books and records, and after a few summonses, the Service determined the business was not keeping adequate books and records.  Using the invoices for the alcohol purchased by the bar, the Service applied the “percentage-markup” analysis (which the California taxing authority had previously used) to determine the under reporting of the income.  This is one of the methods used by the IRS during audits of cash intensive businesses – here is a portion of the IRS’ audit guide on the topic.  For bars, this is calculated by taking “liquor purchases divided by average drinks per bottle times average price per drink with allowance for spillage.”  There are a lot of things practitioners and the Service can quibble about in this calculation.  The Service issued its notice of deficiency, and the taxpayer petitioned the court.  Prior to a hearing, the matter was largely settled and a stipulated settlement was filed with the court.

In the instant case, it does not appear a qualified offer was made, so the Tax Court did a Section 7430(c)(4)(A) review to determine if the taxpayer substantially prevailed.  In this case, the Service largely argued that it was substantially justified in its position because Mr. Fenta failed to provide various receipts until after he filed his petition.  Once the Service received those items, it settled.  The Court agreed with the Service.  Interestingly, the Court did not indicate whether the Service argued that the settlement precluded fees.  I was too lazy (busy) to pull the briefs to see if the Service did not argue the same or if the Court found it more appropriate to only discuss the substantially justified argument.

  • The First Circuit, in In Re: Brian S. Fahey, consolidated four cases, all with the same question, which was:

whether a Massachusetts state income tax return filed after the date by which Massachusetts requires such returns to be filed constitutes a “return” under 11 U.S.C. § 523(a) such that unpaid taxes due under the return can be discharged in bankruptcy.

The Court, joining a recent Tenth Circuit decision, held “we conclude that it does not.”  The Court found persuasive the holding in Mallo v. Internal Revenue Service, where the Tenth Circuit held late filed returns were not returns for the applicable paragraph in the bankruptcy code.  Keith had a great write up of Mallo found here (comments are worth a review also).

  • From the Federal Tax Crimes Blog, Jack Townsend discusses the DOJ press release regarding another plea deal for a UBS client.  Jack quotes the release and then covers his thoughts, which are insightful, as always.  Great point about the taxpayer’s lie to the Service in a meeting potentially extending the statute on the underlying crime (and being a crime itself).

Summary Opinions for 1/6/15-1/23/15

Les and Keith ditched me for the end of last week, while they both attended the ABA Tax Section Meeting (much more on that to come).  Thankfully, Carlton Smith provided two guest posts.  One was on unpublished CDP orders and how those can implicate substantive and other important procedural matters, and a second on his victory in the Volpicelli equitable tolling case out of the Ninth Circuit.  Thanks again to Carl for both of those and a big congratulations on the important victory.

To the other procedure:

  • A couple cases on administrative costs are first up.  First Milligan v. Comm’r, where the IRS clearly did a poor job handling the taxpayer’s appeal, filing it incorrectly, not acting promptly (probably being difficult to contact), and requiring the Taxpayer Advocate to intervene.  Based on Section 7430(f)(2), the Tax Court correctly held that the IRS CP 2000 notice and Letter 105C denying the refund were not the “position of the United States” as required under the statute.  For the statute, the “position” only arises under a notice of decision by Appeals or the notice of deficiency.  Prior to that date, the IRS’s position and actions don’t count for fee shifting, and fees are not available.
  • Switching to a taxpayer win, the District Court for New Hampshire in United States v. Baker held that the Service was not substantially justified in its position that an ex-wife’s real estate was subject to a lien from her ex-husband’s tax liability because the divorce decree (and/or deed) was not recorded transferring the property to the wife pursuant to the divorce (which occurred before the lien arose).  We covered the underlying case in SumOp last year here.  The District Court found the position was contrary to the First Circuit’s law on the topic and awarded costs to the real estate owner.
  • Moving to a different topic, Steven Mopsick published “IRS to Issue More Tickets to the Tax Court in 2015” on LinkedIn and his blog last week, which discusses changes to Letter 5262.  Mr. Mopsick indicates that the changes to the document make it clear that if a taxpayer isn’t prompt in following requests for information (Form 4564), the taxpayer will no longer be able to remove the issue to Appeals in nondocketed cases, and will instead get a 90 day letter directing him to the Tax Court (where he could go to Appeals, but as a docketed case).  I have not looked into this further than Mr. Mopsick’s post.  In the post, it seems to indicate this is being done to reduce the Appeals backlog.  If this is correct, it will be interesting to see if there is an increase in small tax court cases over the next year or two, and a corresponding decrease in Appeals cases.  If, however, Appeals cases decrease, while Tax Court filings remain the same, it may indicate many taxpayers are not receiving review that they otherwise may have obtained.  Given the frequency with which the IRS is incorrect and Appeals high success rate in settling matters (when someone can actually review the matter), this would be unfortunate.  It would be interesting to see how often Form 4564 is issued, in what types of matters, and for what income groups.  Similarly, it would be interesting to see who is not responding.
  • The District Court for the Western District of Wisconsin has tossed a complaint by the Freedom from Religion Foundation (I wonder what percentage of its constituents are ten year old kids who don’t want to go to church every Sunday), which sought to block the IRS from granting churches and religious organizations exemptions from reporting requirements under Section 6033.  FFRF claimed that the Code section violated the establishment clause and the equal protection clause.  FFRF lost a similar case in November of 2014 regarding parsonage allowances.  The District Court, largely following the 7th Circuit, found that FFRF did not have standing, as it had never sought the exemption.
  • The Tax Court, in Lee v. Comm’r, denied the government’s motion for summary judgment on a taxpayer’s challenge to its lien imposition for failure to serve letter 1153.  The Court stated that whether the letter was served was a subject to a genuine dispute as to a material fact, and, further, whether the letter was properly issued was  a requirement of the statute that the Court would review regardless of whether the taxpayer raised the issue in his CDP hearing.
  • Last year, SumOp covered the Julia R. Swords Trust v. Comm’r, a Tax Court case discussing transferee liability and declining to apply the federal substance over form doctrine to recast a transaction being reviewed under Section 6901.  The case, and various related cases, have been appealed by the Service to the Sixth Circuit.  In December, the trustees were successful in moving venue to the Fourth Circuit.  The Sixth Circuit found both circuits could be the appropriate venue.  The Court noted the Service sought review in the Sixth Circuit because it had not held on the underlying question (at least not against the Service).  Most of the action in the case had occurred in Virginia (not in the Sixth Circuit). The deficiency notice was issued in Virginia and the tax court petition was filed in Virginia, where the case was decided.  The Court noted that the Service conceded venue was appropriate in the Fourth previously, but that did not preclude venue in other locations; however, the trustees had relied upon the venue statement in filing their petitions to the Tax Court.  As such, it found the Fourth circuit more appropriate.  This could be a slight blow to forum shopping for the Service, and perhaps taxpayers.  I couldn’t find the case for free on line. Sorry.
  • The University of South Dakota has a football program!!!!!  I had no idea – It is DI also. The program seems pretty terrible at football, but apparently some of its former players are really good at committing tax fraud.
  • Jack Townsend’s Federal Tax Crimes Blog has the creepiest headline of the year, Foot Kissing Chiropractor Sentenced for Bribing IRS Agent.  I have two takeaways from the post. First, don’t try to bribe the IRS, you will probably go to jail.  Second, don’t try to bribe the IRS after admitting to being a weirdo, you will go to jail, and all kinds of news outlets and bloggers will circulate posts about you for the world to see.
  • In what appears to be a really terrible case, the district court for the Southern District of Ohio has upheld delinquency penalties against an estate for failure to timely file and pay estate taxes in Specht v. United States.  The executor of the estate was a high school educated homemaker who was around the age of 73.  She did not own any stock, and had never been to a lawyer.  When her cousin died, she retained her cousin’s lawyer, Mary Backsman, who had been an estates lawyer for decades and was well respected.  Ms. Backsman was also suffering from brain cancer at the time, and did not disclose this to the executor or various other clients.  The attorney claimed to be doing various tasks, including obtaining extension of time to file and pay tax.  She also claimed to be contacting UPS for assistance in selling a large amount of UPS stock, and handle various other requirements.  None of these tasks were actually done.  Eventually, the executor realized, and fired the attorney and sued her for malpractice.  Unfortunately, the attorney had similar issues with various other clients.

The executor hired a new attorney, filed the estate tax return, and paid all tax due.  The IRS imposed a huge amount of penalties and interest. Due to the above facts, the executor argued the failure to file was due to reasonable cause and not willful neglect.  Unfortunately, based on Treasury Regulation 301.6651-1(c)(1) and Boyle, the executor had not exercised ordinary business care, as reliance on an attorney to file does not remove the executor’s obligation to ensure the return is timely filed and the tax paid.  The Court stated the executor did not need to be an expert to determine the due date.  I’ve shared my frustration with this line of cases repeatedly in the past, but I do somewhat understand why the rule is crafted in this matter.  I would be interested to know how the malpractice case panned out.  The coverage may have a maximum payout amount, and if there were a bunch of these cases, the various clients could be dividing up a limited pie.  In theory, the executor could be held liable to the beneficiaries for anything not recouped.  Any result where the executor ends up responsible seem completely inequitable to me.

  • I’m not a fan of Hartland Management Services Inc. v. Comm’r either, which is a recent Tax Court case reforming a Form 872 that the IRS screwed up.  Just when you think you get lucky, with the IRS completely blowing something, the Tax Court comes in and bails them out.  Without getting too far into the facts, the taxpayer and various entities were being audited for multiple years.  During the audit, the Service needed to extend the statute for assessment to continue discussing the matters.  On the Form 872, the Service included the extended date as the date of the return being extended (so the form effectively extended the statute for assessment on a return that wouldn’t have been filed yet or would never be filed).  The Service and the taxpayer continued to discuss the matter, and eventually the Service assessed tax.  The taxpayer contested the validity of the assessment, because the Form 872 did not state the year of assessment.  The Court found a mutual mistake of fact, which was evidenced by the taxpayers’ actions before and after the signing of the Form 872.  Because of the mistake, the Court reformed the document to extend the appropriate year.  I wonder if the taxpayers had contemporaneous notes indicating they were happy to sign because of the IRS error, and then immediately ceased negotiations if the Court would have held differently.  Then it would have arguably just been an IRS error.  Although I’m not sure I can create a winning legal argument against this holding, it does seem there are a lot of situations where a taxpayer could make a similar error, which was accepted by the IRS, that would never be reformed to save the taxpayer.  For those interested in learning more about this topic, Saltzman and Book touches on contract principles applicable to Form 872 in the newly rewritten Chapter 8.08[4][b].

Summary Opinions for 12/19/14 to 1/05/15

Back in the saddle after quite a few weeks off.  Holidays, home renovations, and the passing of my maternal grandfather (phenomenal guy, who will be incredibly missed by everyone who knew him) took priority over blogging.  SumOp isn’t usually that time sensitive though, so we can pack three weeks into one post.

Here are the items we found interesting that we didn’t otherwise cover over:

  • Let’s start off with Jack Townsend’s Federal Tax Crimes blog, and his post on Muncy v. Comm’r, which can be found here.  This Muncy is a gentleman who was not fond of following tax laws, and not the quaint town in north central Pennsylvania where I lived as a teenager.  Leroy Muncy created some type of fake employment agency and amazingly convinced his employer to pay his wages to this fake company in an effort to stop paying employment taxes.  I would guess he ran inflated expenses through the company to decrease his income taxes also, but that is just speculation.  When his fake employment company concept failed, he claimed he was a “sovereign living soul”, not subject to the rules of his home state of Arkansas or the United States of America. The civil court found he had failed his sovereign citizenship test (because it is made up and never recognized as a valid argument). Fast forward a few years, and there was criminal tax restitution and a potentially larger civil liability outstanding.  The Tax Court discussed the new legislation allowing immediate tax restitution on the criminal amount, and the issues that could cause in requiring a notice of deficiency for the full civil amount (which includes the criminal restitution amount).  Jack discusses the issue and provides his thoughts in the post.
  • Chief Counsel determined that employment tax liabilities and worker classifications were not partnership items under TEFRA, as they were items imposed and determined under Subtitle C, whereas TEFRA partnership items are those found under Subtitle A.  See LAFA 20145001F.  This general position has been stated before.  For an interesting discussion regarding this topic, and when related items of income may require TEFRA proceedings see CC Memo 200215053.
  • The Service shared its international tax training materials, which are found here.  There is a lot of material, and I have not gotten through it all yet.  The Service did caution that such training does not constitute pronouncements of law, and cannot be relied upon…but it will show how your agent will be approaching your audit.  Some of the units provide good overviews, while others dig down into specifics, like “Disposition of a Portion of an Integrated Hedge.”  My wife literally fell asleep when I was explaining that unit to her (or pretended to be asleep so I would stop talking).
  • The Fourth Circuit, in Wolff v. US,  in early December had a bankruptcy holding that I doubt is breaking new ground regarding preferential transfers (see Begier v. IRS. 496 US 53, cited by the 4th Cir.), but I hadn’t reviewed a case on the specific matter before.  The issue and holding, as outlined by the Court were:

whether the trustee in bankruptcy may reclaim as property of the debtor the approximately $28 million transferred by the debtor to the IRS during the 90 days preceding the filing of the bankruptcy petition. We agree with the bankruptcy court and the district court that, as a matter of law, the debtor lacked an equitable interest in the funds paid over to the IRS, and therefore we affirm the judgment.

The Fourth Circuit found that the property lacked the prerequisite of being the debtor’s property, because under applicable state law it held the funds in express trust and had no interest in the assets or discretion to use those funds for anything other than paying the government.

  • In US v. Titan International, the Service sought to obtain enforcement of its summons looking for the company’s 2009 airplane flight logs and general ledger in connection with its 2010 audit.  The taxpayer objected, as the Service has previously audited its 2009 return, and reviewed the requested documents. The taxpayer attempted to rely upon Section 7605(b), which generally states taxpayers do not have to hand over their books and records multiple times for the same year.  In Titan, the IRS argued it needed the documents to verify a 2010 deduction, and did not intend to review 2009 again.  The Court found the testimony and reasoning of the Service valid, and enforced the summons. This drives me crazy also (especially when they ask for the return), though the law (as Titan explains) gives the Service quite a bit of leeway to examine records from a previously examined year if the records relate to another possible year’s liability.
  • “Double-D Ranch” seems like a place in Nevada my wife would be very upset to find credit card receipts from, but it was apparently a far less seedy tax shelter for the one-time American Home Products (Wyeth) owner, Albert Diebold.  The Ninth Circuit found that shareholders, here the Salus Mundi Foundation, were responsible for a corporation’s taxes based on the state fraudulent conveyance statute and the transferee liability rules. See Salus Mundi Foundation v. Comm’r.   Peter Reilly has coverage at Forbes, where he loops in Frodo Baggins, all the tax shelter goodness, and the Diebold family history, found here.  If this all sounds familiar, it’s because the Second Circuit reviewed the exact same facts in Diebold Foundation v. Comm’r from 2013, which the Ninth Circuit looked to in its holding.
  • Southern District of Mississippi denied the Government’s motion to dismiss a taxpayer’s son’s action for quiet title on property the IRS was trying to foreclose its liens upon for the father’s taxes based on nominee theory; the Government argued that Sections 6325(b)(4) and Section 7426(b)(4) relating to some expedited lien remedies were the only remedies available to the taxpayer.  The Court in US v. McFarland disagreed, holding those were available remedies, but did not foreclose a quiet title action under 28 USC 2410.
  • In Larry J. Austin v. Comm’r (there was a Larry P. Austin case decided a few days later by the Tax Court – little confusing), the IRS prevailed in showing it was substantially justified in its position regarding foreign interest on accounts held in the name of the taxpayer, even though the interest was not actually taxable to the taxpayer.  Although the taxpayer prevailed on the item and amount in controversy, and met the financial thresholds for fees, the Service position was reasonable enough to prevent the imposition of costs.  A qualified offer was presumably not provided in this matter; although, there was a stipulated settlement, so the Service could have argued the concession was not the taxpayer prevailing, perhaps making such an offer useless.  We’ve discussed that before here and here (and I don’t like the court holdings very much).
  • John Doe is apparently involved in shipping, not just banking.  The DOJ has issued summonses to FedEx, DHL, and UPS to obtain information about clients who may be facilitating illegal activity resulting in tax fraud.  Robert Woods at Forbes has coverage here.

Is There a Future Role for Circular 230 in the Internal Revenue Service’s Efforts to Improve Tax Compliance?

In this post, Michael Desmond of the Law Offices of Michael J. Desmond discusses recent judicial developments highlighting limits on IRS and Treasury’s authority under Circular 230 to regulate aspects of practitioner conduct. The post explains the connection between the IRS’s efforts to use Circular 230 in a more muscular way and its lack of resources. The post comes on the heels of a panel presentation at the ABA Tax Section this past month in Denver where Mike, Stuart Bassin and Professor Steve Johnson appeared on a panel of the Standards of Tax Practice Committee. Les

This is a reposting of this article because something in our software prevented the article from going out on Wednesday.  The article is super and we wanted to make sure that all of our email subscribers got it in addition to those coming to the website.  Keith

In 1984, the Treasury Department and the Internal Revenue Service (“Service”) first amended Circular 230 to target practice standards on “tax shelter” transactions. Since then, Circular 230 has been amended on a number of occasions. Many of these amendments have refined the focus of Circular 230 on new generations of aggressive tax planning through, for example, the much-maligned and now repealed “covered opinion” rules in former section 10.35. Other amendments have addressed more mundane aspects of practitioner conduct ranging from the fees that can be charged to a practitioner’s ability to endorse refund checks and the failure by a practitioner to file a client’s tax return electronically. A common theme reflected in these changes is the use of Circular 230 as a tool to improve compliance, as distinguished from the more general role of fostering good practice standards.

The 30-year evolution of Circular 230 and, more broadly, the Service’s effort to use Circular 230 as a tool to improve compliance, has recently been called into question. The D.C. Circuit’s opinion earlier this year in Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014) was the first shoe to drop. Loving has been discussed extensively in recent months and is noteworthy not only for the fact that it upheld the District Court’s order enjoining the Service from implementing key components of its highly publicized and far reaching return preparer initiative, but also because it marked the reversal of a prior leaning in the courts to uphold the Service’s authority to regulate a broad range of conduct under Circular 230. While Loving raises fundamental questions about what role Circular 230 will play in the Service’s enforcement toolbox going forward, it also highlights shortcomings with other tools in that box, which may be the better place to focus going forward.


Legal Challenges to Service’s Authority to Regulate Practice

Prior to Loving there had been only a handful of court challenges to the scope of the Service’s authority to regulate “practice” under 31 U.S.C. § 330. In Tinkoff v. Campbell, 158 F.2d 855 (7th Cir. 1946), the appellant was a disbarred attorney who moved into the business of “advising taxpayers in filling out income tax returns.” Enforcing the limited practice rules under Circular 230 (currently found in section 10.7(c)), the Service prohibited the appellant from representing taxpayers in a non-legal capacity, “explaining adjustments and computations in their returns” and “accompanying them upon interviews” in connection with an audit of their return. The Seventh Circuit had little trouble dismissing the appellant’s constitutional challenge to the Service’s authority to regulate his return preparation “practice” under Circular 230: “We find no merit whatsoever in any of the contentions raised by appellant and are fully in accord with the District Court in dismissing the petition for injunction.” Id. at 856.

Sixty years later, in Wright v. Everson, 543 F.3d 649 (11th Cir. 2008), the Eleventh Circuit rejected a challenge to the Service’s refusal to allow, under Circular 230, an “unenrolled” return preparer to represent taxpayers through use of an IRS Form 2848 Power of Attorney. In Wright, the court framed the issue as whether the practice limits applicable to unenrolled preparers were “arbitrary, capricious, or manifestly contrary to statute” (a Chevron “Step Two” inquiry), without questioning the Service’s threshold ability to regulate “practice” under 31 U.S.C. § 330 or the scope of its authority under that statute. The Eleventh Circuit in Brannen v. United States, 682 F.3d 1316 (11th Cir. 2012) similarly had little trouble finding authority for the Service to require return preparers to obtain registration numbers, distinguishing what was then the district court’s holding in Loving by citing the specific statutory authority under Code section 6109 for requiring preparer identification numbers. Tinkoff, Wright and Brennen were not cited by the D.C. Circuit in Loving. While not involving the Administrative Procedure Act arguments at issue in Loving, the trend seen in those prior cases to uphold the Service’s broad authority to act under 31 U.S.C. § 330 was nonetheless reversed.

The Service did not seek en banc review or certiorari from the Supreme Court in Loving. Rather, the Service indicated that it would follow the Court’s holding narrowly and not apply its interpretation of the terms “practice” and “representatives” in 31 U.S.C. § 330 to other aspects of Circular 230. In other words, while Loving may have enjoined the Service from mandating testing and continuing education for paid return preparers, its holding would not be applied to other provisions of Circular 230 that also purport to regulate conduct not involving direct interaction with the Service.

The Service’s effort to limit Loving lasted less than six months. In July 2014, the U.S. District Court for the District of Columbia issued its decision in Ridgely v. Lew, 2014 U.S. Dist. LEXIS 96447 (D.D.C. July 16, 2014), enjoining the Service from enforcing the limitation on a practitioner’s ability to charge a contingent fee for “ordinary refund claims” in Circular 230 section 10.27. In doing so, the court rejected the government’s effort to distinguish Loving on the basis that the plaintiff was a practicing CPA who, at some point in his career, had had direct interaction with the Service even if not in connection with the contingent fee arrangements at issue. The Service has long relied on (and continues to rely on) this “once a practitioner, always a practitioner” position as a jurisdictional hook for Circular 230.   (n.b., in the IRS Form 2848 Power of Attorney and Declaration of Representative released in July 2014, the Service now requires that practitioners affirmatively declare that they are “subject to regulations contained in Circular 230.” The Form 2848 previously required only that practitioners declare they were “aware” of the regulations.).

The government did not appeal Ridgely and has since stated, consistent with its reaction to Loving, that it will apply the holding in that case narrowly. William R. Davis, ABA Meeting: OPR Will Narrowly Apply Ridgely, 2014 TNT 184-11 (Sept. 23, 2014 (quoting IRS Office of Professional Responsibility Director Karen Hawkins as saying “I am going to treat Ridgely the same way I treated Loving, which is I’m going to stick to the issue that was decided and the dicta is very colorful but it is not law.”). The Service has, however, yet to confront or develop a response to the basic rationale of Loving: That a person’s conduct in assisting taxpayers in any manner that does not involve direct interaction with the Service does not constitute “the practice of representatives of persons before the Treasury Department” within the meaning of 31 U.S.C. § 330(a). While some have pointed to the Service’s authority under 31 U.S.C. § 330(b) to regulate “incompetent” or “disreputable” representatives, or to the “nothing shall be construed to limit” language of 31 U.S.C. § 330(d) which applies to the rendering of certain written advice, the Service’s authority under those provisions is far more limited than under 31 U.S.C. § 330(a).

Were the logic of Loving and Ridgely to be extended, not only is the Service’s ability to regulate paid return preparers under Circular 230 limited or non-existent, but the vitality of other “non-practice” provisions in Circular 230 has also been called into serious question. If the Service cannot regulate return preparation because it does not constitute “practice” before the Treasury Department, where is its authority to promulgate the “due diligence” standards applicable to communications between practitioners and their clients under Circular 230 section 10.22(a)(3)? To promulgate the standards applicable to advice with respect to documents submitted to the Service other than tax returns under section 10.34(b)?  To enforce the “written advice” standards in new section 10.37? Or to promulgate numerous other provisions in Circular 230 that purport to regulate conduct not involving direct interaction with (or “practice” before) the Service? As a practical matter, there may be little incentive for a practitioner to challenge the Service’s authority to enforce these provisions, at least through an injunction action similar to Loving or Ridgely. If a practitioner were to be sanctioned by the Service under any of these “non-practice” rules, however, it is easy to see a judicial challenge to their validity in a district court appeal of an administrative law judge’s final determination upholding that sanction. And under Loving and Ridgely it is easy to see that challenge succeeding.

Why the IRS Attempted to Use Circular 230 to Regulate Preparers: Resource

While Loving and Ridgely provide an interesting look at the application of the Administrative Procedure Act to tax administration, their holdings—and the potential for a broad extension of their holdings—begs the question of why Circular 230 evolved into a enforcement tool targeted at “tax shelters,” “covered opinions,” contingent fee arrangements and other real and perceived compliance problems in the first place. The holdings similarly beg the question of why Circular 230 was chosen as the vehicle through which the Treasury Department and the Service would subject hundreds of thousands of paid return preparers to mandatory competency testing and continuing education requirements.   A report from the Treasury Inspector General for Tax Administration (“TIGTA”) released on September 25, 2014, helps to highlight an answer: resources.

Apart from Circular 230, the Service has unchallenged authority to regulate the conduct of paid return preparers and others who assist taxpayers in complying with the tax law (or not complying with the tax law, as the case may be) through a broad range of civil and criminal provisions in the Code. These include the preparer penalty provisions in Code sections 6694 and 6695, the penalty for promoting abusive tax shelters under Code section 6701 and the civil injunction provisions in Code sections 7407 and 7408. To enforce these provisions, however, takes a commitment of significant resources. After identifying the bad actors and developing an administrative case against them (itself a resource-intensive effort), the Service can be dragged into protracted litigation in seeking to obtain a court injunction or in defending its penalty determinations against a challenge brought by a preparer or practitioner who is highly motivated to clear their name or delay imposition of an inevitable sanction.

Notwithstanding the wide range of tools that can be used against problematic preparers, the recent TIGTA report found that the Service failed to follow up on more than one third of preparer conduct referrals, most of which were from internal sources within the Service. The TIGTA report references a prior report, which evaluated the Service’s inability to timely respond to thousands of other referrals that are submitted each year on IRS Form 14157, mostly by taxpayers who have been victimized by unscrupulous or fraudulent preparer conduct. Rather than build an entirely new regulatory regime under the questionable authority of 31 U.S.C. § 330 at a cost estimated to be up to $77 million annually, could that same $77 million could be targeted at the thousands of preparer conduct leads that seem to go unopened each year?

The problem, of course, is that committing resources to enforcing existing law must come from the Service’s general enforcement budget, an area that Congress has been moving down on its funding priority list. Using Circular 230 as the vehicle for regulating paid return preparers and “practitioner” conduct more generally sidesteps this problem because, as originally envisioned, the $77 million cost would be self-funded through user fees imposed on all (or most) practitioners. Legislative proposals authorizing the Service to regulate paid preparers (which would address the holding in Loving)similarly envision a user-fee regime to sidestep the funding problem. See Tax Return Preparer Accountability Act of 2014, section 3, H.R. 4470 (113th Con., 1st Sess.).

The funding problem raises the larger policy question of why such a basic tax enforcement issue as regulating paid return preparers should be funded by a user fee, a question the courts might have an opportunity to consider in the context of a pending challenge to the remains of the preparer user fee regime. The politics of that question extend beyond this posting, but they will have to be addressed if there is to be any comprehensive response, legislative or otherwise, to Loving and the largely unchallenged proposition that paid return preparers should be subject to broader oversight than current law appears to permit.

Summary Opinions for 9/19/14


Another great tax procedure week.  We have news on two (alleged for one) celebrity tax cheats.  More importantly, the Tax Court issued another qualified offer holding regarding concessions, and one on what constitutes a prior opportunity to dispute a liability when the Service denies such a request.  Plus a handful of other tax procedure matters, and an interesting case on when the proceeds from suing your accountant will not be taxable income.

  • The Tax Court, in Bussen v. Comm’r, had another holding on whether a full IRS concession is tantamount to a settlement for purposes of qualified offers under Section 7430(c)(4)(E)(ii)(I).  For those of you unfamiliar with the issue, I wrote on it in the infancy of PT here , and Keith followed up with an excellent post focusing on interesting issues in the Knudsen appeal.  A full concession by the Service during the pendency of the court case has been held to both be a settlement and not a settlement in the past, although the majority of the holdings appear to be leaning towards concessions being settlements.  I am not sure I agree with the holdings, and think it advances a Service-favorable policy that is contrary to the statute, allowing the Service to go well beyond the ninety day qualified offer period and still thwart fees.  Unfortunately, Bussen is a terrible fact pattern for the taxpayer.  In Bussen, the taxpayer withheld the information from the Service that it needed to make its determination.  The Service requested the information repeatedly.  Only after filing with the court did the taxpayer provide the information, and the Service promptly conceded.  This is not the type of case where the taxpayer equitably seems entitled to costs.  Jan Pierce of Lewis and Clark Law school, who knows as much on this topic as just about anyone, also noted that in Bussen the Service conceded before the actual trial, where in other cases, notably Knudsen, the Service waited until after the trial.

 Given the bad facts, if a court were inclined to hold concessions were not settlements, perhaps an appropriate holding in Bussen would have been a limiting of the “reasonable administrative costs”  and “reasonable litigation costs” because it was unreasonable for the Bussens to protract the process and not provide the requested information-thereby making the costs unreasonable and not appropriately payable.   Keith also noted that the statute specifically provides that a prevailing party that unreasonably protracts the proceedings will not be entitled to costs.  See Section 7430(b)(3).

  • In Johnson v. Comm’r, the Tax Court offered an interesting discussion of what constitutes a prior opportunity to dispute a liability.  In a prior CDP hearing, the settlement officer affirmatively told the taxpayer he could not challenge amount or existence of the underlying liability in connection with an unclaimed notice of deficiency.  In a subsequent CDP hearing, the taxpayer was denied the opportunity to question the amount or existence of the underlying liability because he may have had the right in the first hearing and did not challenge the settlement officer’s preclusion.   It is hard to find that the second settlement office abused his or her discretion, but the Service did bar the taxpayer from contesting the underlying liability when it perhaps was allowed, leaving a somewhat inequitable result.
  • Not exactly tax procedure, but the Tax Court, in Cosentino v. Comm’r,  has held that malpractice proceeds received by taxpayers from their accountants was not taxable income.  The accountants assisted the taxpayers in the disposition of some rental property pursuant to a bunk plan that increased basis somehow offsetting boot received in a 1031 exchange.  The plan was disallowed, and the taxpayers paid tax on the gain (or at least the boot).  The taxpayers sued their accountants for bad advice, and were made reimbursed for the tax paid.  The Service took the position this was taxable income, while the taxpayers argued they would have otherwise done a 1031 exchange with no boot, thereby not recognizing the gain.  The Court agreed that the malpractice proceeds were a return of capital and not taxable.
  • In Dynamo Holdings, LP v. Comm’r, the Tax Court has allowed the IRS to use predictive coding in digging through very large quantities of electronic documents to determine what is and what is not privileged and relevant to the IRS discovery requests.  We may have more on this in the future, so I won’t delve too much into the topic.  And, my knowledge of coding is about as strong as Keith’s knowledge on the Jersey Shore (I would say Les also, but I think he secretly loves that show)…more on that below.
  • In the most recent celebs behaving tax badly, the Situation has ended up before a judge on tax evasion charges(Keith was not familiar with the Situation’s work, and is on a Jersey Shore binge this weekend after completing some amazingly long MS bike ride ).  Sometimes you just completely misjudge a celebrity.  I was certain that Mike “the Situation” Sorrentino was smart enough not to get embroiled in tax evasion, he just seemed to have such a good head on his shoulders.  TMZ (I am starting to question the amount of times we have referenced them) reports that the Sitch is blaming his business manager, who is, of course, his brother, and claiming he knew nothing of his finances (sort of believable).  His Bro, in turn, is blaming their accountant.  The NY Times reports (now I feel slightly better about covering this) the indictment was based on the Situation and his brother running personal expenses through their pass through entities to reduce their taxable income, including personal grooming expenses (appropriate tanning salon and hair gel jokes are made).  All of which may have been hidden from the accountant.
  • In the immortal words of just about every rapper ever, “I gotsta get paid”, and, as such, I’m a pretty big fan of Section 6323(b)(8) giving lawyers a super priority in settlement provisions for reasonable compensation in obtaining the settlement.  The Eastern District of Louisiana recently reviewed this provision in Barnett v. D’Amico.  Although the case did not break any new legal ground, it did provide an outline for the reasons behind the priority and what lawyer fees could be deemed to relate to the settlement (and were reasonable), and which advances were properly made under Louisiana law and could be part of the priority lien.

Summary Opinions for 08/29/14

photoAfter a great summer, I’m feeling a little old, with my youngest daughter starting kindergarten this week!  I don’t have a Facebook account, so I will subject the PT readers to my sentimentality and photo sharing.  This melancholy did not prevent me from pulling together a bunch of interesting tax procedure material from last week that we did not otherwise cover.  SumOp this week touches are some really interesting bankruptcy matters, and some PT favorites, such as extended statutes of limitations for understating income and for preparer fraud, preparer reliance for penalties, and obtaining fees and costs from the Service.

Before getting to those materials though, I would encourage you all to check out Wednesday’s lead Tax Notes article regarding the Tax Court’s electronic access to documents, in which Keith Fogg is quoted extensively.  You can find the article here (sorry, TNT subscription required).

And now to the tax procedure:

  • The Tax Court, in Barkett v. Comm’r, held that the reported taxable gain by the taxpayer and not the gross amount realized by the taxpayer was the applicable amount for determining if the reported amount understated the gross income by more than 25% for purposes of the extended six year statute of limitations under Section 6501(e)(1)(A).  The taxpayer argued that the gross amount of sale value reflected on its original return should have been the number considered when comparing the reported amount against the actual gross income, and the instructions to the regulations stating otherwise were thrown out under Home Concrete.  The Court found that was not the case, and even if it were, that would not necessarily overturn various prior Tax Court rulings on the subject matter.
  • We’ve previously touched on whether a return preparer’s fraud, or an agent’s fraud, extend the statute of limitations with coverage on BASR, Citywide, and Allen.  Les had an excellent post on this topic last October.  BASR is currently up on appeal in the Federal Circuit.  Briefing has occurred, and Jack Townsend has summarized the positions here.
  • Last week, the Service released CCA 201434021, which provided guidance on when a withholding agent may obtain late documentation to indicate a foreign person was entitled to the portfolio interest exemption for withholding.  E&Y has an extensive background write up found here.  Sections 1441 and 1442 require withholding agents to withhold 30% of interest, dividends, rents, or other fixed periodic payments made to foreign persons from US sources.  There are various exceptions, including interest on portfolio debt obligations.  The regulations under Section 871 allow for evidence of qualifying for the portfolio interest exception to be offered during any period where the refund statute is open (three years from date return is filed, or two years from date tax is paid).  In one of the scenarios, one of the foreign persons had not paid over any tax, nor filed a tax return, so the time frame for providing the documentation had not run, thus allowing the withholding agent to avoid liability if the documentation is provided at any point. This is a taxpayer and withholding agent friendly position.
  • In Wright v. Comm’r, the Tax Court held that  taxpayers did not show reasonable cause in relying on an opinion letter from an attorney who the Court determined not have experience in the area the opinion letter covered, and found it important that the letter was contingent on the taxpayers signing the “Investor Representations,” which was never done.  The taxpayers’ estate planning attorney also reviewed the materials, and indicated it seemed reasonable.  It was not clear if their accountant also reviewed the transaction, but the Court did indicate that the taxpayers failed to show reliance on the estate planning lawyer or the accountant.  The failure to sign the investor representations is highlighted as a major issue, but I would think it wouldn’t matter much if the practitioner clearly had expertise and the position was defensible.  I would also note, the Court did not provide much guidance on how the taxpayer should or should not have known the attorney would not be competent.  It simply indicated he lacked experience in the particular area of tax.  Prior experience is not the only way to gain competency in many matters.  I do not doubt the Court was correct, and this may have been a clear case of rubber stamping a BS tax shelter for all I know, but his having no prior experience shouldn’t automatically disqualify a practitioner.
  • In Swiggart v. Comm’r, the Tax Court found the taxpayer was the “prevailing party” under Section 7430 and allowed to recover litigation and administrative costs.  Underlying matter was whether or not the taxpayer was entitled to file as head of household, which the Service initially disagreed with because the taxpayer did not indicate who the individual was that allowed him to file as HoH.  The taxpayer had an agreement with the child’s mother, whereby he waived any claim for the year for the dependency deduction, so he had not listed the child, but that did not disallow the HoH status.  After an administrative appeal, the taxpayer went to the Tax Court, where he and the Service entered into a stipulated settlement agreement whereby the taxpayer prevailed.  The Court found the taxpayer was clearly the prevailing party, and, importantly, the Service was not substantially justified in its position (clearly contrary to the statute).  Although not directly on point, this initially brought my mind to the situation where the Service concedes litigation when a qualified offer has been made, which we have discussed here.  There the Service took the position that did not make the taxpayer the prevailing party, and therefore not entitled to costs.
  • The Second Circuit had an interesting bankruptcy holding in United States v. Bond.  The holding related to the jurisdiction of the bankruptcy court to review a liquidating trustee’s refund claim, reversing the bankruptcy court and the district court which held the claim could be reviewed.  The Second Circuit stated that Section 505 of the Bankruptcy Code allowed refund suits in bankruptcy court after a refund claim was filed with the IRS by the bankruptcy trustee.  The Second Circuit found the liquidating trustee who was a representative of the bankruptcy estate appointed under the reorganization plan was distinct from the bankruptcy trustee, and therefore not entitled to bring the claim.  The Second Circuit did note the assignment of the claim and the appointment of the liquidating trustee were both appropriate, but that did not change the fact that the bankruptcy trustee had to bring the claim with the Service.  Had that occurred, the liquidating trustee could have brought the suit through the bankruptcy court.
  • Sticking with bankruptcy, the Tenth Circuit has affirmed the district court and bankruptcy court holding that a taxpayer who entered into some bu!!$h*! tax shelter willfully attempted to evade taxes and therefore could not discharge the liability under Chapter 11 pursuant to Section 523(a)(1)(C) of the Bankruptcy Code.  Jack Townsend  has a post on the case on his federal tax crimes blog, and Keith will hopefully be posting something on this soon (which will show that this blurb is slightly misleading…and that this case also involves ex-spouses benefiting over the Service…which leads us to the next case).
  • Would you propose a divorce to get around tax or an IRS lien (you might have to be clairvoyant, and move quickly before tax was assessed)?  How far would you go to prove it wasn’t a sham?  Dating other people?  I’m pretty confident my wife is not down with that plan.  Folks have divorced to reduce their taxes in the past, but I have not seen it suggested that a divorce could have been a sham simply to get around an IRS lien, until US v. Baker.  Neither the Court nor the IRS actually indicated the Bakers’ divorce was a fraudulent sham to get around the liens, but the Court did indicate that a sham divorce, pursuant to which property was transferred, would not be respected.  In Baker, the Service did argue that the failure to record the divorce decree resulted in transferred real estate owned by the ex-wife was subject to the ex-husband’s IRS lien.  The Court disagreed based on an interpretation of New Hampshire law which allows the divorce decree itself, without further recording, to serve as a transfer of the property.  Because the divorce decree was entered prior to the assessment date, no property of the taxpayer existed at the time of the creation of the federal tax lien, following assessment, notice and demand and failure to pay, to which the federal tax lien could attach.
  • The law firm Paul Hastings has a nice write up of the Sixth Circuit decision in FDIC v. AmFin Financial Corporation, which is based on a dispute over the ownership of a $170MM tax refund that the Service issued to the parent company of a consolidated group, and not to the subsidiary that generated the refund.  The parent and its subsidiaries had entered into a tax-sharing agreement, which allocated liability.  Later the parent entered into bankruptcy, resulting in the subsidiary going into FDIC receivership.  FDIC demanded the portion of the refund generated from the subsidiaries operating, but the bankruptcy estate for the parent did the same.  The district court held that the agreement clearly allocated it to the parent’s bankruptcy estate.  The Sixth Circuit reversed and remanded, instructing the district court to consider the evidence concerning the parties’ intent in accordance with Ohio trust and agency law.  PH points out this case is instructive in drafting TSAs, and notes that the FDIC is requiring its insured to amend agreements to allocate refunds to the subsidiaries generating the refund.

Interest on Deposits May Prevent Taxpayers From Obtaining Costs and Fees from Service.

Today’s post deals with the intersection of the deposit procedures for suspending the running of overpayment interest and seeking administrative costs and fees.  Although not quite as sexy as Rihanna settling her tax case, it highlights a strange and potentially unfair requirement for obtaining interest on deposits, and shows the impact of the rule that may not have been considered by the drafters.  As discussed below, taxpayers seeking interest on their deposits in the event of their ultimate success must “endorse” the position of the IRS as reasonable at the same time they are attacking the position as incorrect.


For years, taxpayers have been allowed to make advanced remittances in the nature of cash bonds to post against potential tax debts.  These remittances stop the running of underpayment interest on the potential debt and allow taxpayers still to seek prepayment review in the tax court, but historically also did not allow the taxpayer to receive overpayment interest on the amount remitted unless the taxpayer pays it after filing a Tax Court petition.  If the taxpayer elected to treat the advanced remittance as a payment, the taxpayer would be entitled to overpayment interest, but there are various reasons why a taxpayer would potentially not want the remittance treated as a payment (tax court review, refund procedures, statute of limitations).   As a side note, Les and I are currently finishing up the rewrite dealing with Chapter 6, in IRS Practice and Procedure by Saltzman and Book, which deals with interest.  Advanced remittances is an area that received a substantial rewrite.  The new version should be available by the fall!

In 2004, Congress amended Section 6603 to codify portions of the advanced remittance treatment that was in largely in place, but also added a provision under Section 6603(d) that offered taxpayers the ability to receive interest on some advanced remittances treated as bonds when there was a “disputable tax”.  Under the statute, interest will be paid on the advanced remittance if the disputable tax is identified at the time the remittance is made.  To identify the disputable tax the taxpayer must specify “at the time of the deposit…the taxpayer’s reasonable estimate of the maximum amount of any tax attributable to disputable items.”  The key issue is the definition of “disputable items”, which is “any item of income, gain, loss, deduction, or credit if the taxpayer has a reasonable basis for its treatment of such item and reasonably believes that the Secretary also has a reasonable basis for disallowing the taxpayer’s treatment of such item.”

This is a strange requirement, and I’m not sure its equivalent is found in any other provision of the Code.  I obviously take no issue with the taxpayer stating it has a reasonable basis for its position, but am perplexed by the requirement that the taxpayer reasonably believe the IRS had a reasonable basis for disallowing the treatment.   I believe the policy behind this provision was to ensure there were actual controversies, and taxpayers didn’t simply park their funds with the Service to generate interest on unnecessary deposits.  But, the statute frames this requirement in a manner requiring the taxpayer to opine on the reasonableness of the Service’s position.

With this requirement, the statute on its face prohibits interest from being paid if the IRS position lacks a reasonable basis (unless the Service is unreasonable, but the taxpayer reasonably believes the IRS is being reasonable).  It is unclear how this advances the tax system, or encourages taxpayers to make deposits.  In fact, by forcing the taxpayer to state the Service is being reasonable, the statute could thwart the overall intention of the statute in increasing deposits and providing interest on those deposits, as it limits the number of controversies covered and, as explained below, taxpayers may not be willing to state the Service has been reasonable.

It is also unclear, save an exception to be discussed below, how a taxpayer would know in all situations if the Service has a reasonable position, and to what extent the taxpayer must investigate this to actually show the taxpayer reasonably believes the Service was reasonable.  It would be entertaining if this caused the Service to make the perverse argument that it was unreasonable in an attempt to deny interest, but I assume any disagreement in this area would be based on whether or not the Service was taking the position claimed by the taxpayer.  Presumably, if the Service declined the taxpayer’s position for interest, there would be some type of appeal allowed.  Revenue Procedure 2005-18 does not specify the appeal procedure, and the statute does not specify what should occur during a disagreement.

As I mentioned above, there is an exception for the taxpayer having to determine what the Service’s position is for a disputable item, and if it is reasonable.  Section 6603(d)(2)(B) states that in the case of a taxpayer who has been issued a 30-day letter, the maximum amount of the disputable tax shall not be less than the amount of the proposed deficiency specified in the 30-day letter.  Taxpayers can, in fact, submit the 30-day letter in lieu of the other disputable tax notification pursuant to Rev. Proc. 2005-18.  Submitting the 30-day letter is an easy way to show the disputable tax, but the statute does not state submitting the 30-day letter will cause the underlying tax attributes to not be “disputable items”.  In submitting the 30-day letter, the taxpayer may still be treated as taking the position the Service was reasonable, although not required to state as much in its submission.  I would certainly argue otherwise, but there was no guidance on the matter.  This is an important point for the fees and costs discussion below.

Not allowing interest when the Service is acting unreasonable seems like a sufficient reason to revisit this statute, but taking the position that something is a “disputable tax” has at least one other presumably unintended consequence.  If a taxpayer subsequently desires to seek administrative or litigation costs and attorneys’ fees, acknowledging the Service position was reasonable would prevent the taxpayer for obtaining the costs under Section 7430.  Under Section 7430, the “prevailing party” is entitled to costs and fees in certain circumstances.  The statute, however, has an exception to treating a taxpayer as the prevailing party if the service is “substantially justified.”  This is shown, under the regulations, by the Service showing it had a reasonable basis in both fact and law.  If the taxpayer has already stated the Service had a reasonable basis for its position when the taxpayer was seeking interest on the deposit, the Service would seemingly have little trouble showing it was substantially justified for that particular tax item.

We’ve discussed before on Procedurally Taxing some of the potential benefits of qualified offers in attempting to receive fees and costs, and this is another potential benefit.  If a qualified offer is made, the Service is precluded from showing it was justified in its position, making the taxpayer’s statement regarding the Service’s position unimportant.  That does provide some relief, but taxpayers rarely use the qualified offer option.

Overall, requiring the taxpayer to endorse the Service’s position as reasonable, allowing no interest when the Service’s position is unreasonable does not advance tax administration and creates a policy for obtaining interest that could disallow fees and costs even if the Service unjustifiably protracts a matter.  There are certainly other ways for the Code to determine if there has been an actual controversy without requiring the taxpayer to state the Service is being reasonable.  For instance, the taxpayer could notify the Service he or she is taking the position that there is a disputable item, and the Service could have a set time period to respond or state it is not taking the alleged position.    There are probably even more efficient and clever ways of handling this that would benefit the Service by encouraging more deposits, and benefit taxpayers by providing interest on those deposits.