Summary Opinions through 02/20/15

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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:

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  • 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).
Stephen Olsen About Stephen Olsen

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

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Comments

  1. The 1st Circuit’s In Re Fahey opinion is just more bankruptcy B.S. The 1st Circuit, as did the 10th Circuit before it, has wrongly turned a fresh start into a false start.

    But there is a bright spot within In Re Fahey: Judge Thompson’s dissent.

    On its strength, those unfortunate 1st and 10th Circuit debtors should hightail it to Congress. If they don’t obtain legislative clarification fast, then soon tax bankrupts will “include” only Melo, Fahey, and likewise deluded appellate panels still to come.

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