Substantial / Gross Valuation or Basis Misstatement Majority Rule Case (9/29/12)

I write this blog to advise readers of an important decision -- Gustashaw v. Commissioner, 696 F.3d 1124 (11th Cir. 2012), here, which continues the majority trend holding that the significant / gross valuation or basis misstatement penalty can apply even if there is some basis other than valuation misstatement for knocking out the shelter -- such as lack economic substance or, in lay terms, just bullshit.

The taxpayer, of course, got into a bullshit tax shelter.  I won't go into it, but suffice it to say that it was bad at many levels and, of course, lacked economic substance (and was therefore bullshit in lay terms).  Bullshit shelters usually go by acronyms or initialisms; this was was called CARDS (I won't tell you what that stands for).  Here is the guts of the holding (footnotes omitted):

A. Gross Valuation Misstatement Penalty in I.R.C. § 6662

Gustashaw argues that the Tax Court erred in upholding the IRS's imposition of the 40% gross valuation misstatement penalties for 2000 through 2002. See I.R.C. § 6662(a)—(h). Specifically, Gustashaw contends that because the CARDS transaction lacked economic substance, there was no value or basis to misstate as to trigger the valuation misstatement penalties, and the penalties should not apply as a matter of law. Gustashaw also argues that Congress has penalized lack-of-economic-substance transactions by enacting I.R.C. §§ 6662A and 6663, and therefore, he should not be subject to gross valuation misstatement penalties under § 6662. 

The Internal Revenue Code establishes penalties for underpayment of tax. Section 6662(a) of the Code imposes an accuracy-related penalty of 20% of the portion of an underpayment of tax "attributable to," inter alia, negligence, any substantial understatement of income tax, or any substantial valuation misstatement. I.R.C. § 6662(a), (b)(1)—(3). Under the applicable regulations, only one penalty may apply to a particular underpayment of tax, even if the IRS determines accuracy-related penalties on multiple grounds. Treas. Reg. § 1.6662-2(c).

Updates to Tax Procedure Text re Work Product and Expert Witnesses (9/29/12)

I have just made changes to my Federal Tax Procedure text to update certain portions to reflect changes in Tax Court Rules for discovery and, in one case, the Federal Rules of Civil Procedure discovery provisions related to work product.

The text as revised (sometimes with context) is as follows (footnotes omitted):

Text at 9. VI.F.1.f. -  footnoted version, p. 399; nonfootnoted version p. 293

f. Work Product Privilege. 

The work product privilege (also referred to as the work product doctrine) protects the work product and thought processes in preparing for litigation.  The work product privilege was blessed in the Supreme Court case of Hickman v. Taylor, 329 U.S. 495  (1947) and is now contained in Rule 26(b)(3))(B) of the Federal Rules of Civil Procedure as follows: 

(3) Trial Preparation: Materials.
(A) Documents and Tangible Things. Ordinarily, a party may not discover documents and tangible things that are prepared in anticipation of litigation or for trial by or for another party or its representative (including the other party's attorney, consultant, surety, indemnitor, insurer, or agent). But, subject to Rule 26(b)(4), those materials may be discovered if:
(i) they are otherwise discoverable under Rule 26(b)(1); and
(ii) the party shows that it has substantial need for the materials to prepare its case and cannot, without undue hardship, obtain their substantial equivalent by other means.
(B) Protection Against Disclosure. If the court orders discovery of those materials, it must protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of a party's attorney or other representative concerning the litigation.
(C) Previous Statement. Any party or other person may, on request and without the required showing, obtain the person's own previous statement about the action or its subject matter. If the request is refused, the person may move for a court order, and Rule 37(a)(5) applies to the award of expenses. A previous statement is either:
(i) a written statement that the person has signed or otherwise adopted or approved; or
(ii) a contemporaneous stenographic, mechanical, electrical, or other recording—or a transcription of it—that recites substantially verbatim the person's oral statement.
Tax Court Rule 70(c)(3) now substantially tracks these provisions for work product.

An Estate Tax Fantasy (on the Keller case) (9/28/12)

I write a fictional story inspired by a recent decision, Keller v. United States,, 697 F.3d 238 (5th Cir. 2012), here.  That decision gave the taxpayer a big estate tax victory for the uber rich.  I personally think the estate tax benefit achieved in the case was extravagant.  But I do not write on the substantive planning involved.  I write rather to address another feature of the case.  This issue I discuss is present whether the taxpayer wins or loses.  The attorney and other administrative costs paid by an estate in a large estate tax case substantially mitigated by the estate tax savings benefit they can achieve.  I just want students to understand the phenomenon.

The Keller case involved a very large estate.  The marginal estate tax rate was 55% at the time and that is the rate that should be assumed for the issues that I will discuss.  The substantive issue was the common estate planning technique whereby the older generation stuffs assets into a partnership to achieve minority discounts thus shifting real value to the objects of her beneficence without the consequent estate or gift tax cost.  This should be old hat for observers of estate tax schemes -- the minority discount just magically appears without diminution in value.  I would have thought the gambit might not work with highly liquid assets, but Keller tells us otherwise.  In Keller, the gambit just caused, for tax purposes, vast amounts of value to disappear from the tax base when, in fact, in terms of the wealth of the family, it did not disappear.  Never mind for present purposes the validity or invalidity, morality or immorality, of the substantive gambit.  I want to focus on the estate's claims for administrative expenses, including in part here pertinent fees related to the estate tax litigation.

As noted, the estate was a very large estate; not surprisingly, the administration expenses, also very large, would apparently achieve a 55% tax benefit under the rate in effect when the estate tax was due and would magnify that 55% tax benefit by the interim interest that would otherwise be due from the estate.  Among the administrative expenses claimed by the estate were various professional fees related to the litigation.  The one that caught my eye was a $9.5 MM "contingency fee" for the lawyers who handled the estate tax litigation.  Here is the district court's discussion resulting in the contingency fee being disallowed (Keller v. United States, 1010 U.S. Dist. LEXIS 96465 (S.D. TX 20110)).

Former IRS Agent Charged with Conflict of Interest and Disclosing Return Information Including Whistleblower Name (9/27/12)

Manhattan U.S. Attorney Charges Former IRS Official With Violating Conflict Of Interest Laws And Illegally Disclosing Whistleblower’s Identity (USAO SDNY Press Release 9/27/12), here.

Here is a cut and paste of the described conduct and charges:

From June 2010 until August 2011, LERNER worked as an International Examiner in the New York office of the IRS. For several months leading up to his resignation from the IRS, one of LERNER’s chief responsibilities involved conducting an audit of an international bank (“Bank 1”) related to approximately $1 billion in allegedly unreported income. This audit was triggered by confidential whistleblower information LERNER reviewed during the course of his IRS employment. Shortly before his resignation, LERNER led negotiations on behalf of the IRS which resulted in a proposed $210 million settlement between Bank 1 and the IRS. The settlement was still pending final approval at the time of his departure. Unbeknownst to his colleagues and supervisors, LERNER applied and interviewed for the position of Tax Director at Bank 1 during the time period in which he was representing the IRS in the Bank 1 settlement discussions. He also sent multiple emails to an individual in which he expressed both his dissatisfaction with his job at the IRS and his hope that he would secure the Bank 1 job. At no time did he notify the IRS of his efforts to obtain employment with Bank 1. 

After LERNER announced his resignation from the IRS, he received written notification of certain restrictions imposed on former IRS employees regarding improper contacts with current IRS officials. However, when the IRS sent Bank 1 additional inquiries regarding the audit after he began working as Tax Director in September 2011, LERNER subsequently placed numerous phone calls to IRS employees and initiated meetings with them regarding the continuing audit. LERNER persisted with attempts to encourage IRS employees to provide information regarding the audit, and to approve the settlement between the IRS and Bank 1, despite warnings that he should not be participating in the audit or settlement discussions.
LERNER also engaged in improper disclosure of IRS tax return information during the time period that he worked as an IRS International Examiner. Specifically, LERNER divulged the identity of a whistleblower who had provided the IRS with confidential information regarding Bank 1 that had triggered the audit to someone not employed by the IRS, and provided details regarding pending IRS audits of other companies to individuals who were not employed by the IRS.

An Interesting Ethical Question (9/27/12)

The Volokh Conspiracy Blog has an interesting blog at the intersection of NFL Football and Legal Ethics.  Eugene Volokh, An Interesting Ethical Question (The Volokh Conspiracy 9/26/12), here.

The lead in is:

Prof. Richard Painter (Legal Ethics Forum) asks: 

If a referee’s call is wrong, does the “winning” player have to say: “Sorry ref, you got it wrong; I did not have the ball; the other guy had it”? No, he does not (please let me know if there is a NFL rule on this that I am not aware of). 

What are the obligations of a lawyer if a judge makes or is about to make a wrong call in litigation? See Rule 3.3. The answer turns on why the judge is getting it wrong. 

What about the same issue in the context of an IRS agent or the Tax Court making the same call?

Barred Collection on Assessment Closes Unlimited Statute of Limitations on Assessment (9/24/12)

In ILM 201238028 (6/19/12), here, the IRS held that, even if the IRS otherwise has an unlimited statute of limitations (either for a fraud return or failure to file per Section 6501(c)(1) and (3)), once the IRS assesses a tax for the year, the unlimited statute on assessment becomes moot if the IRS does not collect the assessed tax within the 10-year collection statute of limitations period in Section 6502(a), here.  Under the facts in that memo, the IRS made the assessment after making a substitute for return under Section 6020(b) and issuing a notice of deficiency.  Once the assessment was made, the 10 year limitations period under Section 6502(a)(1) commenced and expired.  The IRS's reasoning is:

The Service may execute a return for any taxpayer who fails to make a return required by any internal revenue law or regulation at the time prescribed, or who makes, willfully or otherwise, a false or fraudulent return. I.R.C. § 6020(b). The execution of a section 6020(b) return will not start the running of the period of limitations on assessment and collection without assessment. I.R.C. § 6501(b)(3) [here]. Accordingly, until the taxpayer files his own return, there will be no deadline by which the Service must assess the tax or file a suit to collect without assessment. Once the Service chooses to assess the tax, however, a 10-year period of limitations on collection of that assessment begins. I.R.C. § 6502(a)(1).

IRS Queasiness Over the Reaches of Allen (9/22/12)

I have recently blogged on the issue of whether the fraud of some person other than the taxpayer signing the return which makes the return fraudulent allows the IRS an unlimited statute of limitations under Section 6501(c)(1), here.  I list below the blogs that deal with that issue.  In Allen v. Commissioner, 128 T.C. 37 (2007), the Tax Court held that a preparer's fraud with no fraud on the taxpayers' part can invoke the unlimited statute of limitations under 6501(c)(1).  In my blogs, I questioned that holding and noted some of the possible other situations that, if correct, the Allen holding could and logically should apply.  Specifically, I mentioned that proliferation of abusive tax shelters such as Son-of-Boss that, in criminal cases, have resulted in convictions of the promoters for tax evasion with respect to the taxpayers' returns.  Even if one were to assume that the taxpayers were not guilty of fraud (the Government conceded that for purposes of the criminal case), the promoters' fraud that resulted in the returns being fraudulent seems to comfortably fit the Allen holding if Allen is correct.

The IRS has released a new internal guidance legal memorandum, ILM 201238026, here.  In that memorandum, one of the owners of an S Corporation had caused income to be falsely underreported and hence, when the underreported income was passed through to the two shareholders, their returns underreported the income.  With respect to the underreported income, the culpable partner had been convicted of "one count of 18 U.S.C. § 371, Conspiracy to Commit Mail Fraud and Tax Fraud, one count of 26 U.S.C. § 7201, Tax Evasion, one count of 26 U.S.C. § 7206(1), Filing a False Individual Tax Return, and one count of 26 U.S.C. § 7206(1), Filing a False Corporate Tax Return for the year 2001."  The issue addressed in the memorandum was whether the nonculpable owner who reported the fraudulently understated net income on his return (1040) was subject to the unlimited states of limitations under Section 6501(c)(1).

Facially, at this point, there is little to distinguish the key facts in the memorandum from the Allen facts and holding.  In Allen, the fraudulent position on the return was attributable to a preparer; in the memorandum, the fraudulent position on the return was attributable to the other S corporation owner.  There is nothing to distinguish the fraudulent position on the return other than its source -- the preparer or the other shareholder.  Nevertheless, the memorandum concludes that the unlimited statute of limitations does not apply.

Updates on Interest Rates (9/23/12)

In my Federal Tax Procedure text, I state the interest for quarters earlier than the 3d quarter of 2012.  The following are the interest rates for the third quarter of 2012.  Please keep in mind that these interests rates are provided for illustration only.  The interest rates can change each quarter, depending upon the federal short term rates.

INTEREST RATES FOR THIRD QUARTER 2012

Underpayment interest rate - 3%  [Text footnoted p. 244, nonfootnoted p. 174]
Underpayment larger corporate (Hot Interest) rate - 5% [Text footnoted p. 244, nonfootnoted p.  174]

Overpayment rate - general - 3% [Text footnoted p. 255, nonfootnoted p.   181]
Corporate overpayment rate - general - 2% [Text footnoted p. 255, nonfootnoted p. 182]
Large Corporate Ovepayments (over $10,000) - .5% [Text footnoted p. 255-6 nonfootnoted p.  182]

See the IRS web page on these interest rates here.

Is there A Statute of Limitations for the Section 6702 Frivolous Return Penalty (9/21/12)

In Crites v. Commissioner, T.C. Memo. 2012-267, here, the Tax Court held that the frivolous return penalty in Section 6702, here, was timely.  Section 6702 penalizes a "frivolous return" and a "specified frivolous submission."  In Crites, the frivolous return penalty applied.  The taxpayer's original return was filed more than 3 years before the penalty assessment.  The amended return which was penalized was filed less than a year before the penalty was assessed.  The holding on the statute of limitations is:

Section 6501(a) does place limits on assessments. With certain limited exceptions not relevant here, the Commissioner must assess a tax liability within three years after a return is filed. Sec. 6501(a). Crites argues that because penalties are generally included within the definition of "tax", see sec. 6665(a)(2), section 6501(a) prevents the Commissioner from assessing a penalty against her under section 6702(a) more than three years from the time she filed her original return. 

We disagree. As the Commissioner observes, penalties under section 6702 do not have a readily observable statute of limitations. The section penalizes not  just frivolous "returns"—and even here Congress was careful to penalize not just returns but "what purports to be a return"—but frivolous "submissions". It would be odd if penalties keyed to "submissions" had somehow to be tied to the limitations period for tax that is supposed to be shown on a "return". 

But let us assume—and here we are expressly assuming without deciding—that Crites is right that the filing date of her "return" is the key date. She had two returns, and the one that the Commissioner wants to punish her for is the amended return that she sent the IRS in October 2008. He assessed the penalty in July 2009, well within three years of her submitting it. Crites of course would prefer that we hold that the clock for penalizing her under section 6702 began to run when she filed her original return, but she cites no authority for her implicit proposition that a statute of limitations can start running before a cause of action accrues or, in a case like hers, before a taxpayer even files a sanctionable submission.

Erroneous Refund Suit is Timely Filed (9/20/12)

In United States v. Davenport, 2012 U.S. Dist. LEXIS 131468 (ND TX 2012), here, the Court held in an erroneous refund suit that the Government's suit had been timely filed.  The erroneous refund suit is brought under Section 7405, here.  The statutes of limitations for such suits is in section 6532, here, which provides:

(b) Suits by United States for recovery of erroneous refunds 

Recovery of an erroneous refund by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund, except that such suit may be brought at any time within 5 years from the making of the refund if it appears that any part of the refund was induced by fraud or misrepresentation of a material fact.

Here's the Court's entire discussion on the timeliness of the Government's erroneous refund suit (footnotes omitted):

The parties acknowledge that the earliest possible date that the statute of limitations could have commenced to run is December 28, 2007, the date that the IRS prepared and mailed David and Myra Davenport's refund check for the 2003 tax year. The Davenports contend that the Government's claim accrued on December 28, 2007, and it was therefore required to file suit by December 27, 2009. The court disagrees, as this argument, if not frivolous, is certainly specious.

IRS Proposes New Practitioner Rules for Opinions and Advice (9/20/12)

The IRS has proposed new regulations for Circular 230, 31 CFR Part 10, regarding tax practitioner opinions and advice.  See REG-138367-00, 77 FR 57055 (9/17/12),here.  Here is a good summary of certain key aspects of the proposed new regulations (excerpted from Michael Cohn, IRS Proposes New Rules for Covered Opinions and Tax Advice (Accounting Today 9/14/12), here):

The proposed regulations will streamline the existing rules for written tax advice by removing the current Section 10.35 and applying one standard for all written tax advice under a proposed Section 10.37. The proposed Section 10.37 provides that the practitioner must base all written advice on reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts that the practitioner knows or should know.  The proposed removal of Section 10.35 will eliminate the requirement that practitioners fully describe the relevant facts (including the factual and legal assumptions relied upon) and the application of the law to the facts in the written advice itself, and the use of Circular 230 disclaimers in documents and transmissions, including e-mails. 

Other provisions, including Sections 10.31, 10.36, and 10.82, are also being updated at this time to reflect the current practice environment, the IRS noted.  In addition, a general competence standard is being proposed in the new Section 10.35. “The proposed regulations also clarify that the Office of Professional Responsibility has exclusive responsibility for matters related to practitioner discipline, including disciplinary proceedings and sanctions,” said the IRS.

Caveat:  These are proposed regs only.  The do not have effect until promulgated and, based on the comments received, may be modified.  Since they are proposed only, they do not affect the current Federal Tax Procedure book.

The Role of the DOJ Tax Division (9/18/12)

I have just published a blog entry on the Tax Division.  See The Role of the DOJ Tax Division in Criminal Tax Enforcement (Federal Tax Crimes Blog 9/18/12), here.  The blog consists of excerpts and links to a Tax Notes article, Shamik Trivedi, For DOJ Tax Division, Consistency and Deterrence Are Key, 136 Tax Notes 1231 (Sept. 10, 2012), here, which is published with the permission of Tax Analysts.  The article principally covers criminal tax enforcement matters, which are a relatively minor part of my course on Tax Procedure.  Readers might still find the article interesting.

DOJ Tax Authority to Settle Tax Cases in Joint Committee Cases (9/18/12)

In United States v. United States District Court for the Northern Mariana Islands, ___ F.3d ___, 2012 U.S. App. LEXIS 19134 (9th Cir. 2012), here, the Ninth Circuit held that, under the facts, the district court had abused its discretion in ordering, in a large tax refund suit, that a Government official with authority to settle the case be present at a compulsory settlement conference.  At the district court, in opposing that order at the trial letter, the Government stated:

because of the size of Baldwin's claim, the lowest-ranking official authorized to settle this case was the officer in charge of the Tax Division of the Department of Justice, the Assistant Attorney General of the Tax Division ("Assistant Attorney General"), fn3 and her authority is limited by the requirement that the Congressional Joint Committee on Taxation ("Joint Committee") reviews and has no adverse criticism to the proposed refund or settlement. fn4 See 28 C.F.R. §§ 0.160-.0162; see also Rules and Regulations, 76 Fed. 1Reg. 15212-02 (Mar. 21, 2011). The government argued that the personal participation of the Assistant Attorney General should not be required and proposed instead that the settlement conference be personally attended by the trial attorneys with primary responsibility for the handling of the case, with the Section Chief of the Tax Division's Office of Review ("Section Chief") available for consultation by telephone during the settlement conference. The Section Chief is authorized to accept offers in compromise in cases against the United States in which the amount of the government's concession, exclusive of statutory interest, does not exceed $1.5 million. See Rules and Regulations, 76 Fed. Reg. 15212-02 (Mar. 21, 2011).

The Scalia-Posner Spat Over Statutory Interpretation (9/18/12)

The Scalia-Posner spat is ratcheting up, with Justice Scalia allegedly accusing Judge Posner of the big lie -- Posner's assertion that Scalia used legislative history.  Fanning furor, Justice Scalia says appeals court judge lied (Reuters 9/17/12), here.  I suppose that, in Justice Scalia's different universe, such an accusation is as low as one can go.

At any rate, I previously blogged on Justice Scalia's new book, in collaboration with Bryan Garner, on Statutory Interpretation which is an important part of my Federal Tax Procedure class and book.   Review of Scalia Book on Statutory Interpretation (7/17/12), here.

I have nothing substantive to offer over this spat, but I think it does illustrate that there is something important -- if neither right nor wrong -- about the role of legislative history in statutory interpretation.

Addendum:

This is a good article by a scholar.  Eric Segall, The Scalia-Posner War and Why it Matters, here.  Excerpts:

Whistleblowers, Carried Interests, Fee Waivers and Swiss Banks (9/15/12)

I previously blogged as to the claim that Revenue Procedures was a legal basis for claiming capital gains for carried interests and the more aggressive fee waivers (the latter of which being the more aggressive strategy to turn ordinary income into capital gains).  See Are Revenue Procedures Influential In Interpreting the Law: Of Profits / Carried Interests and Administrative Billion Dollar Largess (9/7/12), here.  It appears that whistleblowers are busy for the more aggressive of these alchemies.

The Wall Street Journal reports that the recently well publicized investigation by the New York State Attorney General is based on whistleblower information.  The WSJ also reports that whistleblower claims have been made to the IRS and that those claims are "active."

The WSJ article is Reed Albergotti and Laura Saunders, Informer Sparked New York Probe (WSJ 9/12/12), here.  Here are a few of the introductory paragraphs to whet your appetites.

New York state Attorney General Eric Schneiderman's probe of tax practices at private-equity firms is based on information from a whistleblower, according to a person familiar with the matter.

The investigation by Eric Schneiderman, pictured in March, has sent subpoenas to 13 private-equity firms. 

The information came from someone who approached Mr. Schneiderman's office between roughly nine months and a year ago, this person said. Under the state's False Claims Act, the attorney general can investigate alleged fraud against the state based on a whistleblower's allegations.

Adequacy of IRS Notices & Variance in Refund Claims (9/15/12)

In Bush v. United States, 2012 U.S. Claims LEXIS 1083 (2012), here, the Court of Federal Claims held in a tax refund suit that a computational adjustment based on a partnership adjustment was subject to the Scar analysis of validity of an IRS determination and that the taxpayer had a fatal variance between an argument first advanced in briefing in the case.  I'll look at both of these issues.

THE SCAR ISSUE

In Scar v. Commissioner, 814 F.2d 1363 (9th Cir. 1987), the Ninth Circuit held that a facially invalid basis for an adjustment in the notice of deficiency meant that the IRS had not made the required determination for a notice of deficiency and thereby invalidated the notice of deficiency.  Bush involves a computational adjustment from a partnership audit rather than a notice of deficiency, but it will be helpful to put Scar in its context.  I offer the  background for the Scar holding (cut and pasted from my Federal Tax Procedure book is (footnotes omitted):

2. The Notice of Deficiency. 

a. The Determination and Explanation. 

The IRS is authorized to issue a deficiency notice “If the Secretary determines that there is a deficiency.”  § 6212(a).  The notice of deficiency should “describe the basis for, and identify the amounts (if any) of, the tax due, interest, additional amounts, additions to the tax, and  assessable penalties included in such notice,” § 7522(a).  Frequently, the notice of deficiency will be somewhat sparse in its explanation, but usually the taxpayer will have been given an agent’s report that explains the IRS position.  And, in any event, the same statute provides: “An inadequate description under the preceding sentence shall not invalidate such notice.”   [Note § 7522(a) was not in the law when Scar was decided; and does not apply to computational adjustments in any event.]

The Danielson Rule: Holding a Taxpayer to his Bargain (9/15/12)

In Hartman v. United States, 694 F. 3d 96 (Fed. Cir. 2012), here, the Federal Circuit applied the constructive receipt rule to tax a service partner when he received shares in a corporation in return for services.  I use a simple example based on the Hartmann facts to illustrate the setting.

Example: Service partner A (Partner A) received 1,000 shares in Corporation X (a spin-off from the partnership).  The shares have a value of $1,000,000.  Under the contract signed at the time, partner A agreed that (i) the value of his shares is $1,000,000, (ii) he will report $1,000,000 ordinary income for tax purposes, (iii) 25% of the shares, 250 shares in this example, would be sold immediately to permit the partner to pay the resulting income tax obligation, (iv) the remaining 75% of the shares (750 shares in this example) would be subject to forfeiture as "liquidated damages," but the amount of the shares subject to such forfeiture would decline over a 5 year period in the event Partner A left the employment of Corporation X or was terminated for cause; and (v) from day one, Partner A received any dividends with respect to the stock and could vote the stock -- i.e., Partner A had all the accouterments of ownership of the stock except that it was subject to the forfeiture provisions.  Partner A reported ordinary income in the year as agreed of $1,000,000 and paid a resulting tax of $250,000 which was funded from the 25% of the shares sold.  Shortly after the next year commenced, Corporation A had a reversal of its fortunes and its stock declined in value by 50%.  This meant that Partner A had paid tax on the 750 remaining shares at a value of $750,000 but now they were worth only $375,000.  So, Partner A wanted to claim that the 750 shares were not constructively received for tax purposes and therefore that the only tax consequences were with respect to the 250 shares sold in the year and that taxation of the remaining shares must be in a future year as the restrictions on his stock lapsed.

From a substantive tax perspective, the reason for the shape of the agreement in the first place was to lock in the ordinary income from receipt of the shares at the inception -- in Partner A's case, $1,000,000 of ordinary income -- so that the expected future major accretions in value would be taxed as capital gain.  These expectations were upset because the value of the stock went down, which, if the phenomenon continued, would mean that Partner A got ordinary income taxed in full at the inception with a subsequent capital loss of limited tax benefit.  This basic phenomenon occurred in many cases after the internet bubble in the late 1990s burst.

Mootness and Tax Court Proceedings (9/14/12)

OK, I know the reaction of most readers for this blog is going to be "So What."  That is probably a good reaction, but I persist in wanting to evoke that reaction.  Here goes.

In Media Space Inc. v. Commissioner, 2010 U.S. App. LEXIS _____ (2d Cir. 2012), here, the Second Circuit remands to the Tax Court "with instructions to dismiss the petition."   The IRS appealed because it thought the decision document did not determine enough of a tax liability for Media Space.  On appeal, , Media Space, advised the 2d Circuit that, notwithstanding the Tax Court decision, it had paid all of the amounts in issue.  If that is true, and the Government apparently did not contest it the representation, the Government has seemingly won the case despite the Tax Court decision which at least partially favored the taxpayer (which is, of course, why the Government appealed).  So, with the Government having practically won, despite the Tax Court decision, the Court of Appeals dismissed on grounds of mootness over the Government's objection.

I think there is something going on that is not evident from the Second Circuit's cryptic opinion.  I think the appropriate resolution of the case would be to remand for entry of decision in the full amount for the IRS.  Maybe there is something I am missing there, so hopefully readers will let me know if I am missing something.

Moreover, despite the payment, the Government still wanted the Second Circuit to decide an issue it felt important.  The Second Circuit punted on the case or controversy dodge, citing as "'established practice' of federal courts is to 'vacate the judgment below and remand with a direction to dismiss.'  Oh well, 

If It's A Tax, What About the Origination Clause? (9/14/12)

One of our first topics in my Federal Tax Procedure class is the roles of the various players -- Congress, the Executive Branch and the Courts (OK, the grand jury as well).  And, one of the first topics it the Origination Clause.  The Origination Clause is Section 7, Clause 1, of the Constitution which says:

All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills

Wikipedia, here,  provides this background on the Origination Clause (footnotes omitted):

This establishes the method for making Acts of Congress. Accordingly, any bill may originate in either House of Congress, except for a revenue bill, which may originate only in the House of Representatives. In practice, the Senate can simply circumvent this requirement by substituting the text of any bill previously passed by the House with the text of a revenue bill.  When the Senate sends an appropriation bill to the House, the House may return it to the Senate with a blue slip, thereby settling the question in practice. Either House may amend any bill, including revenue and appropriation bills. 

The Origination Clause stemmed from an English parliamentary convention that all money bills must have their first reading in the House of Commons. It was intended to ensure that the "power of the purse" lies with the legislative body responsible to the people. The clause was also part of a compromise between small and large states. The latter were unhappy with equal representation in the Senate.

The Volokh Conspiracy has this discussion of the Origination Clause as a new line of attack on the "tax" as pronounced by the Supreme Court for the individual mandate in the Affordable Care Act.  Randy Barnett, New Obamacare Challenge: The Origination Clause (The Volokh Conspiracy 9/13/12), here.  Here are excerpts of the press release related to the new attack.

Tax Court Applies Chevron Analysis to Validate Regulation (9/14/12)

In Gaughf Properties, LP v. Commissioner, 139 T.C. No. 7 (2012), here, the Tax Court (Judge Goeke) held that the taxpayers were subject to an extended period of time for a TEFRA partnership adjustment because they, as indirect partners not listed on the partnership return, had failed to "furnish" the IRS proper notice of their status as indirect partners.  See Section 6229(e), here. The Regulations stated that the taxpayer "furnish" the information by filing.  The taxpayer did not file the required information.  However, the taxpayer argued that taxpayers' status as indirect partners was otherwise known to the IRS from other sources and therefore that the IRS should not be allowed the extended period to assess.  The Tax Court rejected the taxpayers' claims, holding that the indirect partner (taxpayers here) must "furnish" the information in the manner prescribed in the Regulations.  Regs. Section 301.6223(c)-1T provides that the information is "furnished" by filing the information in a prescribed manner.  The Tax Court held that equating "furnishing" with "filing" was a proper exercise of the authority to interpret an ambiguous statutory term under Chevron.  The Court's Chevron analysis follows (some footnotes omitted):

Petitioner's final argument regarding section 6229(e) is that section 301.6229(e)-1T, Temporary Proced. & Admin. Regs., supra, which incorporates section 301.6223(c)-1T, Temporary Proced. & Admin. Regs., supra, regarding the procedure for furnishing additional information for purposes of section 6229(e), is invalid. Petitioner argues that while section 6229(e) merely requires information identifying a partner to be "furnished" to the Commissioner, section 301.6223(c)-1T, Temporary Proced. & Admin. Regs., supra, restricts the plain meaning of section 6229(e) by requiring that identifying information be "filed" with the Commissioner. Petitioner also points out that section 6229(e) contains no "regulation-enabling language". We find that section 301.6229(e)-1T, Temporary Proced. & Admin. Regs., supra, is a valid regulation. 

We first address petitioner's point regarding the lack of "regulation-enabling language" in section 6229(e). As the Supreme Court has noted, section 7805(a) provides the Commissioner with "explicit authorization to 'prescribe all needful rules and regulations for the enforcement' of the Internal Revenue Code." Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___, ___, 131 S. Ct. 704, 714 (2011). Section 301.6229(e)-1T, Temporary Proced. & Admin. Regs., supra, was issued pursuant to the authority section 7805 provides to the Commissioner. 52 Fed. Reg. 6779, 6780 (Mar. 5, 1987). Secondary authority for issuance of the regulation is found in section 6230(k), which provides: "The Secretary shall prescribe such regulations as may be necessary to carry out the purposes of this subchapter"; i.e., subchapter C of chapter 63, which contains sections 6221 through 6234. Id. We thus find petitioner's argument on this point has no merit.

IRS Audits Are Good for Companies; Thanks IRS! (9/13/12)

I always knew that IRS Audits were good for the bottom line -- my bottom line, anyway.  Now, Research says it is good for some taxpayers as well.  Michael Cohn, IRS Audits Keep Companies Honest, Says Research (Accounting Today 9/12/12), here.  Here is the introduction as a teaser for you to link to read the whole article.

The likelihood of being audited by the Internal Revenue Service has its strongest impact on laxly governed companies and fosters corporate truthfulness not just in confidential tax returns, but in public financial reports, according to new research. 

Like what you see? Click here to sign up for Accounting Today's daily newsletter to get the latest news and behind the scenes commentary you won't find anywhere else. 

The study, which appears in the September/October issue of the American Accounting Association’s journal Accounting Review, found that a lesser degree of auditing will translate into significantly less corporate taxes paid to the federal government. 

Less auditing by the IRS is probably not only bad for federal tax coffers but for shareholders as well, according to the study. The paper’s findings, along with those of a related, unpublished study, reveal that the likelihood of being audited has its strongest effect on companies whose governance is lacking. 

“The idea that shareholders benefit from having their companies audited by the IRS may seem strange to some investors,” said Jeffrey Hoopes of the University of Michigan, who co-authored both studies. “Our research, however, suggests that strict tax enforcement promotes good financial reporting and tends to check managers' proclivities to divert corporate resources for their personal use under the guise of saving taxes.”

Click here for the rest of the article.

IRS NonAcquiesces in IBM after 45 Years (9/13/12)

In AOD 2012-02; 2012-40 IRB 1, here, the IRS formally announced its nonacquiescence in International Business Machines Corp. v. United States, 343 F.2d 914 (Ct. Cl. 1965), cert. denied, 382 U.S. 1028 (1966), here, "the IBM case" or just "IBM".  For those unfamiliar with the IBM cases, here is a cut and paste from my Federal Tax Procedure book (footnoted version pp. 80-81; nonfootnoted version pp. 55-56); :

(1) The IBM Case. 

Can the taxpayer complain about more favorable tax treatment given to a competitor?  Allowing the taxpayer seeking the private letter ruling to obtain a benefit ultimately contrary to the law while denying that benefit to others, particularly competitors where the erroneous benefit gives a competitive advantage, has at least the appearance of unfairness.  The Court of Claims – the predecessor to the current Court of Appeals for the Federal Circuit – addressed this issue in 1966 in International Business Machines Corp. v. United States. n255 One of IBMs competitors in the highly competitive computer business had sought and obtained a ruling that ultimately proved to be based on an incorrect interpretation of law.  Shortly thereafter, IBM learned of the ruling and sought one for itself.  After over two years consideration / reconsideration of the issue, the IRS simply denied IBM’s requested ruling and revoked the ruling to the competitor but revoked prospectively only.  During the interim before prospective revocation (about 2 ½ years), the competitor had a substantial advantage over IBM, which had not sought a ruling and was taxed on the basis of the correct interpretation of law.  In a fairness / equity based decision, the court required the IRS to refund the taxes during the period to IBM.  The technical basis for the ruling was that (i)§ 7805(b) authorizes IRS interpretations to be applied prospectively (thus implicitly permitting the IRS to apply wrong interpretations prior to a prospective application date), and (ii) that the IRS’s refusal to make prospective the ruling it gave IBM was an abuse of discretion because of the favorable interpretation that the competitor secured in the interim before its ruling was revoked prospectively.

Sixth Circuit Declines to Defer to Revenue Rulings (9/13/12)

A significant topic in tax procedure is the various IRS pronouncements, from Regulations on down (down in terms of authority), and their influence in the interpretation of the tax law.  I posted a blog a few days ago discussing a case in which the Second Circuit gave deference to an IRS interpretation of a regulation.  See 2d Circuit Defers to the IRS's Litigating Position (9/9/12), here.  The issue of deference is a big subject and will likely be the subject of many blogs going forward.

Today, I discuss the issue again as presented in a recent Sixth Circuit opinion, United States v. Quality Stores, Inc., ___ F.3d ___, 2012 U.S. App. LEXIS 18820 (6th Cir. 2012), here.  The substantive issue presented in the case was whether severance payments are subject to FICA taxes.  This is a bit of an esoteric issue, but for some taxpayers it involves a large amount of money.  In Quality Stores, a refund of over $1 million in employer and employee FICA taxes were involved.  The Sixth Circuit held that the FICA payments were not subject to FICA.  Basically, the court reviewed the statute and legislative history as supporting its conclusion despite the fact that the income paid on severance was subject to income tax withholding.  In so holding, the Sixth Circuit created a conflict with a previous holding in CSX Corp. v. United States, 518 F.3d 1328 (Fed. Cir. 2008).

I won't bore the reader by boring into the substance  of the holding.  Suffice it to say that there was  no regulation on point, so the Sixth Circuit first reached its holding based upon the statute, the legislative history and the cases.  The Court gave this as its conclusion (footnote omitted):

Accordingly, we conclude, under the stipulated facts of this case, that the payments Quality Stores made to its employees pursuant to the Pre- and Post-Petition Plans qualify as SUB payments under I.R.C. § 3402(o). Because Congress has provided that SUB payments are not "wages" and are treated only as if they were "wages" for purposes of federal income tax withholding, such payments are not "wages" for purposes of FICA taxation.

Consents to Extend the Statute of Limitations Must Be Properly Executed During Open Period (9/12/12)

My partner, Larry Jones, called this IRS memorandum to my attention.  ILM 201235009, here, published also at 2012 TNT 171-27.   The bottom line is that, while the statute of limitations of limitations was still open a Form 872-I, Consent to Extend the Time to Assess Tax As Well As Tax Attributable to Items of a Partnership, here, had been signed by the Revenue Agent who did not have authority to sign a consent.  A person authorized to sign the consent subsequently signed the consent over two years later, after the statute of limitations had expired.  Held, the consent was invalid because an authorized signature for the IRS had not occurred during the period of the statute of limitations.

The memo summarizes the requirements for a valid consent as follows:

To be valid, an agreement by the taxpayer to extend the statute of limitations on assessment must be (1) in writing; (2) entered into before the expiration of the original collection period or a previously agreed upon extension; and (3) executed by the taxpayer and an authorized delegate of the Commissioner. I.R.C. § 6502(a); Treas. Reg. § 301.6502-1(a)(2)(i). In an Action on Decision regarding Rohde v. United States, 415 F.2d 695 (9th Cir. 1969), the Service acceded that, under applicable Treasury Regulations, the Commissioner (or his delegate) must counter-sign a waiver form prior to the expiration of the period of limitations for the waiver to be effective. AOD-1973-442, 1973 WL 35098 (IRS AOD). Although Rohde only addressed the validity of a waiver of the six-year period of limitations on collection after assessment, the AOD states that the signature requirement also applies to extensions of time for the assessment of income tax (i.e. Form 872). Id.

This requirement of valid signatures by the taxpayer and the IRS within the open period of limitations applies to the types of consents tax controversy practitioners usually deal with - such as most prominently the regular Form 872, here.  We recommend that taxpayers check their consents to make sure that they are signed by a person with proper authority.

Birkenfeld Gets $104 Million Whistleblower Award (9/11/12)

Bradley Birkenfeld the Whistleblower who whistleblowing brought UBS to its knees and set in motion the IRS offensive against Swiss and other foreign banks has been awarded $104 million as a whistleblower award under Section 7623(b), here.  Birkenfeld was also convicted and sentenced for crimes related to his alleged reticence in coming fully clean.  Still, he was the man.  He was formerly named Tax Analysts "Person of the Year" for 2009.

This is a stunning development.  I am sure there will be a lot of buzz and hype.  But I do think this signals some significant movement in the Whistle Blower office.

Also, since the Swiss would say that his whistleblowing violated its law, we now know that the IRS admits having used the information in violation of other country law to collect revenue (which is what is required to grant an award).  So for all who thought that our Government might not used illegally obtained information, think again.  See also Payner v. United States, 447 U.S. 727 (1980), here, Government can use against a depositor information from a "flagrantly illegal search."

Resources:

Timely-Mailing, Timely-Filing - Tax Court Case Reminder of Requirements (9/11/12)

In my Tax Procedure class last Thursday, we covered return filings.  A key component of the discussion was the timely mailing, timely filing rule in Section 7502, here.  The Tax Court yesterday decided Scaggs v. Commissioner, T.C. Memo. 2012-258, here.  Scaggs offers an object lesson in how not to qualify for the timely mailing, timely filing rule.  So I will review the rules and then the decision in Scaggs.

I cut and paste my discussion from my Federal Tax Procedure book (no footnotes):

Section 7502 provides a “timely-mailing, timely-filing” rule, which treats the mailing date as the filing date for returns (and other documents) received by the IRS after the due date (either the original due date where there is no extension or the extended due date if there is an extension) but mailed on or before that due date.  The timely-mailing, timely-filing rules (and risks) may be summarized as follows:

1.   The document filed must be a “return, claim, statement, or other document required to be filed.”  I focus here on the “required to be filed” element.  Original tax returns are the quintessential type of document that is required to be file and thus clearly meets this element of the statute.  Tax Court petitions are also required to be filed by the Code in order to meet the jurisdictional requirements for the Tax Court and, in that sense, are required to be filed and thus meet this element of the statute.  What about amended returns?  The standard conceptualization of the amended return is that the Code itself does not require amended returns to be filed.  So, do amended returns qualify?  The answer is that some clearly do and some may not.  Since, as we shall see later, the Code requires claims for refunds to be filed within a statute of limitations period, amended returns making refund claims qualify as returns required to be filed thus permitting the taxpayer to meet this element of the timely mailing, timely filing rule.  But, that analysis does not apply to amended returns reporting additional liability.  The IRS has ruled that amended returns reporting additional liability are not “required” and thus any tax reported on such returns actually filed after the assessment limitations period but otherwise mailed within the assessment period, do not qualify under § 7502.  What this means is that the IRS may not assess and must return any payment remitted with the amended return reporting a liability.

Case on Collateral Estoppel [Issue Preclusion] as to Civil Fraud (9/9/12)

I have just posted on my Federal Tax Crimes Blog a short discussion of the recent case of Anderson v. Commissioner, 2012 U.S. App. LEXIS 18831 (3d Cir. 2012), here.  The blog entry for that discussion is Walter Anderson Re-Appears But Unsuccessfully (9/9/12), here.  Anderson involves the collateral consequences of a conviction for tax evasion.

We study in Tax Procedure two key collateral civil tax consequences of a conviction of tax evasion.  These consequences both flow from the taxpayer convicted of tax evasion under Section 7201, here, being collaterally estopped [precluded by issue preclusion] as to civil fraud, an estoppel which invokes the 75% civil fraud penalty in Section 6663, here, and the unlimited statute of limitations in 6501(c)(1), here.   The statute of limitations consequence is straight-forward.  The application for the civil fraud penalty is a little more complex.

The amount subject to the civil fraud penalty must be quantified.  The conviction for tax evasion does not necessarily establish the amount subject to the 75% civil fraud penalty.  Unless the taxpayer stipulates the amount in the plea agreement, all a conviction will establish is the elements of the crime of tax evasion -- (i) willfulness, (ii) some amount of tax due and owning (most courts required it to be significant but not quantified), and an affirmative act of evasion.

Section 6663(b) provides a sequential burden of proof requirement in order to impose the civil fraud penalty.  First, the IRS must establish by clear and convincing evidence that the taxpayer committed fraud as to some portion of the underpayment.  The conviction will be collateral estoppel [issue preclusion] as to this IRS burden.  Second, once the first step is met, all of the underpayment is deemed attributable to fraud except for the portion that the taxpayer shows by a preponderance of the evidence is not due to fraud.

2d Circuit Defers to the IRS's Litigating Position (9/9/12)

In Union Carbide Corporation v. Commissioner, ___ F.3d ___, 2012 U.S. App. LEXIS 18876 (2012), here, sustains the IRS's interpretation on brief of an ambiguous IRS regulation of an ambiguous statute.  In Chevron, the Supreme Court held that an IRS regulation interpretation of an ambiguous statute is entitled to deference.  However, what if an ambiguous regulation interprets the ambiguous statute?  Well, the IRS can in its brief interpret the regulation and that interpretation of the ambiguous interpretation of the ambiguous statute is entitled to deference.  Here is the Second Circuit's analysis:

We agree with the Tax Court that the costs for which UCC seeks a research credit are "at best, indirect research costs excluded from the definition of [qualified research expenses] under section 1.41-2(b)(2) [of the Treasury Regulations]." Id. The Tax Court's reference to the Treasury Regulations is consistent with the principle that "if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute." Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843 (1984). The Treasury Regulations explain section 41(b) by stating that "[e]xpenditures for supplies or for the use of personal property that are indirect research expenditures or general and administrative expenses do not qualify as inhouse research expenses." Treas. Reg. § 1.41-2(b)(1) (as amended in 2004). This regulation, however, does not clearly resolve whether the supplies at issue here were "used in the conduct of qualified research" because it is not clear how one distinguishes between direct and indirect research expenses. 

Nevertheless, the Commissioner argues in his brief that "[s]upply costs are 'indirect research expenditures' if they would have been incurred regardless of any research activities." We ordinarily give deference to an agency's interpretation of its own ambiguous regulations, even if that interpretation appears in a legal brief. Auer v. Robbins, 519 U.S. 452, 461-62 (1997). The interpretation advanced here does not fall into any of the enunciated categories where we would withhold such deference as it is not "plainly erroneous or inconsistent with the regulation," does not "conflict with prior interpretation" of the same regulation, and is not merely a "convenient litigating position" or a "post hoc rationalization advanced by an agency seeking to defend past agency action against attack." Christopher v. SmithKline Beecham Corp., 132 S. Ct. 2156, 2166 (2012) (internal quotation marks and citation omitted).

Are Revenue Procedures Influential In Interpreting the Law: Of Profits / Carried Interests and Administrative Billion Dollar Largess (9/7/12)

An issue that has surfaced in the Presidential campaign is whether the private equity and hedge fund industries have improperly benefited from "carried interests" that allow them to claim capital gains tax treatment for income that is, at its core, compensation for management services that, if characterized as such, would be taxed as ordinary income.  See e.g., Victor Fleischer, What’s at Issue in the Private Equity Tax Inquiry (NYT Deal Book 9/4/12), here, dealing with an extrapolation where fee waivers are transformed into carried interests.  The potential tax revenue is in the mega billions.  The industry benefiting from claiming capital gains treatment for carried interests claims from time to time that it is the law (an unsupported claim) and attempts to support the claim with the notion that the IRS has blessed the capital gains treatment in two Revenue Procedures.  The purpose of this blog entry is to address the role of Revenue Procedures and dispel any the notion that the IRS has blessed a particular substantive tax treatment in a Revenue Procedure.

The balance of this blog consists of a revision that I have just made to my Federal Tax Procedure book as a substitution for the discussion of Revenue Procedures at Ch. 2 II.B.6.d. (beginning on p. 52 of footnoted version and p. 35 of nonfootnoted version).  Please note that the footnote numbers are interim from the draft for the next edition.

(2) Revenue Procedures.

Revenue Procedures are IRS publications advising the public of internal management and procedural matters. They thus differ from Revenue Rulings which advise the public of IRS substantive law positions. n170 For example, the IRS uses Revenue Procedures to advise the public about detailed requirements for requests for private letter rulings (discussed immediately below).  In this sense, they act as “check lists” that taxpayers and practitioners follow in order to seek private letter rulings.  Like Revenue Rulings, Revenue Procedures are published in the Internal Revenue Bulletins and Cumulative Bulletins.

Ninth Circuit Denies an Untimely Claim for Refund (9/1/12)

In Reynoso v. United States, 692 F.3d 973, 2012 U.S. App. LEXIS 18208 (9th Cir. 2012), here, the Ninth Circuit applied the Section 6511, here, rules for statutes of limitations applying to refund to deny the taxpayer a claim for refund.  I don't think the Ninth Circuit broke new ground in the holdings.  See Oropallo v. United States, 994 F.2d 25, 30 (1st Cir. 1993).  I have,however, added the following examples to the examples in the text to show how the refund statute of limitations works:

Example 8.  Taxpayer prepays year 01 taxes in the amount of $100,000 by combination of estimated tax and withholding tax, but then fails to file the return timely on 4/15/02 and does not request an extension.  Those prepayments are deemed paid on 4/15/02.  The taxpayer thereafter files a delinquent year 01 original return on 7/15/05 on which he reports a tax liability of $50,000, claims credit for the prepaid tax of $100,000, and claims a resulting year 01 refund of $50,000.  The taxpayer meets the three year requirement of § 6511(a) because the claim for refund is filed contemporaneously with the return.  However, he flunks § 6511(b)(2)(A)’s look-back period requirement because the refund cannot exceed the taxes paid in the preceding three year period. Strangely, if the taxpayer had originally timely received an extension of the year 01 return which would have permitted him to file a timely year 01 return by 10/15/02, then the taxpayer will have met the § 6511(b)(2)(A) 3-year look-back requirement because extensions are counted even if not used. 

Example 9.  Same Example 8, except assume (i) the taxpayer does not apply for an extension, (ii) for some reason, the IRS treats the prepayment of $100,000 not as a payment of tax deemed paid on 4/15/02 but as a deposit or cash bond and (iii) the IRS applies the cash bond as a payment on 9/1/02.  The refund claim is then timely because the 7/15/05 filing is within 3 years of the date of payment.