Missing Graphic from p. 424 of Student Edition (10/15/15)

There is a graphic mission from p. 424 of the student edition.  The graphic is here.  The graphic is in the practitioner edition.

You Lie, You Lose -- Another Midco Transaction Fails (10/15/15)

I have discussed so-called Midco transactions in this blog before where a seller and buyer of a C Corporation with a built-in liability use a bullshit tax shelter to claim to eliminate the tax and share in the tax thus "eliminated." Yesterday, the Tax Court issued a new opinion in a Midco transaction where the parties tried to scam the fisc.  Tricharichi v. Commissioner, T.C. Memo. 2015-201, here:

The Tax Court offers this succinct explanation of the Midco transaction:

Although Midco transactions took various forms, they shared several key features, well summarized by the Court of Appeals for the Second Circuit in Diebold Found. Inc. v. Commissioner, 736 F.3d 172, 175-176 (2d Cir. 2013), vacating and remanding T.C. Memo. 2010-238. These transactions were chiefly promoted to shareholders of closely held C corporations that had large built-in gains. These shareholders, while happy about the gains, were typically unhappy about the tax consequences. They faced the prospect of paying two levels of income tax on these gains: the usual corporate-level tax, followed by a shareholder-level tax when the gains were distributed to them as dividends or liquidating distributions. And this problem could not be avoided by selling the shares. Any rational buyer would normally insist on a discount to the purchase price equal to the built-in tax liability that he would be acquiring. 

Promoters of Midco transactions offered a purported solution to this problem. An "intermediary company" affiliated with the promoter -- typically, a shell company, often organized offshore -- would buy the shares of the target company. The target's cash would transit through the "intermediary company" to the selling shareholders. After acquiring the target's embedded tax liability, the "intermediary company" would plan to engage in a tax-motivated transaction that would offset the target's realized gains and eliminate the corporate-level tax. The promoter and the target's shareholders would agree to split the dollar value of the corporate tax thus avoided. The promoter would keep as its fee a negotiated percentage of the avoided corporate tax. The target's shareholders would keep the balance of the avoided corporate tax as a premium above the target's true net asset value (i.e., assets net of accrued tax liability). 

In due course the IRS would audit the Midco, disallow the fictional losses, and assess the corporate-level tax. But "[i]n many instances, the Midco is a newly formed entity created for the sole purpose of facilitating such a transaction, without other income or assets and thus likely to be judgment-proof. The IRS must then seek payment from other parties involved in the transaction in order to satisfy the tax liability the transaction was created to avoid." Id. at 176. 

In a nutshell, that is what happened here. Petitioner engaged in a Midco transaction with a Fortrend shell company; the shell company merged into West Side and engaged in a sham transaction to eliminate West Side's corporate tax; the IRS disallowed those fictional losses and assessed the corporate-level tax against West Side; but West Side, as was planned all along, is judgment proof. The IRS accordingly seeks to collect West Side's tax from petitioner as the transferee of West Side's cash. We hold that petitioner is liable for West Side's tax under the Ohio Uniform Fraudulent Transfer Act and that the IRS may collect West Side's tax liabilities in full from petitioner under section 6901(a)(1) as a direct or indirect transferee of West Side. We accordingly rule for respondent on all issues.

The opinion is longer, but that is the opinion in a "nutshell."

Second Circuit Opinion Affirming Denial of Motion to Quash Summons (10/1/15)

We have studied IRS summonses and summons enforcement in the class.  See Student edition pp. 271 - 282.  A recent nonprecedential opinion from the Second Circuit provides a useful review.  Highland Capital Management LP v. United States, 2015 U.S. App. LEXIS _____ (2d. Cir. 2015), here.

The Court provides a helpful introduction (footnote omitted):

Petitioner-Appellant Highland Capital Management, L.P. ("Highland Capital") challenges a decision and order of the District Court denying its motion to quash a third-party summons served by the Internal Revenue Service ("IRS") on Barclays Bank PLC ("Barclays") and granting the IRS's cross-motion for enforcement. The IRS had issued the summons seeking documents related to its audit of Highland Capital (the "2008 audit"), and particularly regarding losses claimed for 2008 related to two transactions with Barclays. On appeal, Highland Capital argues that the District Court erred in refusing to quash the summons because (1) the IRS failed to provide reasonable notice in advance of issuing the summons, as required by 26 U.S.C. § 7602(c)(1);1 (2) the summons seeks privileged and irrelevant documents; and (3) the summons was issued in bad faith or for an improper purpose. Finally, Highland Capital argues that the District Court erred by refusing to grant an evidentiary hearing on the question of the IRS's bad faith. "We review the district court's factual findings for clear error and its interpretation of the Internal Revenue Code de novo." Adamowicz v. United States, 531 F.3d 151, 156 (2d Cir. 2008). We assume the parties' familiarity with the underlying facts and the procedural history of the case.

Summons Relevance

As in some many of the endless stream of summons enforcement and quashing cases, the Court cites the Powell standard:

The standard set forth in United States v. Powell, 379 U.S. 48 (1964), governs motions to quash an IRS summons. Under Powell, "[t]he IRS must make a prima facie showing that: (1) the investigation will be conducted pursuant to a legitimate purpose, (2) 'the inquiry may be relevant to the purpose,' (3) 'the information sought is not already within the Commissioner's possession,' and (4) 'the administrative steps required by the [Internal Revenue] Code have been followed.'"

The Court then moves to the second Powell requirement -- relevance.  The Court reasoned:

Highland Capital contends that the summons seeks irrelevant information insofar as it requests documents related to transactions other than the two being investigated in connection with the 2008 audit. In determining relevancy, "[t]his court has consistently held that the threshold the Commissioner must surmount is very low, namely, 'whether the inspection sought might have thrown light upon' the correctness of the taxpayer's returns." Adamowicz, 531 F.3d at 158 (quoting United States v. Noall, 587 F.2d 123, 125 (2d Cir. 1978)). A court properly "defer[s] to the agency's appraisal of relevancy . . . so long as it is not obviously wrong." Mollison, 481 F.3d at 124 (internal quotation marks omitted). 

Here, the IRS agent conducting the 2008 audit has submitted a declaration explaining that information about the other transactions was necessary to determine how payments made in connection with a settlement agreement relate to the two transactions being investigated in the audit. Highland Capital has provided no reason for us to conclude that the IRS's appraisal of relevancy was "obviously wrong," and we accordingly find that Highland Capital has not satisfied its "heavy" burden to disprove this Powell factor. Mollison, 481 F.3d at 122-23, 124.

JAT Comment:  Basically, the agent said it was relevant to the tax investigation and the taxpayer did not show otherwise.  Obviously in a discovery context where the proponent of the discovery may not know the actual relevance of the documents requested, a broad standard of potential for relevance is required.

Reasonable Notice Pursuant to § 7602(c)(1)

Good Review of Points Previously Covered in Class (9/28/15)

Lua v. United States, 2015 U.S. Claims LEXIS 1235 (9/25/15), here, offers a good review of concepts we have studied in this case.

In Lua, upon completion of the audit, the unsophisticated taxpayers who did not have a representative signed a Form 4549 Income Tax Examination Changes.  This form has language "waiving their right to a notice of deficiency."  Section 6213(a), here, prohibits the IRS from assessing prior to issuing a notice of deficiency in income tax cases.  Section 6213(d) provides that a taxpayer may waive the right to receive a notice of deficiency, thus allowing an assessment without the notice of deficiency.  This waiver is often done on the Form 870, Waiver of Restrictions on Assessment, but also from the language quoted above, may be done on the Form 4549.  See Student Edition pp. 145-146 & 334-335.

Shortly after signing the waiver, the taxpayers engaged a tax professional.  The tax professional requested audit reconsideration in a telephone call to the agent and a day later confirmed the request in a letter to the group manager.

On November 26, 2007, the IRS assessed the deficiencies, but granted the request for audit reconsideration.  As a result of the audit reconsideration, the IRS ultimately reduced the amount of the deficiencies, but by that time the taxpayers had filed amended returns and, apparently protectively, payments substantially in excess of the amounts ultimately determined to be due.  It is a little fuzzy to me precisely what happened after the assessment, but it may not be critical for the points discussed below.  What appears to be in issue in this refund litigation is the amount paid up to the amount that was not abated in audit reconsideration -- in other words the amount determined due after audit reconsideration

1. Did the taxpayers waive the right to a notice of deficiency.

Yes.  The taxpayers did sign the Form 4549 which waives the notice of deficiency in clear language.  In this regard, the Court indicated in footnote 12 that the waiver had not been improperly induced.

2.  Did the taxpayers withdraw the waiver of the notice of deficiency.

No.  The taxpayers asked for audit reconsideration which is a separate procedure.  Audit reconsideration is addressed in the text.  See Student edition p. 452.

Writing Tips from a Master (9/26/15)

This is not about tax procedure.  It is about writing and persuading.  The goal of learning tax procedure is to persuade in a tax setting.  So, I encourage students to read this blog entry about the art of persuasion and the use of hyperbole.

“If you are a lawyer, don’t write this stuff. … If you hire lawyers, don’t let them write it.”  (The Volokh Conspiracy 9/24/15), here.  The actual author of the content is Gary Kinder at Wordrake, here.

Indeed, there is another good recent offering from Gary Kinder, Once Upon a Time I Fell, and It Has Made All the Difference (Wordrake), here, where Kinder recommends the best writers' reference books.

Both are pretty short reads, entertainingly written and, well, persuasive.

Enjoy!

Are Appeals Officers Equipped and Trained to Assess Accurately the Litigating Hazards of a Case? (9/25/15)

Appeals' standard for settlement is to reflect the litigating hazards of the case.  See IRM 8.6.4.1  (10-26-2007), Fair and Impartial Settlements per Appeals Mission, here ("A fair and impartial resolution is one which reflects on an issue-by-issue basis the probable result in event of litigation"). One of the concerns expressed with that standard is that Appeals Officers are not litigators nor are most of them even lawyers.  How then do they assess the litigating hazards of a case?

Keith Fogg of Procedurally Taxing has this blog on the subject where he expresses concern:  Judging Litigation Hazards without Seeing or Following Litigation (Procedurally Taxing Blog 7/6/15), here.  Keith is a law professor now but formerly was with Chief Counsel and had considerable opportunity to observe Appeals Officers' application of the standard.  He expresses concern that Appeals may be paying less attention to insuring that Appeals Officers at least observe litigation to sharpen their skills at determining the litigation hazards.  And, of course, the Appeals Officers have difficulty assessing evidentiary and procedural problems and how they may affect the outcome of the case if it proceeds to trial.  Among the problems is credibility of witnesses.  Many cases (including the anecdote I present at the end of this blog entry) really turn on credibility, and the Appeals Officer has no way of factoring credibility into a settlement.  It is true that many revenue agents may view the witnesses as not credible, often without even interviewing them and the Appeals Officer will usually be aware of the revenue agent's assessment of credibility.  But, the Appeals Officer has no way of assessing the revenue agent's determination of credibility or, more directly,  making an independent determination of credibility to properly assess the litigating hazards.

Sheldon ("Shelly") Kay, currently with a law firm but previously with district counsel and thereafter with Appeals where he served as National Director of Appeals, does not agree with Keith.  He has written his views in a blog on Procedurally Taxing:  “Judging Litigating Hazards – Another View” (Procedurally Taxing 9/24/15), here.  Shelly makes a strong rebuttal.

I encourage tax procedure fans and particularly students in my class to read these blogs.  They are relatively short and discuss a core function of Appeals.  We will cover Appeals on October 1, and I have provided a link to this blog (with the links to the Procedurally Taxing Blogs).

Revision to Texts on Tax Shelters and Case Assignment (9/24/15)

I have assigned in Unit/Class 10 the following case (trial and appellate level opinions):  Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999), rev’d 277 F.3d 778 (5th Cir. 2002).   I have revised the text on p. 544 of the student edition and p. 783 of the practitioner edition as follows:

Eliminate the last four sentences (beginning The Compaq case) in the carryover paragraph to p. 544 of the student edition in the paragraph beginning "Tax shelters are" of the practitioner edition.  After that elimination add the following paragraph as a new paragraph:

A good example of a classic tax shelter is Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999), rev’d 277 F.3d 778 (5th Cir. 2002).  Please read both the Tax Court and the Appellate opinions now.  In net, a classic abusive tax feature present in the case is that, except for the benefit of the foreign tax credit for foreign taxes paid that Compaq did not bear the economic burden, the deal was a money-loser.  The Tax Court viewed the transaction as abusive and imposed penalties; the Fifth Circuit blessed the transaction.  It was a tax shelter; it was just a tax shelter that, at least the appellate court, believed – or at least held, regardless of what it believed – was legal and not abusive.  Both the Tax Court and the Fifth Circuit are good courts, with good judges having radically different views of what is an abusive tax shelter and where to draw the line.  (Note the Fifth Circuit’s opinion, however, has not worn well with time.)

For practitioners, the only footnote in the paragraph is at the end to support the statement that the Fifth Circuit decision has not worn well with time.  The footnote is:

fn E.g., Bank of N.Y. Mellon Corp. v. Commissioner, ___ F.3d ___, 2015 U.S. App. LEXIS 15993 (2d Cir. 2015) (“In so holding, we agree with the Federal Circuit in Salem and disagree with decisions of the Fifth and Eighth Circuits (Compaq and IES, respectively));” Lee A. Sheppard, The Fun Goes Out of Foreign Tax Credit Planning, 148 Tax Notes 1283 (Sept. 21, 2015) (hyperbolically, as is her wont, “The Second Circuit essentially reversed the Compaq and IES decisions.”)

Flora Full Payment Rule and the Rough Edges (9/17/15)

In the class we discuss the rule -- called the Flora rule -- that, in order to maintain a tax refund suit, the taxpayer generally must fully pay the amount of the assessment.  See Flora v. United States, 362 U.S. 145 (1960), here.  There are some key nuances to that rule.  I discuss those nuances in the Student edition pp. 382-384 and in the practitioner edition pp.  545-549.

One of the key nuances is that, if the assessment in question is a "divisible tax," the taxpayer may pay only the divisible amount.  Flora v. United States, p. 175 n.38 (some taxes "may be divisible into a tax on each transaction or event, so that the full-payment rule would probably require no more than payment of a small amount.”)   For example, for trust fund recovery penalty ("TFRP") based on all employees for a particular quarter or quarters, because the underlying trust fund taxes are divisible, the taxpayer contesting assessment of the TFRP, need only pay for one taxpayer for one quarter.

The divisible tax rule mitigates the full bore application of Flora, and usually makes a refund remedy within the reach of a taxpayer subject to a divisible tax assessment.  The problem comes if the tax (or penalty treated as a tax for this purpose) is so large that paying the full assessment is beyond the reach of the taxpayer.

In Diversified Group Inc. v. United States, 123 Fed. Cl. 442, 2015 U.S. Claims LEXIS 1276 (2015), here [see note below at *], appeal docketed, No. 16-1014 (Fed. Cir. October 6, 2015), the promoter of an abusive shelter and his corporation involved with the promotion of the shelter was assessed a penalty under § 6707, here, for failing to register the shelter.   The penalty was over $24 million.  The promoter paid a small amount and sued for refund, hoping to fit within the divisible penalty exception to full payment.  The Court held that the penalty was not divisible, hence requiring the promoter to pay the full penalty before pursuing a refund suit.

I do not know the financial ability of the promoter or his corporation, but for most ordinary people, paying that amount would difficult, probably impossible.

So the question is when a taxpayer is financially unable to meet the Flora full payment rule and must do so for a refund suit remedy, does he have an alternative to obtain a judicial remedy?  Of course, for the types of tax that require a predicate notice of deficiency, the taxpayer can obtain a Tax Court remedy.  But sometimes the taxpayer may not have received the notice of deficiency (the last known address issue) or the type of tax or penalty does not require a notice of deficiency (§ 6707 is one).

In a case like that, the taxpayer or the person assessed a penalty may be able to get a CDP remedy that could lead to a Tax Court review of the liability.  Keith Fogg a contributor on the Procedurally Taxing Blog discusses this issue in Another Flora Decision – Bad News for Tax Shelter Promoters Highlights Possible CDP Jurisdictional Issue (Procedurally Taxing Blog 9/15/15), here.   Keith concludes:  "It appears that they can litigate the merits of this penalty using the CDP process though the path to that answer may not be as clear as one might like and the answer appears to turn on whether the taxpayer has administratively requested penalty abatement after the assessment."  Keith does a great job of discussing his reasoning and nuance, so I strongly encourage readers to read the blog.

CDP review is discussed in the text - student edition, pp. 457-463 and practitioner edition pp. 657-667.

* This blog entry was prepared on the basis of the original opinion.  The court subsequently reissued the opinion on 9/2/15.  I have changed the citation reference and the link.  Although I have not compared to see what might have changed in the reissued opinion, I don't believe anything was changed relevant to the discussion in this blog entry.

IRS Terminates Appeals Arbitration (9/12/15)

The IRS has terminated Appeals arbitration.  Rev. Proc. 2015-44, 2015-38 IRB 1, here

I have revised the text of the pdf text books.  In the text of the student edition on p. 346 and of the practitioner edition on p. 491, the following is substitued for the paragraph commencing "The IRS has Appeals mediation."

The IRS tested appeals arbitration for 14 years, but in 2015 decided to discontinue the program.  The IRS still has an Appeals mediation program.  The Appeals mediation process, referred to as the “Post Appeals Mediation,” can be invoked in appropriate cases after the taxpayer and the Appeals Officer have failed to reach agreement as to an issue or issues, but before the Appeals Office closes the case.  Issues eligible and ineligible for mediation are listed in the IRM; thus, for example, legal and factual issues are eligible for mediation.

The significant new citation in the footnotes is Rev. Proc. 2015-44, 2015-38 IRB 1.

Payment of "Tax" After the Assessment Limitations Period Expires - Refunds (9/11/15)

Apropos to our discussions in class of the statute of limitations on assessment, in ECC 201536020 (9/4/15), here, the IRS attorney addresses the refund of taxes paid after the assessment statute of limitations expired:

A tax payment made to the Service after the expiration of the period of limitation on assessment is considered an overpayment, even if there was no tax liability. Section 6401(a) & (c). The Service has authority to refund overpayments, but only within the applicable period of limitations. Section 6402(a); Rev. Rul. 74-580. The IRM in section 25.6.1.10.2.5.6.2 (10-11-2012) Claim for an Amount Paid After the ASED, (stating "If an amended return is filed after the expiration of the period of limitations on assessment, any amount paid with that return must be refunded to the taxpayer. The taxpayer does not need to file a claim for refund in order to receive a refund of the payment made with the late filed amended return for additional tax assessment.") is discussing the need for filing a claim, not the applicability of the period of limitations. Therefore, a payment made after the ASED may be refunded to the taxpayer, but only within the limitations set forth in section 6511.

ASED in the quote means:  assessment statute expiration date and is the usual IRM term for the date the statute on assessment expires.  In the above quote, the payment was made with no timely assessment.

As indicated, the IRS can refund the overpayment resulting from payment after expiration of the statute of limitations, but the taxpayer must file the claim for refund within the refund claim statute of limitations if the IRS does not refund voluntarily.