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.