constructive dividends section 301(c)

Funds that a corporation distributes to a shareholder with respect to its stock are taxed to the shareholder as dividends to the extent of the corporation's earnings and profits. Secs. 301(c), 316. Any excess is considered to be a nontaxable return of capital to the extent of the shareholder's basis in the [*10] corporation, and any remaining amount is taxable to the shareholder as a gain from the sale or exchange of property. See sec. 301(c)(2) and (3); Truesdell v. Commissioner, 89 T.C. 1280, 1295-1298 (1987). Characterization of a distribution as a dividend does not depend upon a formal dividend declaration. See Boulware v. United States, 552 U.S. 421, 429 [101 AFTR 2d 2008-1065] (2008); Truesdell v. Commissioner, 89 T.C. at 1295; see also Noble v. Commissioner, 368 F.2d 439, 442 [18 AFTR 2d 5982] (9th Cir. 1966), aff'g T.C. Memo. 1965-84. Corporate funds that a controlling shareholder diverts to personal use are generally characterized as constructive distributions to the shareholder for tax purposes. See Erickson v. Commissioner, 598 F.2d 525, 531 [44 AFTR 2d 79-5241] (9th Cir. 1979), aff'g in part, rev'g in part T.C. Memo. 1976-147; Strong v. Commissioner, T.C. Memo. 2005-125. Such a diversion may occur where a controlling shareholder causes a corporation to pay his or her personal expenses and the payment is made without expectation of repayment or without a bona fide intent that it be in repay[pg. 942] ment of a shareholder loan. See Hood v. Commissioner, 115 T.C. 172, 179-180 (2000); see also Noble v. Commissioner, 368 F.2d at 443; Clark v. Commissioner, 266 F.2d 698, 710-711 (9th Cir. 1959), aff'g in part, rev'g in part and remanding T.C. Memo. 1957-129.




www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

section 6663 fraud penalty

In deciding whether a failure to file is fraudulent under section 6651(f), the same elements that are considered in imposing the addition to tax for fraud under section 6663 and former section 6653(b). Clayton v. Commissioner, 102 T.C. 632, 653 (1994). Those elements are: (1) the existence of an underpayment and (2) fraudulent intent with respect to some portion of the underpayment. See Petzoldt v. Commissioner, 92 T.C. 661, 698-699 (1989).  

Section 6663 Fraud Penalty Fraud is an intentional wrongdoing on the part of a taxpayer with the specific purpose to evade a tax believed to be owed. Sadler v. Commissioner, 113 [*18] T.C. 99, 102 (1999). 



The penalty in the case of fraud is a civil sanction provided primarily as a safeguard for protection of revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391, 401 [20 AFTR 796] (1938); Sadler v. Commissioner, 113 T.C. at 102.

 The Commissioner has the burden of proving by clear and convincing evidence an underpayment for each year in issue and that it is due to fraud. Sec. 7454(a); Rule 142(b). 

The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner, 90 T.C. 1130, 1143 (1988). If the Commissioner establishes that any portion of the underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud and subject to a 75% penalty, unless the taxpayer establishes that some part of the underpayment is not attributable to fraud. Sec. 6663(a) and (b). In the case of a joint Federal income tax return, the section 6663 penalty “shall not apply with respect to the spouse unless some part of the underpayment is due to the fraud of such spouse.” Sec. 6663(c). 

 Fraudulent intent may be inferred from various kinds of circumstantial evidence, or “badges of fraud”, including the consistent understatement of income, inadequate records, implausible or inconsistent explanations of behavior, concealing assets, and failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303, 307 [58 AFTR 2d 86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC].

In the context of the seventy-five percent penalty of § 6663,  “fraud is intentional wrongdoing on the part of the taxpayer with the specific intent to avoid a tax known to be ow ing.” Bradford v. Comm'r, 796 F.2d 303, 307 [58 AFTR 2d 86-5532] (9th Cir. 1986) (quoting Akland v. Comm'r, 767 F.2d 618, 621 [56 AFTR 2d 85-5649] (9th Cir. 1985)). To estab lish liability for the civil fraud penalty, “the Government must establish: (1) a knowing falsehood; (2) an intent to evade taxes; and (3) an underpayment of tax.” Considine v. United States, 683 F.2d 1285, 1286 [50 AFTR 2d 82-5678] (9th Cir. 1982). [pg. 2013-473]

. Fraudulent intent is a question of fact that must be considered on the basis of an examination of the record and the taxpayer's course of conduct, drawing reasonable inferences therefrom. Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943); Petzoldt v. Commissioner, 92 T.C. at 699. Because fraudulent intent can seldom be established by direct proof, it may be proved by circumstantial evidence. See Clayton v. Commissioner, 102 T.C. at 647; Petzoldt v. Commissioner, 92 T.C. at 700. Thus, intent to defraud may be inferred from any conduct the likely effect of which would be to conceal, mislead, or otherwise prevent the collection of taxes believed to be owing. Spies, 317 U.S. at 499. Courts look to a nonexclusive list of factors, or “badges of fraud”, to determine whether fraudulent intent exists. Niedringhaus v. Commissioner 99 , T.C. 202, 211 (1992); King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992). 

Fraud may be proved by circumstantial evidence and inferences drawn from the facts because direct proof of a taxpayer's [*19] intent is rarely available. Niederinghaus v. Commissioner, 99 T.C. 202, 210 (1992). The taxpayer's entire course of conduct may establish the requisite fraudulent intent. DiLeo v. Commissioner, 96 T.C. at 874; Stone v. Commissioner, 56 T.C. 213, 223-224 (1971).   Fraudulent intent can be inferred from strong circumstantial evidence.” Bradford, 796 F.2d at 307; see 26 U.S.C. § 7454(a) (“In any proceeding involving whether the petitioner has been guilty of fraud with intent to evade tax, the burden of proof in respect to such issue shall be upon the Secretary.”). 

They include: (1) failure to file income tax returns; (2) failure to maintain adequate records; (3) failure to cooperate with tax authorities; (4) assertion of frivolous arguments and objections to the tax laws; (5) lack of credibility in testimony; (6) failure to make estimated tax payments; (7) understatement of income; and (8) concealment of income. See Laurins v. Commissioner, 889 F.2d 910, 913 [65 AFTR 2d 90-364] (9th Cir. 1989), aff'g Norman v. Commissioner, [*14] T.C. Memo. 1987-265 [¶87,265 PH Memo TC]; Bradford v. Commissioner, 796 F.2d 303, 307-308 [58 AFTR 2d 86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC]; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988). No single factor is determinative of fraud; however, the existence of several indicia may constitute persuasive circumstantial evidence of fraud. Niedringhaus v. Commissioner, 99 T.C. at 211; Petzoldt v. Commissioner, 92 T.C. at 700. The taxpayer's background and the context of the events in question may also be considered circumstantial evidence of fraud. Spies, 317 U.S. at 497; Plunkett v. Commissioner, 465 F.2d 299, 303 [30 AFTR 2d 72-5122] (7th Cir. 1972), aff'g T.C. Memo. 1970-274 [¶70,274 PH Memo TC]. We address the badges of fraud individually. 1. Failure To File Income Tax Returns[pg. 146]

www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

Ordinary and necessary section 162 business expenses

Ordinary and Necessary Tax deductions are a matter of legislative grace, and taxpayers must satisfy the specific statutory requirements for the item claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 [69 AFTR 2d 92-694] (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934). 

Generally, a taxpayer may deduct ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). 

Whether an expense satisfies section 162 is generally a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 [31 AFTR 783] (1943). An expense is ordinary if it is customary or usual within a particular trade, business or industry or relates to a common or frequent transaction in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 [23 AFTR 808] (1940).

 A necessary expense is appropriate and helpful to the operation of the taxpayer's trade or business. See Commissioner v. Tellier, 383 U.S. 687, 689 [17 AFTR 2d 633] (1966); Carbine v. Commissioner, 83 T.C. 356, 363 (1984), aff'd, 777 F.2d 662 [57 AFTR 2d 86-406] (11th Cir. 1985).



www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

Trust fund recovery penalty - "significant control" to be a "responsible person"

.  Code Sec. 6672 imposes the trust fund recovery penalty on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The amount of the penalty is equal to the amount of the tax that was not collected and paid. 

The penalty is imposed on a “responsible person,” i.e., anyone in a business entity who has the duty to collect, account for, or pay over the tax. In determining whether there is willfulness, the courts have focused on whether a taxpayer had knowledge about the non-payment of the payroll taxes, or showed reckless disregard with respect to whether the payments were being made. Although the Code doesn't define who is “responsible” for purposes of the penalty, the Second Circuit has said that the determinative question is whether the individual has significant control over the enterprise's finances. 

The Second Circuit has instructed courts to consider the following relevant factors in determining whether an individual had significant control: whether the individual (1) is an officer or member of the board of directors; (2) owns shares or possesses an entrepreneurial stake in the company; (3) is active in the management of day-to-day affairs of the company; (4) has the ability to hire and fire employees; (5) makes decisions regarding which, when, and in what order outstanding debts or taxes will be paid; (6) exercises control over daily bank accounts and disbursement records; and (7) has check-signing authority. (U.S. v. Rem, (CA 2 1994) 74 AFTR 2d 94-6649)




www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

Commuting expenses

Costs of commuting between a taxpayer's residence and place of business are generally nondeductible personal expenses. However, the Internal Revenue Service recognizes three exceptions: (1) transportation between the taxpayer's residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works is deductible (“temporary distant workplace exception”); 

(2) if the taxpayer has one or more “regular work locations away from the taxpayer's residence,” transportation between the taxpayer's residence and a temporary work location is deductible (“regular work location exception”); and

 (3) transportation between the taxpayer's residence (if the residence serves as the taxpayer's principal place of business) and a regular or temporary work location is deductible (“home office exception”). Rev. Rul. 99-7, 1999-1 C.B. 361 

www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

FATCA Tax Compliance

FATCA compliance primer for U.S. multinationals 

The Foreign Account Tax Compliance Act (FATCA) rules, which impose significant reporting, documentation and withholding obligations, are not limited to financial institutions. These rules can also impose significant and burdensome requirements on U.S. multinationals. 

Below is a summary of the steps U.S. multinationals should take in order to ensure their compliance with FATCA. Background.  Generally effective for payments made after Dec. 31, 2012 (but delayed in IRS guidance; see below), the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147) established rules for withholdable payments to foreign financial institutions (FFIs; generally including non U.S. banks, broker-dealers and other custodians, investment vehicles, and certain insurance companies) and for withholdable payments to other foreign entities by adding a new Chapter 4 to the Code (Code Sec. 1471 through Code Sec. 1474). 

The new rules provide for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified U.S. persons or by U.S.-owned foreign entities (“U.S. accounts”). Under Code Sec. 1471(d), a financial account is defined as any depository or custodial account maintained by the financial institution, or any equity or debt interest in the financial institution (other than interests regularly traded on an established securities market).

 Under Code Sec. 1471(a), a withholding agent must withhold 30% of certain payments to an FFI unless the FFI has entered into a “FFI agreement” with IRS to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes on withholding agents withholding, documentation, and reporting requirements with respect to certain payments made to certain other foreign entities. 

The registration, due diligence, information reporting and withholding obligations for U.S. source FDAP income under FATCA are generally effective as of Jan. 1, 2014. Entities will have to determine by October of 2013 whether they qualify as FFIs and, to the extent they do, register with IRS. The final FATCA regs were explained in a detailed six-part article published earlier this year 

. Application to U.S. multinationals.  U.S. multinationals may have group companies that could qualify as FFIs, such as treasury centers, captive financing or insurance companies, and retirement funds. Although most of the discussion related to FATCA's implications on U.S. payors of U.S. source withholdable payments has been focused on financial institutions, U.S. multinationals and, in certain scenarios, U.S. citizens and tax residents, may have withholding obligations. U.S. multinationals making withholdable payments to entities outside of the U.S. have to withhold 30% under the FATCA rules unless the entities make certain disclosures to IRS and to the U.S. withholding agent payor. For purposes of complying with the FATCA rules, U.S. multinational enterprises are expected to implement certain procedures that may require changes to previously used account payable systems and compliance processes. Roadmap to compliance.  U.S. multinationals should consider taking the following steps to ensure their compliance with FATCA:

 (1) The multinational has to make a determination as to which of the payments it makes qualify as a “withholdable payment” for purposes of FATCA. Withholdable payments generally include U.S. source fixed or determinable, annual or periodical (FDAP) income, such as interest, dividends, and most types of royalties and rents as well as gross proceeds from the sale of securities that could generate U.S. source income. Income effectively connected to a U.S. trade or business (e.g. fees for certain services), however, will not be subject to withholding under FATCA. 

(2) Next, the multinational should determine whether the non-U.S. recipient of the withholdable payment is an FFI or a non-financial foreign entity (“NFFE”). Generally, NFFEs that are publicly traded (including their subsidiaries) are not subject to FATCA. Non-publicly traded NFFEs and FFIs, however, must either comply with the disclosure rules or be subject to the 30% withholding tax. (3) To the extent the income recipient identified in Step 2 is an FFI, an inquiry must be made to determine whether the FFI is a participating FFI or a non-participating FFI. Non-participating FFIs will be subject to the 30% withholding. (4) For NFFE recipients, information should be requested and reported regarding any substantial U.S. owners. If such information is not provided, the payment should be subject to the 30% withholding tax. In order to meet the above requirements, MNEs would have to build out compliance processes to ensure that all necessary determinations, monitoring, documentation and reporting is in place for purposes of complying with the FATCA rules. References: For withholdable payments to FFIs and other foreign entities, 




www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com

www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com