Monday, February 28, 2011
How decision not to defend the Defense of Marriage Act affects same-sex married couples' taxes. The Attorney General has announced that the Justice Department will no longer defend the constitutionality of Section 3 of the Defense of Marriage Act, which denies recognition of same sex marriages for purposes of administering Federal law. However, Section 3 will remain in effect unless Congress repeals it or there is a final judicial finding that strikes it down. In the meantime, the government will continue to enforce it. This article examines how this controversial development could affect Federal taxes imposed on legally-married same-sex couples. The decision not to defend Section 3 has no impact on same-sex couples who are not legally married. Background. In '96, Congress enacted, and President Clinton signed, the Defense of Marriage Act (DOMA) into law. Section 3 of DOMA defines marriage for purposes of administering Federal law as the “legal union between one man and one woman as husband and wife.” It further defines “spouse” as “a person of the opposite sex who is a husband or wife.” Statement of Attorney General. The Attorney General's statement notes that, in the two years since the Obama Administration took office, the Justice Department has defended Section 3 of DOMA on several occasions in federal court. Until recently, those cases were in jurisdictions in which binding circuit court precedents hold that laws singling out people based on sexual orientation, as DOMA does, are constitutional if there is a rational basis for their enactment. While the President opposes DOMA and believes it should be repealed, the Justice Department has defended DOMA because it was able to advance reasonable arguments under the rational basis standard. More recently, Section 3 of DOMA has been challenged in two cases in the Second Circuit, which has no established or binding standard for how laws concerning sexual orientation should be treated. These cases are Pedersen v. OPM, No. 3:10-cv-1750 (D Conn) and Windsor v. U.S., No. 1:10-cv-8435 (SD NY). Pedersen challenges the federal government's denial of marriage-related protections in multiple areas of federal law including federal income taxation. Windsor challenges the denial of an estate tax marital deduction to the estate of a woman who was married in Canada in May 2007 to her same-sex partner of 40 years. New York state, where the couple resided, recognized the marriage but the federal government denied the marital deduction because of Section 3 of DOMA. The Attorney General's statement notes that, in these cases, the Administration faces for the first time the question of whether laws regarding sexual orientation should be subject to a more rigorous standard. After careful consideration, the President has concluded that classifications based on sexual orientation should be subject to a more heightened standard of scrutiny. The President has also concluded that Section 3 of DOMA, as applied to legally married same-sex couples, fails to meet that standard and is therefore unconstitutional. As a result, upon the President's instruction, the Justice Department won't defend the constitutionality of Section 3 of DOMA as applied to same-sex married couples in Pedersen and Windsor. Members of Congress have been informed so that they may defend the statute if they wish. Furthermore, pursuant to the President's instructions, the Attorney General will instruct Justice Department attorneys to advise courts in other pending DOMA litigation that a heightened standard should apply, that Section 3 is unconstitutional under that standard, and that the Justice Department will cease defense of Section 3. Section 3 of DOMA will continue to remain in effect unless Congress repeals it or there is a final judicial finding that strikes it down and the Executive Branch will continue to enforce the law. Federal tax impact on married same-sex couples. This is obviously a big development for legally married same-sex couples. If the law is repealed, or struck down, legally married same-sex couples may be able to secure tax breaks that are presently available only to legally married couples of the opposite sex. These include: ... the right to file a joint return, which can produce a lower combined tax than the total tax paid by the same-sex spouses filing as single persons; ... the possible opportunity to get tax-free employer health coverage for the same-sex spouse; ... the possibility of more easily obtaining a dependency exemption for the same-sex spouse; ... the opportunity for either same-sex spouse to utilize the marital deduction to transfer unlimited amounts during life to the other same-sex spouse free of gift tax; ... the opportunity for the estate of the first same-sex spouse to die to get a marital deduction for amounts transferred to the surviving same-sex spouse; ... the opportunity for the estate of the first same-sex spouse to die to transfer the deceased spouse's unused exclusion amount to the surviving same-sex spouse; and ... the opportunity for a surviving same-sex spouse to stretch out distributions from a qualified retirement plan or IRA after the death of the first same-sex spouse under more favorable rules than apply for nonspousal beneficiaries (which same-sex spouses presently must use). In addition to tax breaks, there are numerous other benefits that could derive for a married same-sex couple whose marriage is respected under Federal law. These include, for example, social security spousal protections; the opportunity for the spouse to stay in the family residence should the other spouse need Medicaid for nursing home care; and various benefits provided for spouses of federal employees. RIA observation: Presumably, IRS will issue guidance on what legally married same-sex couples can do to make protective refund claims should Section 3 of DOMA be repealed or struck down. RIA recommendation: In the meantime or in the absence of any guidance from IRS, one option for legally married same-sex couples would be to file their return applying the current rules denying their marital status. Subsequently, they can file an amended return claiming a tax break that is currently allowable only to spouses of the opposite sex. In making such a claim or claims, they should disclose that they are a legally married same-sex couple and are making the claim on the basis that Section 3 of DOMA is unconstitutional. Presumably, under the policy of continued enforcement, IRS will deny the claim. After IRS denies the claim, the couple can then sue for a refund in district court, which may produce a favorable result as occurred in Nancy Gill, et al. v. Office of Personnel Management, et al., (DC MA 07/08/2010) 106 AFTR 2d 2010-5154 , see Weekly Alert ¶ 7 07/15/2010 . If the couple does not have the resources or desire to proceed with a suit, at the very least they will have made a timely claim that may preserve their opportunity to get a refund in the event the law is repealed or struck down.
Saturday, February 26, 2011
House Ways And Means Committee Approves 1099 Repeal Legislation, Provides Relief to Small Businesses, Families and Individuals Thursday, February 17, 2011 Washington, DC – Today, the Committee on Ways and Means approved two separate pieces of legislation to repeal the onerous 1099 reporting provisions enacted in 2010. At the conclusion of the markup and approval of both H.R. 4, the “Small Business Paperwork Mandate Elimination Act of 2011,” and H.R. 705, the “Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011,” Chairman Camp made the following statement: “The legislation approved by the Committee today is a victory for America’s small businesses, families and individuals. Congress should make every effort to reduce the heavy burden of paperwork that takes time, energy and resources away from creating jobs. Families and individuals who do something as common as rent out a room and either replace an appliance at their rental property or pay a lawn service should not have to worry about the added headache of reporting that transaction to the IRS. “We took a fiscally responsible path to achieve this relief by reducing waste, fraud and abuse from the Democrats’ health care law, which also allowed us to reduce the deficit. I look forward to consideration of this legislation by the House very soon so that all those affected by the uncertainty of these provisions can breathe a long-awaited sigh of relief.” Background and Key Facts: • H.R. 4, the “Small Business Paperwork Mandate Elimination Act of 2011,” repeals the onerous new Form 1099 information reporting requirements that were imposed on small businesses to help pay for the Democrats’ trillion dollar health care law. • H.R. 705, the “Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011”: o Repeals the onerous new Form 1099 information reporting requirements that were imposed on small businesses to pay for the Democrats’ health care law; o Repeals an additional Form 1099 information reporting requirement on owners of rental real estate; and o Reduces improper overpayments of Exchange subsidies established under the Democrats’ health care law. • According to the Joint Committee on Taxation (JCT), H.R. 705 would, on net, reduce the deficit by $166 million over the 2011-2021 period. • More than 175 organizations support 1099 repeal, including many in the small business community who signed a letter for repealing the1099 reporting provisions on job creators.
Friday, February 25, 2011
IRS abused its discretion in refusing to consider subordinating its tax lien Alessio Azzari, Inc., (2011) 136 TC No. 9 The Tax Court has concluded that IRS's refusal to consider a corporation's request to subordinate its tax lien, based on the settlement officer's erroneous conclusion that a lender's security interest in the corporation's accounts receivable already had priority over the tax lien, was an abuse of discretion. The Court further held that IRS abused its discretion in denying the corporation's request for an installment agreement based on the corporation's failure to stay current on its tax deposits where such failure was largely due to IRS's refusal to subordinate its lien. Background. Under Code Sec. 6321 , when a taxpayer fails to pay a tax liability after notice and demand, a lien arises that attaches to all the taxpayer's property and rights to property. Under Code Sec. 6331 , IRS is authorized to seize and sell the taxpayer's property and rights to property subject to a federal tax lien. Thus, IRS may seize any property or property right (unless it's exempt under Code Sec. 6334(a) ) of a delinquent taxpayer (whether held by him or someone else), sell it, and apply the proceeds to pay the unpaid taxes. Seized property may be real, personal, tangible, or intangible, including receivables, bank accounts, evidences of debt, securities, and salaries, wages, commissions or compensation. ( Code Sec. 6331(a) , Reg. § 301.6331-1(a) ) Lenders who enter “commercial transactions financing agreements,” in which the lender makes a loan against certain types of commercial financing security such as accounts receivable, are given a 45-day grace period in which to make advances or purchases which are protected against tax liens previously filed within the period under Code Sec. 6323(c) . Accounts receivable acquired by a taxpayer more than 45 days after a federal tax lien is filed aren't protected by a financing agreement entered into before the filing of a federal tax lien. Under Code Sec. 6159 , IRS may enter into written agreements with any taxpayer. IRS must enter into an installment agreement requested by an individual whose aggregate tax liability (without interest, penalties, additions to tax, and additional amounts) isn't more than $10,000, and who hasn't failed to file or to pay income tax, or entered into another installment agreement, during any of the preceding five tax years, if IRS determines that the taxpayer is financially unable to pay the liability in full when due (and the taxpayer submits information that IRS may require to make this determination). The agreement must require full payment within three years, and the taxpayer must agree to comply with all Code provisions while it's in effect. Facts. Allesio Azzari, Inc. (Azzari) is a New Jersey-based corporation in the homebuilding industry. In 2005 and 2006, Azzari experienced financial difficulties and fell behind on its Federal employment tax deposits. Azzari failed to timely file its employer's quarterly tax returns for the last 2 quarters of 2005, but it did timely file such returns for each quarter in 2006. IRS assessed the tax shown on the return for each period but Azzari didn't fully pay its liabilities, which total $1,100,622 for the periods at issue. During January of 2007, Azzari received financing from a lender secured by an interest in Azzari's accounts receivable. The lender filed a financing statement to record its security interest with the State of New Jersey. The lender's financing helped Azzari remain current with its tax deposits for six consecutive quarters. Around Nov. 6, 2007, IRS mailed Azzari a notice of intent to levy and subsequently filed a notice of federal tax lien (NFTL) for Azzari's unpaid employment tax liabilities. Around Jan. 2, 2008, Azzari timely submitted a request for a Collection Due Process (CDP) hearing. It also requested that IRS withdraw its lien and consider an installment agreement as a collection alternative, explaining that the tax lien made it more difficult for Azzari to satisfy its tax liabilities. On Jan. 25, 2008, before receiving any reply from IRS, Azzari submitted a written request asking IRS to subordinate its NFTL to a line of credit from the lender and agree to a proposed installment agreement. In this request, Azzari stated that the lender refused to extend any more credit to it unless IRS agreed to subordinate the NFTL to the lender's security interest. Azzari's counsel and the IRS settlement officer had a face-to-face conference on June 26, 2008. The settlement officer told Azzari that the IRS lien could not be subordinated because it didn't have priority over the lender's earlier-filed security agreement. The officer suggested that the lien might be withdrawn if Azzari paid $300,000 immediately and entered an installment agreement to pay the balance within 10 years, provided that Azzari remained current on its tax deposits. Azzari again fell behind on its deposits in the third quarter of 2008. The settlement officer contacted Azzari's lawyer and told him that failure to make deposits would render Azzari ineligible for an installment agreement, and also told him that Azzari's proposed installment agreement was likely unrealistic. The lawyer responded that Azzari had taken drastic actions to cut its costs, and again stated that it was “severely hurt” by its inability to borrow against its accounts receivable. On Sept. 29, 2008, the settlement officer told Azari's lawyer that he would no longer consider an installment agreement, and a notice of determination was mailed to Azzari on October 9. The notice explained that IRS wouldn't withdraw its lien or enter into the proposed installment agreement due to Azzari's compliance record. The notice didn't address the subordination request. Conclusion. The Tax Court concluded that it was an abuse of discretion for IRS to refuse to consider Azzari's request to subordinate the NFTL based on the erroneous conclusion of law that the lender's security interest already had priority over the NFTL in Azzari's accounts receivable. Contrary to the settlement officer's determination, under Code Sec. 6323(c) , the lender's security interest did not have priority over the tax lien in Azzari's accounts receivable acquired more than 45 days after the NFTL was filed, despite the fact that it was first-in-time. Based on this erroneous belief, the settlement officer didn't even consider subordinating the tax lien, even though it was within his discretion to do so under Code Sec. 6325(d) . The Tax Court further determined that IRS abused its discretion by declining to enter into an installment agreement with Azzari. Although the Court has previously upheld IRS's rejection of collection alternatives based on taxpayers' failures to pay their current taxes, which Azzari admittedly did, those cases were distinguishable because IRS had not contributed to such failures. However, in this case, IRS's abuse of discretion contributed to Azzari's failure to make timely tax deposits. Azzari contended that it would have been able to remain current with its employment tax deposits if it had been able to borrow against its accounts receivable, but it was unable to do so because of IRS's refusal to subordinate its lien. Further, despite Azzari's clear indication to IRS that the need for subordination was urgent, IRS didn't respond to Azzari's request for nearly four months. In effect, Azzari wasn't given the opportunity to become current on its obligations. Since IRS abused its discretion in denying Azzari's request to subordinate the NFTL on the basis of an erroneous conclusion of law, then denied Azzari's request for an installment agreement based on its failure to stay current on its tax obligations (which was arguably attributable in part due IRS's prior error), the case was remanded back to IRS's Appeals office for reconsideration. References: For property subject to a tax lien, see FTC 2d/FIN ¶ V-5902 ; United States Tax Reporter ¶ 63,214.02 ; TaxDesk ¶ 911,025 ; TG ¶ 71974 . For installment agreements, see FTC 2d/FIN ¶ V-5010 ; United States Tax Reporter ¶ 61,594 ; TaxDesk ¶ 901,006 ; TG ¶ 71904 . Alessio Azzari, Inc. v. Commissioner, 136 T.C. No. 9, Code Sec(s) 6320; 6325; 6323; 6159. ________________________________________ ALESSIO AZZARI, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent . Case Information: Code Sec(s): 6320; 6325; 6323; 6159 Docket: Docket No. 27532-08L. Date Issued: 02/24/2011 Judge: Opinion by WELLS HEADNOTE XX. Reference(s): Code Sec. 6320 ; Code Sec. 6325 ; Code Sec. 6323 ; Code Sec. 6159 Syllabus Official Tax Court Syllabus P's business experienced financial difficulties and cash flow problems, and P fell behind on its Federal employment tax deposits. P later received financing from a lender which made loans secured by an interest in P's accounts receivable. The lender's financing helped P remain current with its tax deposits for six consecutive quarters. During that time, R filed a notice of Federal tax lien (NFTL) for the tax P still owed. P's lender refused to extend any more credit to P because of the NFTL unless R agreed to subordinate the NFTL to the lender's security interest. P requested that R subordinate the NFTL and grant it an installment agreement to satisfy its tax liabilities. Because the lender's security interest antedated the NFTL, R determined that the lender's security interest already had priority in P's accounts receivable and that it was unnecessary to subordinate the NFTL. In part on account of its inability to borrow against its accounts receivable because of the NFTL, P again fell behind on its employment tax deposits, and R therefore refused to consider P's proposed installment agreement. Held: It was an abuse of discretion for R to refuse to consider P's request to subordinate the NFTL on the basis of R's erroneous conclusion of law that the lender's security interest already had priority over the NFTL in P's accounts receivable. Held , further, it was an abuse of discretion for R to deny P's request for an installment agreement on the basis of P's failure to stay current on its tax deposits where R's abuse of discretion in refusing to consider subordination of the NFTL to P's lender's security interest contributed to P's falling behind on its tax deposits and where R did not allow P the opportunity to become current again. OPINION This case is before the Court on respondent's motion for summary judgment and petitioner's cross-motion for summary judgment pursuant to Rule 121. 1 We must decide whether respondent's settlement officer abused his discretion in denying petitioner's request to subordinate or withdraw a notice of Federal tax lien (NFTL), or in denying petitioner's request for an installment agreement. Background The record consists of the parties' pleadings; their respective cross-motions for summary judgment; various responses, declarations, and memoranda in support of or opposition to the motions; and the administrative record from the collection due process hearing. Petitioner is a New Jersey corporation with its principal place of business in Mickleton, New Jersey. Petitioner's business relates to the homebuilding industry. For the quarters ending September 30 and December 31, 2005, petitioner did not timely file its employer's quarterly tax returns. Petitioner timely filed its employer's quarterly tax returns for the quarters ending March 31, June 30, September 30, and December 31, 2006. Respondent assessed the tax shown on the return for each period, but petitioner did not fully pay its liabilities. Petitioner's unpaid employment tax liabilities total $1,100,622 for the quarters ending September 30 and December 31, 2005, and March 31, June 30, September 30, and December 31, 2006 (collectively, the periods in issue). On or about November 6, 2007, respondent mailed petitioner a Final Notice - Notice of Intent to Levy and Notice of Your Right to a Hearing (notice of intent to levy), informing petitioner that respondent intended to levy to collect petitioner's unpaid employment tax liabilities. Petitioner did not request a hearing or otherwise dispute the notice of intent to levy. Respondent subsequently filed an NFTL with respect to petitioner's unpaid quarterly employment tax liabilities for the periods in issue. 2 Respondent notified petitioner on November 27, 2007, of the NFTL filing. On or about January 2, 2008, petitioner timely submitted Form 12153, Request for a Collection Due Process or Equivalent Hearing. Petitioner checked the boxes on Form 12153 requesting that an installment agreement be considered as a collection alternative and that the lien be withdrawn. In the attached explanation, petitioner stated that the lien made it more difficult for petitioner to satisfy its tax liabilities by making it impossible to sell its accounts receivable to a factor. On January 25, 2008, and before receiving any reply from respondent, petitioner submitted a written request to respondent asking that the NFTL be subordinated to a line of credit from Penn Business Credit, LLC (Penn Business Credit). Petitioner also asked that respondent agree to a proposed installment agreement attached to the letter. In a footnote to petitioner's request, petitioner explained that there had been a misunderstanding about the nature of the financing relationship with Penn Business Credit when it filed the Form 12153 and that petitioner's counsel had not yet obtained the loan documents at that time. After examining the documents, petitioner's counsel ascertained that the financial relationship with Penn Business Credit was lending, not factoring, and that petitioner should be eligible to have the NFTL subordinated to the line of credit from Penn Business Credit. 3 Therefore, in its January 25, 2008, letter, petitioner replaced its request in its Form 12153 that respondent withdraw the NFTL with a request that respondent subordinate the NFTL to Penn Business Credit's security interest. In the January 25, 2008, letter, petitioner explained that it had fallen behind on its employment tax payments during the periods in issue, through the end of 2006, because of slowing demand in the market for new home construction and because many of petitioner's major customers had become unable to timely pay their invoices or had entirely defaulted on their obligations. Petitioner also explained that the situation left it in a “cash crisis” without available funds to both pay its employment taxes and have the cash necessary to operate its business. During January 2007, as part of its effort to address the cash crisis, petitioner had entered into a financing agreement with Penn Business Credit (financing agreement). Under the terms of the financing agreement, Penn Business Credit extended credit to petitioner equal to the lesser of 50 percent of its qualifying accounts receivable 4 or $1 million. On February 2, 2007, Penn Business Credit filed with the State of New Jersey a financing statement to record its security interest under the financing agreement. The financing statement covered, among other things, “accounts”, “accounts receivable”, and “all other rights to the payment of money whether or not yet earned, for services rendered or goods sold, consigned, leased, or furnished” by petitioner. In its January 25, 2008, request, petitioner stated that the financing agreement with Penn Business Credit had enabled petitioner to begin paying its employment taxes even though its own customers continued to lag behind in their payments. Without the financing from Penn Business Credit, petitioner predicted that it would be unlikely to have sufficient cashflow to satisfy the terms of its proposed installment agreement. To support its contention, petitioner attached two cashflow projections prepared by its accountant. Petitioner also informed respondent in its January 25, 2008, letter that Penn Business Credit had refused to make any loans to petitioner since learning of the NFTL. However, petitioner asserted that Penn Business Credit would resume making loans to petitioner under its financing agreement if respondent would subordinate his lien to Penn Business Credit's security interest. Petitioner attached documentation from Penn Business Credit affirming that the lender would, indeed, resume making loans to petitioner if respondent subordinated the NFTL. In a footnote at the end of the letter, petitioner's counsel wrote: As a protective measure, because the need for subordination at this time is critical, the undersigned intends to send on the behalf of *** [petitioner] a letter to *** [respondent's] District Director applying for a Certificate of Subordination of Federal Tax Lien. Such letter is intended to complement and not supersede this letter. [Emphasis added.] For almost 4 months, respondent's office did not reply to petitioner's request. On May 12, 2008, respondent mailed to petitioner's counsel a letter informing him that the case had been forwarded to respondent's Philadelphia Office of Appeals. On May 20, 2008, respondent's Appeals Office confirmed its receipt of petitioner's request for a collection due process hearing and scheduled a telephone conference at 11 a.m. on June 17, 2008. On June 12, 2008, petitioner's counsel contacted respondent's settlement officer Darryl K. Lee (Mr. Lee) and requested a face-to-face conference hearing in respondent's Philadelphia Office of Appeals and a minimum 1-week extension to prepare documents requested by Mr. Lee. Petitioner complied with Mr. Lee's document requests and also submitted a revised collection alternative with two cashflow projections, one with the accounts receivable financing from Penn Business Credit and one without. Petitioner explained that it had experienced a greater loss in revenue and higher fuel costs than anticipated and stated that it would be unable to satisfy the terms of its original proposed installment agreement. Petitioner's counsel met with Mr. Lee in person on June 26, 2008. At the meeting, petitioner's counsel again requested that the lien be subordinated to Penn Business Credit's security interest. Mr. Lee told petitioner that the lien could not be subordinated because it did not have priority over Penn Business Credit's security interest since the NFTL had been filed later than the security agreement with Penn Business Credit. Mr. Lee suggested that the lien might be withdrawn if petitioner would pay $300,000 immediately and enter an installment agreement to pay off the balance of the liability within 10 years. At the time, Mr. Lee also warned that petitioner would have to stay current with its deposits for its Federal employment tax liabilities if it wanted to be eligible for an installment agreement. Petitioner fully paid its employment taxes throughout 2007 and the first half of 2008 but began to fall behind on its deposits during the third quarter of 2008. By September 22, 2008, petitioner had not made any Federal tax deposits for its third quarter employment taxes, and Mr. Lee called petitioner's counsel to inform him that if these deposits were not made, petitioner would not be eligible to proceed with the installment agreement. Mr. Lee also stated his belief that petitioner's proposed installment agreement was unrealistic given the current state of petitioner's business and the housing market. After conferring with petitioner, petitioner's counsel confirmed that petitioner had not made any deposits for employment taxes during the period ending September 30, 2008. In a letter to Mr. Lee dated September 26, 2008, petitioner's counsel explained that the housing crisis had dramatically worsened during the third quarter of 2008. However, petitioner contested Mr. Lee's assertion that it would be unable to meet its obligations under the installment agreement, explaining that it had recently taken steps to cut its costs and diversify its business. Since July 1, 2008, petitioner had laid off 45 employees, more than half of its work force, and it had recently secured 10 contracts outside the home building industry as well as a large housing contract. In the letter, petitioner again contended that it had been “severely hurt” by its inability to borrow against accounts receivable since the filing of the NFTL. Petitioner also stated that it “is certain that it will make the late deposits on or before September 30, 2008 and will keep current.” On September 29, 2008, upon receipt of petitioner's letter dated September 26, 2008, Mr. Lee called petitioner's counsel and told him that even if petitioner made its deposits by September 30, 2008, penalties would be assessed and he would not consider an installment agreement under those circumstances. On October 9, 2008, respondent issued petitioner a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (the notice of determination). The notice of determination explained that petitioner's request to have the lien withdrawn was being denied because respondent's Appeals Office had determined on the basis of the amount due and petitioner's compliance record that withdrawal would not facilitate collection. The Appeals Office rejected petitioner's proposed installment agreement because petitioner had not remained current with its Federal tax deposits for the quarter ending September 30, 2008. The notice of determination did not address petitioner's request to subordinate the NFTL. Discussion Rule 121(a) allows a party to move “for a summary adjudication in the moving party's favor upon all or any part of the legal issues in controversy.” Rule 121(b) directs that a decision on such a motion shall be rendered “if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law.” The moving party bears the burden of demonstrating that no genuine issue of material fact exists and that the moving party is entitled to judgment as a matter of law. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 [73 AFTR 2d 94-1198] (7th Cir. 1994). Facts are viewed in the light most favorable to the nonmoving party. Id. Where the underlying tax liability is not in issue, we review the determination of the Appeals Office for abuse of discretion. See Sego v. Commissioner, 114 T.C. 604, 610 (2000). In reviewing for abuse of discretion, we review the reasoning underlying the settlement officer's determination to decide whether it was arbitrary, capricious, or without sound basis in fact or law. See Murphy v. Commissioner, 125 T.C. 301, 308 (2005), affd. 469 F.3d 27 [98 AFTR 2d 2006-7853] (1st Cir. 2006). Petitioner does not dispute the underlying liabilities. Consequently, we review the determination of the Appeals Office for abuse of discretion. I. Whether Respondent's Appeals Office Abused Its Discretion by Denying Petitioner's Request To Subordinate or Withdraw the NFTL Petitioner contends that the Appeals Office abused its discretion when it refused to consider the subordination of the NFTL to Penn Business Credit's security interest. Section 6325(d)(2) allows the Commissioner to issue a certificate of subordination to a Federal tax lien if: the Secretary believes that the amount realizable by the United States from the property to which the certificate relates, or from any other property subject to the lien, will ultimately be increased by reason of the issuance of such certificate and that the ultimate collection of the tax liability will be facilitated by such subordination *** Internal Revenue Service (IRS) guidelines instruct: The Service must exercise good judgment in weighing the risks and deciding whether to subordinate the federal tax lien. The Service's judgment is similar to the decision that an ordinarily prudent business person would make in deciding whether to subordinate his/her rights in a debtor's property in order to secure additional long run benefits. 188.8.131.52.6(4) (Dec. 14, 2007). In a collection due process hearing in which the taxpayer has requested that the Federal tax lien be subordinated, it is the task of the IRS Appeals Office to determine whether subordination will ultimately facilitate collection of the tax liability. Mr. Lee did not reach the question of whether subordinating the Federal tax lien would facilitate collection because he determined that the Federal tax lien was already junior to the security interest held by Penn Business Credit. In determining the order of priority, Mr. Lee simply compared the dates on which the financing statements had been filed. Because Penn Business Credit's financing statement had been filed on February 2, 2007, and the NFTL had not been filed until November 26, 2007, 5 Mr. Lee determined that Penn Business Credit already had a priority interest in petitioner's accounts receivable and that it was not possible to subordinate the NFTL. Petitioner contends that Mr. Lee's determination was an error of law 6 and that the Federal tax lien does have priority over Penn Business Credit's security interest in after-acquired accounts receivable. In a priority dispute involving a Federal tax lien, the Supreme Court has held that questions of whether a property (2003). interest exists and the nature of that interest are State law issues, but Federal law governs the question of priority between conflicting interests. Aquilino v. United States, 363 U.S. 509, 513-514 [5 AFTR 2d 1698] (1960). Before the Federal Tax Lien Act of 1966, Pub. L. 89-719, 80 Stat. 1125, the Code did not contain any rules for resolving priority contests between Federal tax liens and liens arising under State law. United States v. Kimbell Foods, Inc., 440 U.S. 715, 720 n.6 (1979). Therefore, before 1966 the Supreme Court determined the relative priority of a rival lien as against a Federal tax lien by applying the common law principle of “first in time is first in right”. Bremen Bank & Trust Co. v. United States, 131 F.3d 1259, 1263 [80 AFTR 2d 97-8389] (8th Cir. 1997) (quoting State Bank of Fraser v. United States, 861 F.2d 954, 963 [63 AFTR 2d 89-389] (6th Cir. 1988)); see, e.g., United States v. City of New Britain, 347 U.S. 81, 85 [44 AFTR 798] (1954). A competing lien was considered in existence for “first in time” purposes only when it had been perfected; that is, when “the identity of the lienor, the property subject to the lien, and the amount of the lien are established.” United States v. City of New Britain, supra at 84. The latter rule is known as the “choateness” doctrine. United States v. Kimbell Foods, Inc., supra at 721 n.8. The “first in time” and choateness tests were modified by the Federal Tax Lien Act of 1966, which “recognized the priority of many state claims over federal tax liens.” United States v. Kimbell Foods, Inc., supra at 738. Congress enacted the Federal Tax Lien Act of 1966 to "`[improve] the status of private secured creditors' and prevent impairment of commercial financing by `[modernizing] . . . the relationship of Federal tax liens to the Id. (quoting S. Rept. 1708, 89th interests of other creditors.” Cong., 2d Sess. 1-2 (1966) (alterations in original)). Among other changes, the legislation modified the priority rule for commercial transaction financing agreements by adding a 45-day safe-harbor period, codified at section 6323(c). 7 Bremen SEC. 6323(c). Protection for Certain Commercial Transactions Financing Agreements, etc. (1) In general.—To the extent provided in this subsection, even though notice of a lien imposed by section 6321 has been filed, such lien shall not be valid with respect to a security interest which came into existence after tax lien filing but which— (A) is in qualified property covered by the terms of a written agreement entered into before tax lien filing and constituting— (i) a commercial transactions financing agreement, (ii) a real property construction or improvement financing agreement, or (iii) an obligatory disbursement agreement, and (B) is protected under local law against a judgment lien arising, as of the time of tax lien filing, out of an unsecured obligation. (continued...)Bank & Trust Co. v. United States, supra at 1263. Under the “first in time” and choateness tests, a creditor would have priority over the Federal tax lien only if its interest was filed first and was choate at the time the NFTL was filed. United States v. Equitable Life Assurance Soc., 384 U.S. 323, 327-328 [17 AFTR 2d 1153] (1966). In relevant part, section 6323(c) modifies the result under the first in time and choateness tests by providing that a Federal tax lien will not have priority against a “security interest” in “qualified property” arising from a loan made to a taxpayer within 45 days after the NFTL filing and before the lender acquires actual knowledge of the NFTL. The “qualified property” must be covered by a written agreement constituting a “commercial transactions financing agreement” that was entered into before the NFTL filing date. Under the statute, “qualified property” is limited to “commercial financing security” acquired by the taxpayer within 45 days of the NFTL filing, and “commercial financing security” includes accounts receivable. , Sec. 6323(c)(2)(B), (C)(ii). The regulations define an “account receivable” as “any right to payment for goods sold or leased or for services rendered which is not evidenced by an instrument or chattel paper.” Sec. 301.6323(c)-1(c)(2)(ii), Proced. & Admin. Regs. A “security interest” is defined by section 6323(h)(1), which provides: Security interest.--The term "security interest" means any interest in property acquired by contract for the purpose of securing payment or performance of an obligation or indemnifying against loss or liability. A security interest exists at any time (A) if, at such time, the property is in existence and the interest has become protected under local law against a subsequent judgment lien arising out of an unsecured obligation, and (B) to the extent that, at such time, the holder has parted with money or money's worth. The regulations provide that, for purposes of the statute, an account receivable is “in existence” when and to the extent that “a right to payment is earned by performance.” Sec. 301.6323(h)- 1(a)(1), Proced. & Admin. Regs. Courts construing section 6323(c) have repeatedly held that if an account receivable is acquired more than 45 days after the NFTL is filed, the lender's security interest in the account receivable will not have priority over the tax lien even though the agreement conferring the security interest antedates the NFTL See, e.g., Am. Inv. Fin. v. United States, 476 F.3d 810 [98 AFTR 2d 2006-8171] filing. (10th Cir. 2006); Shawnee State Bank v. United States, 735 F.2d 308 [54 AFTR 2d 84-5150] (8th Cir. 1984); Texas Oil & Gas Corp. v. United States, 466 F.2d 1040 [30 AFTR 2d 72-5488] (5th Cir. 1972); Penetryn Intl., Inc. v. United States, 391 F. Supp. 729 [35 AFTR 2d 75-1225] (D.N.J. 1975); Distrib. Prods., Inc. v. Albert Enourato & Co., 34 AFTR 2d 5690, 74-2 USTC par. 9697 (D.N.J. 1974); Contl. Fin., Inc. v. Cambridge Lee Metal Co., 265 A.2d 536 (N.J. 1970). The manner in which section 6323(c) assigns priority with regard to accounts receivable is illustrated by examples in the regulations: Example (1). (i) On June 1, 1970, a tax is assessed against M, a tool manufacturer, with respect to his delinquent tax liability. On June 15, 1970, M enters into a written financing agreement with X, a bank. The agreement provides that, in consideration of such sums as X may advance to M, X is to have a security interest in all of M's presently owned and subsequently acquired commercial paper, accounts receivable, and inventory (including inventory in the manufacturing stages and raw materials). On July 6, 1970, notice of the tax lien is filed in accordance with § 301.6323(f)-1. On August 3, 1970, without actual notice or knowledge of the tax lien filing, X advances $10,000 to M. On August 5, 1970, M acquires additional inventory through the purchase of raw materials. On August 20, 1970, M has accounts receivable, arising from the sale of tools, amounting to $5,000. Under local law, X's security interest arising by reason of the $10,000 advance on August 3, 1970, has priority, with respect to the raw materials and accounts receivable, over a judgment lien against M arising July 6, 1970 (the date of the tax lien filing) out of an unsecured obligation. (ii) Because the $10,000 advance was made before the 46th day after the tax lien filing, and the accounts receivable in the amount of $5,000 and the raw materials were acquired by M before such 46th day, X's $10,000 security interest in the accounts receivable and the inventory has priority over the tax lien. The priority of X's security interest also extends to the proceeds, received on or after the 46th day after the tax lien filing, from the liquidation of the accounts receivable and inventory held by M on August 20, 1970, if X has a continuously perfected security interest in identifiable proceeds under local law. However, the priority of X's security interest will not extend to other property acquired with such proceeds. Example (2). Assume the same facts as in example 1 except that on July 15, 1970, X has actual knowledge of the tax lien filing. Because an agreement does not qualify as a commercial transactions financing agreement when a disbursement is made after tax lien filing with actual knowledge of the filing, X's security interest will not have priority over the tax lien with respect to the $10,000 advance made on August 3, 1970. Sec. 301.6323(c)-1(f), Proced. & Admin. Regs. Petitioner and Penn Business Credit entered into the financing agreement in which Penn Business Credit agreed to make loans to petitioner that would be secured by petitioner's then- existing accounts receivable. The arrangement under the financing agreement was structured like a revolving line of credit, allowing petitioner to pay off the loan or a portion thereof and then take out further loans when needed. When Penn Business Credit learned of the NFTL filing, it refused to make any more loans unless and until the Federal tax lien had been subordinated to Penn Business Credit's security interest in petitioner's accounts receivable under the financing agreement. The facts of the instant case are analogous to an example in the regulations: E, a manufacturer of electronic equipment, obtains financing from F, a lending institution, pursuant to a security agreement, with respect to which a financing statement was duly filed under the Uniform Commercial Code on June 1, 1970. On April 15, 1971, F gains actual notice or knowledge that notice of a Federal tax lien had been filed against E on March 31, 1971, and F refuses to make further advances unless its security interest is assured of priority over the Federal tax lien. Upon examination, the district director believes that ultimately the amount realizable from E's property will be increased and the collection of the tax liability will be facilitated if the work in process can be completed and the equipment sold. In this case, the district director may, in his discretion, subordinate the tax lien to F's security interest for the further advances required to complete the work. Sec. 301.6325-1(d)(2)(ii), Example (3), Proced. & Admin. Regs. (emphasis added). However, in petitioner's case, even though Mr. Lee had the discretion, pursuant to the foregoing example, to subordinate the Government's tax lien if it would be in the Government's interest, Mr. Lee did not even consider subordination because he erroneously believed the NFTL did not have priority over petitioner's accounts receivable. As a preliminary matter, we note that the property over which there is a disagreement about priority is accounts receivable and that Penn Business Credit's financing agreement gave it a security interest in the property. In analyzing a priority dispute under the “first in time” and choateness tests, the Court must first determine what property interest exists under State law and then determine priority under Federal law. Aquilino v. United States, 363 U.S. at 512-514. Under New Jersey law, an “account” is defined as a right to payment for, among other things, “property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, *** [or] for services rendered or to be rendered” that is not “evidenced by chattel paper or an instrument”. N.J. Stat. Ann. sec. 12A:9-102(a)(2) (West 2004). Penn Business Credit's financing statement covers, among other things, accounts, accounts receivable, and other rights to payments for services rendered. Neither party contests that the rights covered by the financing statement are accounts receivable under both New Jersey law and section 301.6323(c)-1(c)(2)(ii), Proced. & Admin. Regs. We proceed to the question of priority in petitioner's accounts receivable, which is governed by Federal law. See Aquilino v. United States, supra at 512-514. It may be assumed that the accounts receivable on petitioner's books before the filing of the NFTL were choate because the amounts were fixed and ascertainable at that time. If so, Penn Business Credit had a priority interest in that property. See United States v. Equitable Life Assurance Soc., 384 U.S. at 327-328; Shawnee State Bank v. United States, 735 F.2d at 310-311. However, accounts receivable petitioner had not yet acquired at the time the NFTL was filed were inchoate. See Shawnee State Bank v. United States, supra at 310-311; Texas Oil & Gas Corp. v. United States, 466 F.2d at 1051. To the extent that accounts receivable were acquired more than 45 days after the NFTL was filed or after Penn Business Credit had actual knowledge of the NFTL, whichever was earlier, the Government's tax lien had priority in such property. See Shawnee State Bank v. United States, supra at 310-311; Texas Oil & Gas Corp. v. United States, supra at 1051-1052. Although the Commissioner's Appeals Office has discretion under section 6325(d) to determine whether it is in the Government's interest to subordinate a Federal tax lien, it appears that Mr. Lee's refusal to consider petitioner's request to subordinate the lien was based on an error of law. To the extent it was based upon an error of law, his determination constitutes an abuse of discretion. See Swanson v. Commissioner, 121 T.C. 111, 119 (2003). Accordingly, we hold that it was an abuse of discretion for respondent's settlement officer to fail to consider petitioner's request to subordinate the Federal tax lien on the basis of an erroneous conclusion of law that the Federal tax lien did not have priority. Petitioner contends that it requested only that respondent withdraw the NFTL as an alternative in the event that respondent determined that it was impossible to subordinate the Federal tax lien. Because we hold that the Federal tax lien could have been subordinated and that respondent's settlement officer committed an error of law when he determined that the Federal tax lien could not have been subordinated, we need not consider the question of whether he abused his discretion by refusing to withdraw the NFTL. II. Whether Respondent Abused His Discretion by Declining To Enter Into an Installment Agreement With Petitioner Respondent contends that because petitioner had fallen behind on its obligation to make timely deposits of its employment taxes, it was ineligible for an installment agreement. Respondent urges us to hold that the issue of subordination of the tax lien is irrelevant because even if the tax lien had been subordinated, petitioner still would have been ineligible for a collection alternative because it was not in compliance with its employment tax deposits. In his briefs respondent did not even address the relevant law governing the priority of tax liens, nor did he bother to respond to petitioner's arguments that Mr. Lee erred in his interpretation of that law. Instead, respondent rests his entire argument on a previous case in which we upheld the Commissioner's policy of rejecting collection alternatives when taxpayers have failed to pay their See Giamelli v. Commissioner, 129 T.C. 107, 111 current taxes. (2007). However, respondent's reliance on Giamelli is misplaced. In Giamelli and other previous cases in which we have upheld the Commissioner's rejection of collection alternatives because the taxpayers had failed to satisfy current tax obligations, the Commissioner had done nothing to contribute to the taxpayers' failures to remain current with their tax liabilities. In contrast, respondent's abuse of discretion contributed to petitioner's failure to make timely tax deposits. After remaining current with its employment tax deposits for six quarters, petitioner failed to make timely deposits of its employment taxes during the third quarter of 2008. It was at that point that respondent issued his notice of determination rejecting petitioner's request for an installment agreement. Petitioner contends that it would have been able to remain current with its employment tax deposits if it had been able to borrow against its accounts receivable. However, because of the NFTL, Penn Business Credit had exercised its right under the security agreement to refuse to extend further loans to petitioner. Petitioner informed respondent of the importance of the accounts receivable financing in its January 25, 2008, letter, and it explained that its request to subordinate the NFTL was urgent. Nevertheless, respondent did not reply to petitioner for nearly 4 months. When respondent's settlement officer, Mr. Lee, met with petitioner's counsel on June 26, 2008, Mr. Lee declined to even consider subordination of the NFTL because of his erroneous conclusion that the NFTL did not have priority over Penn Business Credit's security interest in petitioner's accounts receivable. At that date, petitioner was still current on its employment tax deposits. Had petitioner been able to borrow against its accounts receivable in June or even earlier, it contends that it would have been able to timely make its deposits for the third quarter of 2008. Accordingly, it appears that petitioner's failure to make timely deposits of employment taxes for the third quarter of 2008 was not independent of Mr. Lee's erroneous determination that it was impossible to subordinate the NFTL, which we have held was an abuse of his discretion. We do not accept respondent's argument that Mr. Lee's decision regarding subordination of the tax lien is irrelevant. Indeed, accepting respondent's contention would be tantamount to granting respondent the power to abuse his discretion at will as long as petitioner eventually misses a deposit on its employment taxes. In situations similar to the instant case, where petitioner's business is in a dire position largely due to industry conditions beyond its control, the Commissioner's decision not to subordinate an NFTL could exacerbate taxpayers' cashflow problems and make it difficult, if not impossible, for taxpayers to remain current with their tax deposits while continuing to run their businesses. The Commissioner could hold off issuing a notice of determination indefinitely until the taxpayer missed a deposit, and the Commissioner could then refuse to grant an installment agreement on the basis of the taxpayer's failure to remain current with its tax deposits. Because the taxpayer would have already fallen behind on current tax liabilities, we would be unable to meaningfully review the Commissioner's decision not to subordinate the NFTL. We find such a scenario unacceptable. The Commissioner has discretion to enter into an installment agreement with a taxpayer if he determines “that such agreement will facilitate full or partial collection of such liability.” Sec. 6159(a). The IRM advises: “When taxpayers are unable to pay a liability in full, an installment agreement (IA) should be considered.” IRM pt. 184.108.40.206(4) (July 12, 2005) (emphasis added). The IRM also instructs: “Compliance with filing, paying estimated taxes, and federal tax deposits must be current from the date the installment agreement begins.” Id. pt. 220.127.116.11.1(19). Accordingly, the Commissioner must consider whether the installment agreement will facilitate collection of the liability, but he may not authorize an installment agreement until the taxpayer is current with its Federal tax deposits. However, nothing in the Code, the regulations, the IRM, or our decisions requires that the Commissioner deny the taxpayer's request for an installment agreement simply because it is not, at that moment, current with its Federal tax deposits. The Commissioner could, instead, wait until the taxpayer is current and then enter into the installment agreement. Even when an installment agreement is in place and the taxpayer fails to remain current with its tax liabilities, the Commissioner is not required to terminate the agreement; rather, he has the discretion to do so. Sec. 301.6159-1(c)(2), Proced. & Admin. Regs. Mr. Lee would not even consider petitioner's efforts to become current on its deposits for the third quarter of 2008. After receiving a letter from petitioner's counsel promising that petitioner would make the late deposits by the end of the third quarter, Mr. Lee telephoned petitioner's counsel and effectively told him that it was too late and that petitioner should not bother because Mr. Lee's decision was already made. Accordingly, we hold that it was an abuse of discretion for respondent's settlement officer to refuse to enter into an installment agreement on the basis of petitioner's failure to stay current with its tax deposits where respondent's abuse of discretion in refusing to consider subordination of the NFTL contributed to petitioner's falling behind on its tax deposits and where petitioner was not given the opportunity to become current. Consequently, we will deny respondent's motion for summary judgment, grant petitioner's motion for summary judgment, and remand this case to respondent's Appeals Office for reconsideration of petitioner's request to subordinate the NFTL and enter into an installment agreement. 8 (June 1, 2010), which does not contemplate rejecting an installment agreement simply because the Commissioner believes that the installment agreement is unrealistic given the taxpayer's financial condition. Insofar as Mr. Lee's determination to reject the installment agreement was based in any part on his assessment that petitioner could not afford to meet its obligations under the installment agreement, such reasoning does not appear to be in accord with the IRM. See Lites v. Commissioner, T.C. Memo. 2005-206 [TC Memo 2005-206]. In reaching these holdings, we have considered all the parties' arguments, and, to the extent not addressed herein, we conclude that they are moot, irrelevant, or without merit. To reflect the foregoing, An appropriate order will be issued. ________________________________________ 1 Unless otherwise indicated, section references are to the Internal Revenue Code of 1986 (Code), as amended, and Rule references are to the Tax Court Rules of Practice and Procedure. ________________________________________ 2 The parties do not agree on the date when respondent filed the NFTL, which we find below is Nov. 26, 2007. See infra note 5. ________________________________________ 3 Factoring would have entailed the discounted sale of petitioner's accounts receivable to Penn Business Credit. In a factoring transaction, the financing company purchases the accounts receivable without recourse and acts as the principal in the debt collection process. See Downes & Goodman, Dictionary of Finance & Investment Terms (7th ed. 2006). Because factoring involves selling the accounts receivable rather than lending collateralized by the accounts receivable, the financing company is not a creditor and therefore possesses no lien of its own to which the tax lien may be subordinated. Accordingly, when petitioner believed that the relationship was factoring, it requested that the lien be withdrawn; but once it realized that the relationship was lending involving Penn Business Credit as a creditor, petitioner changed its request to ask that the lien be subordinated. ________________________________________ 4 The financing agreement defines which accounts receivable qualify as part of the borrowing base. Considerations include the solvency of the debtors, the finality of the sale, the terms of the account, and other factors that might affect the collectibility of the account. ________________________________________ 5 The NFTL shows that it was prepared and signed on Nov. 15, 2007, and petitioner contends that it was filed on that date; but respondent denies that was the date it was filed. However, respondent does not offer an alternative date for the filing. New Jersey State records provided by petitioner and included in the administrative record show that the NFTL was filed on Nov. 26, 2007, and we therefore find Nov. 26, 2007, as the date of filing of the NFTL. ________________________________________ 6 An error of law by the Appeals Office may be an abuse of discretion. See Swanson v. Commissioner, 121 T.C. 111, 119 ________________________________________ 7 The following is the full text of the relevant portion of sec. 6323: ________________________________________ 1 ________________________________________ 8 Some of Mr. Lee's notes in his case activity log suggest that Mr. Lee's belief that petitioner's proposed installment agreement was unrealistic may have been a factor in his denial of the installment agreement. On remand, we also direct the Appeals Office to consider Internal Revenue Manual (IRM) pt. 18.104.22.168(8)
Thursday, February 24, 2011
Below is the new IRS position on tax liens in IR-2011-20 The IR states in part that "The IRS will significantly increase the dollar thresholds when liens are generally filed. The new dollar amount is in keeping with inflationary changes since the number was last revised. Currently, liens are automatically filed at certain dollar levels for people with past-due balances. There are problems with a "threshold" that will trigger a tax lien are, as follows: 1. An individual or business may have NO ASSETS; therefore, a tax lien is meaningless and it will only serve to ruin the credit of the individual or business. The IRS does not "get it." This position makes no economic sense. Why file a tax lien against an individual or business with no assets to seize or levy? Nothing is accomplished except ruining their credit. Without credit, businesses close & jobs are lost. Without credit an individual cannot rent, but a care, or get a job. And the credit stain will stay on their credit report during the period the tax debt is owed and for SEVEN YEARS AFTER THE TAX DEBT IS PAID OR OTHERWISE DISCHARGED. The IRS should be required to do an ECONOMIC ANALYSIS on the taxpayer to determine if the tax lien will give the IRS a real security interest in assets that make economic sense. It is hard for me to believe that the IRS can be this void of the ability to undersand that it is futile and nonproductive to file a tax lien that serves no purpose other than to destroy businesses and lose jobs due to the loss of credit. And there is no safe harbor in that rule. For example, taxpayers in the financial services industry will not get work with any kind of a tax lien. And why file a tax lien against someone who can full pay that tax lien in 12 months, 24 months, etc.? Those who wrote this administrative rule work in ivory towers and do not understand the real world where credit is essential for their abusility to survive and grow income in the present economy. 2. CONGRESS DID NOT WRITE A MANADTORY TAX LIEN STATUTE. The IRS "may" file a tax lien under section 6321. The IRS mandatory tax lien is legislative, a function reserved to Congress, not to the IRS. Congress should not allow the IRS to have the authority to legislate; in this instance, converting a discretionary lien statute into a mandatory lien statute under certain circumstances. The new rules on Offers in Compromise have not been explained. But I have repeated experiences with the IRS in OIC cases where the IRS Offer Specialists DO NOT FOLLOW THEIR OWN MANUAL. For example, the standards for settlement are based on "reasonable collection potential" determined by objective factors. But, repeatedly, I get responses where the IRS does NOT accept an OIC without stating why they will not accept the OIC. In reality, this is misconduct. But without IRS oversight, the IRS increasingly takes aggressive and prosecutorial positions. What is needed is IRS hearings to consider those instances where the IRS is ineffective, inefficient, and not following the law. The National Taxpayer Advocate (NTA) is of no help because that office REFUSES TO ISSUE TAXPAYER ASSISTANCE ORDERS contemplated as the tool of the NTA to stop IRS lien and levy abuses. In the 2010 NTA report to Congress, the NTA TAO use was negligible - far less than 1% of all of the requests for assistance received by the NTA. If Congress is looking to cut the IRS budge, they can easily eliminate the 2,000 NTA jobs because that office does NOT follow its congressional mandate to issue Taxpayer Assistance Orders to prevent economic hardship on individual and business taxpayers because of abusive and unjustified tax liens and tax levies. IRS hearings would also help to document the ineffectiveness of the office of the NTA. http://www.irs.gov/newsroom/article/0,,id=236540,00.html
BROWN v. U.S., Cite as 107 AFTR 2d 2011-XXXX, 02/15/2011 ________________________________________ TERRI LYNN BROWN, Plaintiff and Counter-Defendant, v. UNITED STATES OF AMERICA, Defendant and Counter-Plaintiff. Case Information: Code Sec(s): Court Name: UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA OCALA DIVISION, Docket No.: Case No. 5:08-cv-118-Oc-10GRJ, Date Decided: 02/15/2011. Disposition: HEADNOTE . Reference(s): OPINION UNITED STATES DISTRICT COURT MIDDLE DISTRICT OF FLORIDA OCALA DIVISION, ORDER Judge: Plaintiff Terri Lynn Brown, proceeding pro se, seeks a refund of federal trust fund recovery penalties paid to the Internal Revenue Service (“IRS”) for the tax period ending June 30, 2000 (Doc. 26). The United States of America filed a counterclaim seeking to reduce to judgment assessments for unpaid federal trust fund recovery penalties for the tax periods ending June 30, 1999 through June 30, 2000, December 31, 2000, and March 31, 2001 (Docs. 3, 15). The case is now before the Court on the United States' motion for summary judgment (Doc. 13). Ms. Brown has filed a response and supplemental response in opposition (Docs. 17, 28), and the United States has filed a reply (Doc. 30). Upon due consideration, the Court finds that the motion for summary judgment is due to be granted in its entirety. Undisputed Material Facts Safe-Deposit, Inc. (“Safe-Deposit”) was an Ocala, Florida business incorporated in 1994 by Ms. Brown's husband. The company initially operated as an armored car service. In 1995, Ms. Brown took over the operations of Safe-Deposit and converted it into a security guard company which provided security services to local businesses. At that time, Ms. Brown became the sole shareholder, president, and only director of Safe-Deposit. She controlled all of the finances and made all financial decisions for the company. Ms. Brown opened a bank account for Safe-Deposit at AmSouth Bank and was the only authorized signatory on that account during the tax periods at issue. She prepared and signed all checks on behalf of the company and decided which creditors to pay. Ms. Brown was in charge of hiring and firing employees, keeping the books and records, advertising for prospective clients, collecting on past due accounts, managing the finances, and making all corporate decisions. Ms. Brown was also responsible for collecting and paying employment taxes with respect to the employees of Safe-Deposit, and she prepared, signed, and submitted to the IRS the Quarterly Federal Tax Returns, Forms 941, for the company. Ms. Brown also maintained all of the company's financial books and records. She would enter all employee time sheets into a bookkeeping computer program, print out quarterly reports, and pay the stated payroll tax liability if funds were available. Safe-Deposit first operated out of Ms. Brown's home, but she eventually moved the company to a separate office building in Ocala, Florida in 1997. At its peak, the company employed over thirty security guards. However, between September 1996 and April 2001, Ms. Brown went through two difficult pregnancies, and her children and grandmother suffered from numerous serious health issues. Safe-Deposit's clients were also frequently delinquent on their accounts, leaving the company with limited cash flow. Ms. Brown also claims that the Ocala Police Department wrongfully interfered with her business by initiating an unfounded investigation into Safe-Deposit's operations. Ms. Brown claims that these events caused financial difficulties for Safe-Deposit, and Ms. Brown ultimately made the decision to dissolve the company in April 2001. Safe-Deposit failed to pay over to the IRS federal trust fund taxes — i.e. payroll and FICA taxes withheld from the wages of Safe-Deposit's employees — for the tax periods ending June 30, 1999 through June 30, 2000, December 31, 2000, and March 31, 2001. During these tax periods, Ms. Brown admits that she did not pay the company's trust fund taxes. She instead used Safe-Deposit's funds to pay its employees first, and to pay other creditors and necessary operating costs. After Safe-Deposit failed to pay the trust fund taxes, the IRS made assessments against Ms. Brown as the person responsible for those payments pursuant to 26 U.S.C. § 6672. On April 16, 2001, the IRS assessed against Ms. Brown a trust fund recovery penalty of $30,924.16 for the tax period ending June 30, 1999 through June 30, 2000. This amount represented the trust fund portion of the unpaid federal payroll taxes of Safe-Deposit for that tax period. On April 21, 2003, Ms. Brown was assessed two trust fund recovery penalties in the amount of $6,322.79 and $6,889.61 for the tax periods ending December 31, 2000 and March 31, 2001, respectively. The IRS mailed notices of assessments and demands for payment to Ms. Brown, who admits that she received such notices. After receiving the notices of assessment and demands for payment, Ms. Brown made some payments towards satisfying her tax liabilities for the tax periods ending June 30, 1999 through June 30, 2000. Ms. Brown entered into an installment agreement with the IRS on July 20, 2005, and made semi-regular payments through November 2008 on her tax liability for the period ending June 30, 2000. She did not make all payments due under the installment agreement. Additionally, credits for overpayments of Ms. Brown's income tax for the tax years 2002, 2004, 2006, and 2007 were applied to reduce the unpaid balance of Ms. Brown's tax fund recovery penalty liability for the period ending June 30, 2000. In November 2006, Ms. Brown also made a payment of $100.00 on each of her tax penalties for the periods ending December 31, 2000 and March 31, 2001. She has otherwise failed to satisfy her tax penalties. As of April 1, 2009, Ms. Brown's total tax liability due and owing for all relevant tax periods was $42,127.49 with interest continuing to accrue. Procedural History This case began as a pro se complaint against the United States of America, the Commissioner of the Internal Revenue Service, and various unknown employees of the IRS and other government agencies alleging violations of Ms. Brown's due process and equal protection rights, as well as various state law claims (Doc. 1). The United States filed an answer and counterclaim seeking to reduce to judgment Ms. Brown's unpaid federal trust fund employment taxes for the tax periods ending June 30, 2000, December 31, 2000, and March 31, 2001 (Doc. 3). The United States moved to dismiss all claims (Doc. 8), and to amend its counterclaim to clarify that the assessments against Ms. Brown also included the tax period ending June 30, 1999 through June 30, 2000 (Doc. 15). The United States also moved for summary judgment on its counterclaim (Doc. 13). The Court granted the United States' motion to amend its counterclaim, as well as the United States' motion to dismiss, and dismissed with prejudice all but one of Ms. Brown's claims (Doc. 25). The Court dismissed without prejudice the remaining claim, and granted Ms. Brown leave to file an amended complaint to assert a claim for a tax refund under 26 U.S.C. § 1346(a)(1) for the tax period ending June 30, 2000. (Id.). The Court deferred ruling on the United States' motion for summary judgment, reopened discovery to allow Ms. Brown to take the deposition of IRS Revenue Agent Richard Hanauer, and directed the parties to file supplemental briefing on the summary judgment motion following the conclusion of Agent Hanauer's deposition. (Id.). Ms. Brown filed her amended complaint as instructed by the Court (Doc. 26). In her amended complaint, Ms. Brown alleges that she is entitled to a refund “for the tax penalties paid for the calendar year June 30, 2000.” (Doc. 26, ¶ 5). However, Ms. Brown does not request an actual refund, but instead asks that “the tax liens [be] removed and the moneys paid to the Defendants be applied to the outstanding tax penalties for the remaining periods which should completely remove all the penalties.” (Id., ¶ 8). Both sides have also filed supplemental papers to be considered along with the United States' motion for summary judgment (Docs. 28, 30–31). 1 The motion for summary judgment is therefore now ripe for disposition. Ms. Brown has also requested leave to take additional discovery of other allegedly previously undisclosed revenue officers (Doc. 28). Summary Judgment Standard Pursuant to Federal Rule of Civil Procedure 56(c)(2), the entry of summary judgment is appropriate only when the Court is satisfied that “the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law.” In applying this standard, the Court must examine the materials on file and record evidence “in the light most favorable to the nonmoving party.” Samples on Behalf of Samples v. Atlanta, 846 F.2d 1328, 1330 (11th Cir. 1988). As the Supreme Court held in Celotex Corp. v. Catrett, 477 U.S. 317 (1986), the moving party bears the initial burden of establishing the nonexistence of a triable issue of fact. If the movant is successful on this score, the burden of production shifts to the non-moving party who must then come forward with “sufficient evidence of every element that he or she must prove.” Rollins v. Techsouth, 833 F.2d 1525, 1528 (11th Cir. 1987). The non-moving party may not simply rest on the pleadings, but must use affidavits, depositions, answers to interrogatories, or other admissible evidence to demonstrate that a material fact issue remains to be tried. Celotex, 477 U.S. at 324. See also Fed. R. Civ. P. 56(e)(2). The party opposing a motion for summary judgment must rely on more than conclusory statements or allegations unsupported by facts. Evers v. Gen. Motors Corp., 770 F.2d 984, 986 (11th Cir. 1985) (“conclusory allegations without specific supporting facts have no probative value”). Discussion I. The Tax Fund Penalty Assessments. Sections 26 U.S.C. §§ 3102(a) and 3402(a) of the Internal Revenue Code respectively require an employer to deduct from wages paid to its employees the employees' share of FICA (social security) taxes, and the withholding tax on wages applicable to individual income taxes. The withheld sums are commonly referred to as “trust fund taxes,” which are deemed to be held in a “special trust fund for the United States.” 26 U.S.C. § 7501(a). However, there is no requirement that these sums be segregated from the employer's other accounts, and the employer need only report and pay these taxes to the IRS quarterly. See 26 C.F.R. §§ 31.6011(a)-4(a)(1); 1.6071(a)-1(a). These trust fund taxes have been dubbed “a tempting source of ready cash to a failing corporation beleaguered by creditors.” Slodov v. United States, 436 U.S. 238, 243 [42 AFTR 2d 78-5011], 98 S.Ct. 1778, 1783 (1978). The withholding tax liability arises at the time the wages are paid, not on the actual due date of the quarterly tax return. “Once net wages are paid to the employee, the taxes withheld are credited to the employee regardless of whether they are paid by the employer, so that the IRS has recourse only against the employer for their payment.” Slodov, 436 U.S. at 243, 98 S.Ct. at 1783; see also 26 C.F.R. § 31(a); 26 C.F.R. § 1.31-1(a). An employer who fails to pay taxes withheld from its employees' wages is liable for the taxes which should have been paid. Slodov, 436 U.S. at 243, 98 S.Ct. at 1783; 26 U.S.C. §§ 3102(b) and 3403. The IRS may use the full range of collection methods available for the collection of taxes generally, including creating a lien against the property of the employer, and assessing penalties against a delinquent employer. In particular, § 6672 of the Internal Revenue Code provides that: Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. 26 U.S.C. § 6672(a). The Code defines “person” to include “an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.” 26 U.S.C. § 6671(b). In this case, the IRS assessed trust fund recovery penalties against Ms. Brown pursuant to § 6672(a). The Eleventh Circuit Court of Appeals has held that the test for liability under §6672(a) may be reduced to two elements: “(1) a responsible person; (2) who has willfully failed to perform a duty to collect, account for, or pay over federal employment taxes.” Thosteson v. United States, 331 F. 3d 1294, 1298 [91 AFTR 2d 2003-2468] (11th Cir. 2003). A person is responsible within the meaning of § 6672 if she has a duty to collect, account for, or pay over taxes withheld from the wages of a company's employees. Thibodeau v. United States, 828 F.2d 1499, 1503 [60 AFTR 2d 87-5763] (11th Cir. 1987). It is a matter of the power and authority to make payment of withholding taxes, and indicia of responsibility includes “the holding of corporate office, control over financial affairs, the authority to disburse corporate funds, stock ownership, and the ability to hire and fire employees.” Thosteson, 331 F.3d at 1299 (quoting George v. United States, 819 F.2d 1008, 1011 [60 AFTR 2d 87-5214] (11th Cir. 1987)). The United States has presented evidence establishing, as a matter of law, that Ms. Brown was the responsible person for collecting, accounting for, and paying the trust fund taxes for Safe-Deposit. Indeed, Ms. Brown does not dispute this fact. See Affidavit of Terri Lynn Brown, ¶ 15 (Doc. 19) (“I have at all times stated that I was the responsible person to make the tax payments timely.”). The United States has also submitted Certificates of Assessment and Payments (Forms 4340) evidencing the tax assessments for each of the tax periods in question, and such documentation is sufficient to establish a prima facie case of liability. United States v. Chila, 871 F.2d 1015, 1017–18 [63 AFTR 2d 89-1278] (11th Cir. 1989); Mersel v. United States, 420 F.2d 517, 518 (5th Cir. 1969). See also Olster v. Commissioner of Internal Revenue Service, 751 F.2d 1168, 1174 [55 AFTR 2d 85-919] (11th Cir. 1985) (“Absent a finding that the computational methods used, and therefore the assessment, was arbitrary and without foundation, the tax deficiency is presumptively correct.”) (citations omitted). While Ms. Brown has stated that she “believe[s] that payments have been applied incorrectly, tax liens were filed with errors, and time sensitive correspondences were mailed to the wrong address,” (Doc. 19, ¶ 18), she has not submitted any evidence to support this contention. Thus, the uncontradicted, admissible evidence before this Court establishes the amount of the assessments as listed in the Certificates of Assessments and Payments. The only issue left to resolve is whether Ms. Brown's failure to pay the trust fund taxes was willful. II. The Failure to Pay Was Willful For purposes of assessing penalties under § 6672, “willfully” does not require proof of criminal intent; it simply means “a voluntary, conscious, and intentional act, such as the payment of other creditors in preference to the United States.” Brown v. United States, 591 F.2d 1136, 1140 [43 AFTR 2d 79-895] (5th Cir. 1979). 2 The responsible person acts willfully if she does not use her authority to make sure the funds are deposited and paid to the IRS rather than permitting the tax money to be paid to other creditors. Woodruff v. United States, No. 8:09-cv-1507-T-26TBM, 2010 WL 3419201 [106 AFTR 2d 2010-6071] at 3 (M.D. Fla. Aug. 27, 2010). See also Smith v. United States, 894 F.2d 1549, 1553 [71A AFTR 2d 93-3456] (11th Cir. 1990) (“The willfulness requirement of section 6672 is satisfied if there is evidence that the responsible officer had knowledge of payments to other creditors after he was aware of the failure to remit withholding taxes.”). The United States has presented undisputed evidence that Ms. Brown acted willfully for each of the tax periods at issue. Ms. Brown admits that she knew of Safe-Deposit's tax obligations to the IRS. She further admits that she knowingly and voluntarily chose to pay her employees, creditors, and necessary operating expenses rather than pay the IRS the trust fund taxes due and owing. Ms. Brown did this in an attempt to keep Safe-Deposit's doors open, despite her knowledge of the growing tax debt. The Court finds that Ms. Brown acted “willfully” in failing to fulfill her duties and pay the company's trust fund taxes over to the IRS. See Thibodeau, 828 F.2d at 1505 (citing Mazo v. United States, 591 F.2d 1151, 1157 [43 AFTR 2d 79-853] (5th Cir. 1979)) (holding that evidence that the responsible person had knowledge of payments to creditors after he was aware of the failure to pay trust fund taxes is sufficient for summary judgment on issue of willfulness). Ms. Brown argues that she had reasonable cause for her failure to pay Safe-Deposit's trust fund taxes, and asks the Court to find that she did not act willfully (or at least find a material question of fact on this point). The Eleventh Circuit has not precisely defined “reasonable cause,” but the former Fifth Circuit has held that, “in order to further the basic purposes of section 6672, ... reasonable cause should have a very limited application.” Newsome v. United States, 431 F.2d 742, 747 [26 AFTR 2d 70-5078] (5th Cir. 1970). See also Bowen v. United States, 836 F.2d 965, 968 [61 AFTR 2d 88-564] (5th Cir. 1988) (“Although we have recognized conceptually that a reasonable cause may militate against a finding of willfulness, no taxpayer has yet carried that pail up the hill.”). Ms. Brown urges the Court to use the standard for reasonable cause applicable to the levy of penalties for the failure to timely pay income taxes or file an income tax return under 26 U.S.C. § 6651 — that the taxpayer exercised “ordinary business care and prudence in providing for payment of his tax and was nevertheless either unable to pay the tax or would suffer an undue hardship if he paid the tax on time.” United States v. Sanford, 979 F.2d 1511, 1514 [71 AFTR 2d 93-405] n. 8 (11th Cir. 1992); see also 26 C.F.R. §301.6651(c)(1). The Eleventh Circuit has not addressed this question, and the circuits are split on whether or not the “ordinary business care and prudence” standard should apply to § 6672 penalties. Cf. Fran Corp. v. United States, 164 F.3d 814, 818–19 [83 AFTR 2d 99-621] (2d Cir. 1999) and Brewery, Inc. v. United States, 33 F.3d 589, 592 [74 AFTR 2d 94-5878] (6th Cir.1994) (both applying ordinary business care and prudence standard to reasonable cause analysis under § 6672) with Finley v. United States, 123 F.3d 1342, 1348 [80 AFTR 2d 97-6321] (10th Cir. 1997) (rejecting the more lenient reasonable cause standard of ordinary business care and prudence for penalties under § 6672, and finding reasonable cause only where “(1) the taxpayer has made reasonable efforts to protect the trust funds, but (2) those efforts have been frustrated by circumstances outside the taxpayer's control.”), and Olsen v. United States, 952 F.2d 236, 241 [69 AFTR 2d 92-395] (8th Cir. 1991) (holding that reasonable cause is no part of the definition of willfulness in Section 6672). The Court need not resolve this question because, regardless of which standard is applied to the facts of this case, it is clear that Ms. Brown did not have reasonable cause sufficient to excuse her willful failure to file and pay Safe-Deposit's trust fund taxes. Ms. Brown cites to a litany of events that occurred between September 10, 1996 and April 2001. Specifically, Ms. Brown points to her difficult pregnancies, the serious medical issues suffered by her children and her grandmother (who lived with Ms. Brown), the supposed interference by the Ocala Police Department in the operation of Safe-Deposit, 3 the supposed malpractice by the law firm she hired to file suit against the Ocala Police Department, the late payments by Safe-Deposit's clients, and the fact that she cannot remember the IRS ever advising her of the penalties for not paying the trust fund taxes as proof of the undue hardships she suffered which prevented her from paying the trust fund taxes. Ms. Brown also contends that she made some attempts to pay the trust fund taxes through her installment plan, firmly believed that Safe-Deposit's business would improve, and believed she would be able to eventually pay in full the trust fund taxes. (Doc. 19, ¶ 17; Doc. 17, p. 2). Ms. Brown claims that her circumstances over this nearly five (5) year period placed Safe-Deposit in dire financial straits, and that she was forced to use the limited corporate funds to pay employees and to keep the doors open. The United States does not dispute the occurrence of any of these events, but argues that they are not sufficient to constitute reasonable cause. And, while the Court is sympathetic to Ms. Brown's circumstances, the Court agrees with the United States. Taxes withheld from the wages of an employee are held by the employer in trust for the government.... These trust fund taxes are for the exclusive use of the government and cannot be used to pay business expenses of the employer, including salaries.... It is no excuse that, as a matter of sound business judgment, the money was paid to suppliers and for wages in order to keep the corporation operating as a going concern-the government cannot be made an unwilling partner in a floundering business.” Brewery, 33 F.3d at 593 (quoting Collins v. United States, 848 F.2d 740, 741–42 [62 AFTR 2d 88-5038] (6th Cir.1988)). Simply put, the Court cannot say that Ms. Brown acted with ordinary business care and prudence or made reasonable efforts to protect the trust funds when she deliberately and knowingly chose to pay other business expenses with those funds from June 1999 through April 2001. The fact that her business was having financial difficulties due to outside forces (the Ocala Police and delinquent customers) does not excuse Ms. Brown's conscious choices. See Greenberg v. United States, 46 F.3d 239, 244 [74 AFTR 2d 94-7343] (3d Cir. 1994) (“It is no defense that the corporation was in financial distress and that funds were spent to keep the corporation in business with an expectation that sufficient revenue would later become available to pay the United States.”). The Court is also persuaded by the Eleventh Circuit's Thosteson decision. While the Court of Appeals refrained from addressing whether a reasonable cause defense applies in a § 6672 action, the Eleventh Circuit held that even if such a defense did exist, it would not apply where a responsible person knowingly used trust fund taxes to pay creditors other than the United States. See 331 F.3d at 1301 (quoting Logal v. United States, 195 F.3d 229, 233 [84 AFTR 2d 99-7047] (5th Cir. 1999)) (“No [reasonable cause] defense may be asserted by a responsible person who knew that the withholding taxes were due, but who made a conscious decision to use corporate funds to pay creditors other than the government.”). Thus, even without express guidance from the Eleventh Circuit, it is clear that Ms. Brown's intentional decision to pay expenses other than Safe-Deposit's trust fund taxes cannot support a reasonable cause defense. Ms. Brown also argues that her own health problems and the health of her children are sufficient to establish reasonable cause. However, Ms. Brown has not submitted any authority for this point, and the Court has been unable to find any. Moreover, the fact that Ms. Brown was able to pay employees' wages, other business expenses, as well as Safe-Deposit's trust fund taxes from 1996 through June 1999 (during which a majority of these health issues were present) militates against a finding that these same health concerns should excuse Ms. Brown's later failures to pay Safe-Deposit's trust fund taxes. 4 Based on the undisputed evidence submitted, the Court finds, as a matter of law, that Ms. Brown was the responsible person for the trust fund taxes for Safe-Deposit; that she willfully failed to pay those taxes for the tax periods ending June 30, 1999 through June 30, 2000, December 31, 2000, and March 31, 2001; and that Ms. Brown's failure to pay these trust fund taxes cannot be excused by reasonable cause. 5 Summary judgment shall be granted in favor of the United States both as to Ms. Brown's tax refund claim and as to the United States' amended counterclaim. 6 III. Requests for Additional Discovery In her supplemental response to the United States' motion for summary judgment, Ms. Brown asks to reopen discovery for a second time to allow her to conduct two additional depositions, and other unspecified discovery (Doc. 28). According to Ms. Brown, the United States did not provide full and complete answers to her prior discovery requests. In particular, she claims that the United States failed to disclose IRS Revenue Agent Richard Hanauer's supervisor, Richard Bartholomew, and the full address for retired IRS Appeals Officer Lee Copeland, who Ms. Brown claims was involved in her failed attempt to obtain an offer in compromise. In response, the United States claims that it fully responded to Ms. Brown's requests for admissions, interrogatories, and requests for production, and provided Ms. Brown with the names and addresses of all IRS employees who were involved in the trust fund investigations. The United States further contends that Mr. Bartholomew and Mr. Copeland did not participate in the investigation into Safe-Deposit and Ms. Brown, and therefore have no information relevant to this case. Mr. Bartholomew was Agent Hanauer's supervisor and had no involvement in the trust fund investigations. Mr. Copeland's contact with Ms. Brown was limited to her failed offer in compromise, which did not take place until after the trust fund investigations were completed. The Court agrees with the United States. The issues in this case are: (1) did Safe-Deposit fail to pay trust fund taxes for the tax periods in question; (2) was Ms. Brown the responsible person for Safe-Deposit during those tax periods; and, if so, (3) was Ms. Brown's failure to pay the trust fund taxes willful. The United States has presented undisputed evidence — including the testimony of Ms. Brown herself — establishing that the answer to each of these questions is “yes.” Ms. Brown has not explained how the testimony of either Mr. Bartholomew or Mr. Copeland would change this result. Moreover, Ms. Brown fully participated in an eight (8) month discovery period, received an additional forty-five (45) days to conduct further discovery, and was given the opportunity to file a supplemental summary judgment response. While the Court is cognizant of Ms. Brown's pro se status, it is clear from her filings in this case that she is aware of the applicable law and rules of civil procedure, and the Court has given her more than enough time to complete discovery and litigate her claims. Any additional discovery would merely be a fishing expedition which would only further delay the resolution of this case. Conclusion Accordingly, upon due consideration, it is hereby ORDERED as follows: ((1)) The United States' Dispositive Motion for Summary Judgment (Doc. 13) is GRANTED both as to the Plaintiff's Amended Complaint (Doc. 26), and the United States' Amended Counterclaim (Doc. 15). ((2)) The Clerk is directed to enter judgment in favor of the United States and against Plaintiff Terri Lynn Brown as to all claims set forth in the Plaintiff's Amended Complaint (Doc. 26). The Clerk is further directed to enter judgment in favor of the United States and against Plaintiff Terri Lynn Brown as to all claims set forth in the United States' Amended Counterclaim (Doc. 15) pursuant to 26 U.S.C. §§ 6671 and 6672 for the unpaid federal trust fund tax liabilities of Safe-Deposit, Inc., for the tax periods ending June 39, 1999 through June 30, 2000, December 31, 2000, and March 31, 2001, in the amount of $42,127.49, plus interest and statutory additions as allowed by law. ((3)) The Plaintiff's Request for Additional Discovery (Doc. 28) is DENIED. ((4)) The Clerk is directed to terminate any other pending motions, and to close the file. IT IS SO ORDERED. DONE and ORDERED at Ocala, Florida this 15th day of February, 2010. /s/ UNITED STATES DISTRICT JUDGE Copies to: Counsel of Record Terri Lynn Brown, pro se Maurya McSheehy ________________________________________ 1 Although the United States' original motion for summary judgment only addressed its counterclaim, it is clear that a resolution in favor of the United States would also dispose of Ms. Brown's amended complaint. The amended complaint seeks a refund of the trust fund recovery penalties paid for the tax period ending June 30, 2000 — one of the same tax periods concerning which the United States is seeking a judgment in its amended counterclaim. Thus, by finding that the United States is entitled to a judgment for that tax period for the unpaid trust fund recovery penalties, the Court also necessarily must find that Ms. Brown is not entitled to a refund of those same penalties. This issue has been fully briefed by both sides, and therefore, the Court will consider the United States' motion for summary judgment to cover both the amended complaint and amended counterclaim. ________________________________________ 2 In Bonner v. City of Prichard, Ala., 661 F.2d 1207, 1207 (11th Cir. 1981) (en banc), the Eleventh Circuit adopted as binding precedent all decisions of the former Fifth Circuit handed down prior to the close of business on September 30, 1981. ________________________________________ 3 Ms. Brown appears to argue that the Ocala Police Department conducted an inappropriate and public investigation into Safe-Deposit's business in order to ensure that her husband (who at the time was an officer with the Ocala Police) was not breaching his duties to the department or operating under a conflict of interest. Ms. Brown further contends that because the Ocala Police Department permitted off-duty officers to provide similar security services —i.e. the Police Department was a direct competitor of Safe-Deposit — the Police Department harassed Safe-Deposit and interfered with the company's business in an attempt to steal Safe-Deposit's customers. ________________________________________ 4 The Court is also unpersuaded by Ms. Brown's unsupported contention that no one at the IRS ever warned her that she would be held personally liable for Safe-Deposit's trust fund taxes. Not only is it common sense that a company must pay its taxes, Ms. Brown herself acknowledges that she was responsible for paying those taxes, and that she received notices of assessment from the IRS. Whether or not she was aware that she could be directly penalized does not constitute reasonable cause for failing to comply with the Internal Revenue Code. ________________________________________ 5 Ms. Brown further contends that IRS Revenue Agent Richard Hanauer testified at his deposition that Ms. Brown had reasonable cause for her failure to pay the trust fund taxes. A review of the deposition excerpts submitted by Ms. Brown (Doc. 28) belies this claim. Agent Hanauer instead testified that if a corporate officer or employee's health prevented her from performing her duties, the company might have a basis for requesting an abatement of a deposit penalty for FICA taxes. That is not the same as stating that Ms. Brown's health issues would excuse her willful failure to pay trust fund taxes under § 6672. ________________________________________ 6 In her amended complaint and affidavit, Ms. Brown makes vague references to a lack of due process, abuse of process, mathematical errors, and illegal assessments, ostensibly because she did not receive IRS notices, and the IRS refused to agree to an offer in compromise. Ms. Brown has not submitted any evidence or legal authority to support this allegation. Moreover, Ms. Brown admits that she was at all times aware of Safe-Deposit's trust fund obligations, received notices of assessments, and failed to satisfy the company's tax obligations as required.
Wednesday, February 23, 2011
February 23—House-passed Appropriations Act includes IRS spending cuts & restricts use of funds to implement health care reform. On February 19, the House by a vote of 235-189 approved H.R. 1, the Full Year Continuing Appropriations Act, 2011, as amended. The bill, which funds various government departments and agencies for the remainder of fiscal year 2011, includes drastic spending cuts throughout, including to the Treasury Department and IRS. The bill, as amended, would also prevent IRS from using any of the provided funds to implement the individual health insurance mandate in the Patient Protection and Affordable Care Act (PPACA, P.L. 111-148 ), including the reporting of health insurance purchased by individuals to IRS. December 24, 2009 Ordered to be printed as passed P.L. 111-148 In the Senate of the United States, December 24, 2009. Resolved, That the bill from the House of Representatives (P.L. 111-148) entitled “An Act to amend the Internal Revenue Code of 1986 to modify the first-time homebuyers credit in the case of members of the Armed Forces and certain other Federal employees, and for other purposes.”, do pass with the following AMENDMENTS: Strike out all after the enacting clause and insert:
Tuesday, February 22, 2011
WB Acquistion, Inc. and Subsidiary, et al. v. Commissioner, TC Memo 2011-36 , Code Sec(s) 172; 6662; 6664; 7491. ________________________________________ WB ACQUISITION, INC. & SUBSIDIARY, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent . Case Information: Code Sec(s): 172; 6662; 6664; 7491 Docket: Docket Nos. 26187-06, 29106-07, Date Issued: 02/8/2011 Judge: Opinion by HAINES HEADNOTE XX. Reference(s): Code Sec. 172 ; Code Sec. 6662 ; Code Sec. 6664 ; Code Sec. 7491 OPINION I. Burden of Proof The Commissioner's determinations in the notice of deficiency are generally presumed correct, and the taxpayers bear the burden of proving them incorrect. See Rule 142(a)(1). In respect of any new matter pleaded in the answer, however, the Commissioner bears the burden of proof. Id. Here, because the issue was raised only in respondent's amended answer, respondent bears the burden of proof with respect to whether the NTC joint venture was a joint venture for Federal tax purposes in 2002, resulting in an assignment of income in 2002 from WCI to WB Partners. Petitioners do not argue that the burden of proof shifts to respondent pursuant to section 7491(a) for any other issue or year, nor have they shown that the threshold requirements of section 7491(a) have been met for any of the other determinations at issue. Accordingly, the burden remains on petitioners with respect to all other issues to prove that respondent's determination of deficiencies in income tax is erroneous. II. The NTC joint venture In United States v. Basye, 410 U.S. 441, 450 [31 AFTR 2d 73-802] (1973), the Supreme Court reiterated the longstanding principle that income is taxed to the person who earns it, stating: “The principle of Lucas v. Earl, [ 281 U.S. 111, 115 [8 AFTR 10287] (1930),] that he who earns income may not avoid taxation through anticipatory arrangements no matter how clever or subtle, has been repeatedly invoked by this Court and stands today as a cornerstone of our graduated income tax system.” For a more recent formulation of this principle, see Commissioner v. Banks, 543 U.S. 426 [95 AFTR 2d 2005-659] (2005), which held that a contingent-fee agreement should be viewed as an anticipatory assignment to the attorney of a portion of the client's income from any litigation recovery. The entity earning income “cannot avoid taxation by entering into a contractual arrangement whereby that income is diverted to some other person or entity.” United States v. Basye, supra at 449. We must determine whether the NTC Joint Agreement created a legitimate joint venture between WCI and WB Partners or was merely a vehicle to divert income from the NTC project to WB Partners and away from WCI. Whether there is a partnership for tax purposes is a matter of Federal, not local, law. Commissioner v. Tower, 327 U.S. 280, 287-288 [34 AFTR 799] (1946); Estate of Kahn v. Commissioner, 499 F.2d 1186, 1189 [34 AFTR 2d 74-5278] (2d Cir. 1974), affg. Grober v. Commissioner, T.C. Memo. 1972-240 [¶72,240 PH Memo TC]; Beck Chem. Equip. Corp. v. Commissioner, 27 T.C. 840, 849 (1957); Comtek Expositions, Inc., v. Commissioner, T.C. Memo. 2003-135 [TC Memo 2003-135], affd. 99 Fed. Appx. 343 [93 AFTR 2d 2004-2537] (2d Cir. 2004). "[T]he term `partnership' includes a syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not *** a corporation or a trust or estate.” Secs. 761(a), 7701(a)(2). The principles applied to determine whether there is a partnership for Federal tax purposes are equally applicable to determine whether there is a joint venture Sierra Club, Inc. v. Commissioner, 103 for Federal tax purposes. T.C. 307, 323 (1994), affd. in part and revd. in part on other grounds 86 F.3d 1526 [78 AFTR 2d 96-5005] (9th Cir. 1996); Luna v. Commissioner, 42 T.C. 1067, 1077 (1964); Beck Chem. Equip. Corp. v. Commissioner, supra at 848-849. The required inquiry for determining the existence of a partnership for Federal income tax purposes is whether the parties “really and truly intended to join together for the purpose of carrying on business and sharing in the profits or losses or both.” Commissioner v. Tower, supra at 287. Their intention is a matter of fact, “to be determined from testimony disclosed by their `agreement, considered as a whole, and by their conduct in execution of its provisions.” Id. (quoting Drennen v. London Assurance Co., 113 U.S. 51, 56 (1885)). In Commissioner v. Culbertson, 337 U.S. 733, 742 [37 AFTR 1391] (1949), the Supreme Court elaborated on this standard and stated that there is a partnership for Federal tax purposes when considering all the facts—the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent—the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. *** In Luna v. Commissioner, supra at 1077-1078, this Court distilled the principles mentioned in Commissioner v. Tower, supra, and Commissioner v. Culbertson, supra, to set forth the following factors as relevant in evaluating whether parties intend to create a partnership for Federal income tax purposes (the Luna factors): The agreement of the parties and their conduct in executing its terms; the contributions, if any, which each party has made to the venture; the parties' control over income and capital and the right of each to make withdrawals; whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation in the form of a percentage of income; whether business was conducted in the joint names of the parties; whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers; whether separate books of account were maintained for the venture; and whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise. See also Estate of Kahn v. Commissioner, supra at 1189. None of the Luna factors is conclusive of the existence of a partnership. Burde v. Commissioner, 352 F.2d 995, 1002 [16 AFTR 2d 5885] (2d Cir. 1965), affg. 43 T.C. 252 (1964); McDougal v. Commissioner, 62 We apply each Luna factor to the facts of T.C. 720, 725 (1974). these cases to determine whether WCI and WB Partners engaged in a joint venture during the taxable periods at issue. 1. The Agreement of the Parties and Their Conduct in Executing Its Terms The NTC joint venture agreement sets forth the terms of the NTC joint venture. However, the existence of a written agreement is not determinative of whether a joint venture existed between WCI and WB Partners. See Sierra Club, Inc. v. Commissioner, supra at 324; Comtek Expositions, Inc. v. Commissioner, supra. It is well established that the tax consequences of transactions are governed by substance rather than form. Frank Lyon Co. v. United States, 435 U.S. 561, 573 [41 AFTR 2d 78-1142] (1978). The NTC joint venture agreement describes the anticipated conduct of, and relationship between, WCI and WB Partners in the NTC joint venture. The NTC joint venture agreement includes, among other things, terms governing each joint venturer's participation in the preparation and submission of the proposal for the NTC project, obligations and responsibilities to the NTC joint venture, the receipt, allocation and distribution of profits, and the NTC joint venture's financial and tax reporting obligations. Petitioners argue that WCI and WB Partners substantially complied with the terms of the NTC joint venture agreement. In at least three instances, however, WCI and WB Partners acted outside the plain language of the agreement. Most notably, Barone testified that because the NTC project was more profitable than expected, the NTC joint venture capped WB Partners' profits and awarded WCI approximately $1,600,000 more than it was entitled to pursuant to the NTC joint venture agreement. This additional allocation resulted in an actual allocation of profits between WCI and WB Partners of 49.6 and 50.4 percent, respectively. Respondent contends that the profit cap is a significant change from the 70 percent of profits allocated to WB Partners in section 4.4 of the NTC joint venture agreement. The NTC joint venture agreement does not include a provision permitting WCI and WB Partners to institute a profit cap for either party. Further, although WCI and WB Partners had the right to amend the NTC joint venture agreement, there is no evidence of such an amendment. Accordingly, WCI and WB Partners did not comply with the terms of the NTC joint venture agreement with respect to the profit allocation. In addition to the profit cap, respondent argues that the NTC joint venture failed to file a Federal income tax return as required pursuant to section 5.1 of the NTC joint venture agreement. Petitioners argue that MRB treated the NTC joint venture as jointly controlled operations under GAAP using a method where each joint venturer included its share of the NTC joint venture profits in its income and its share of the NTC joint venture assets on its balance sheets. MRB's treatment of the NTC joint venture pursuant to GAAP is not determinative as to whether the NTC joint venture must file a Federal income tax return. The treatment of an item for financial accounting purposes does not always mesh with its treatment for Federal tax purposes. Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 531 [43 AFTR 2d 79-362] (1979); see also Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 128 (1991); UFE, Inc. v. Commissioner, 92 T.C. 1314, 1321 (1989); Sandor v. Commissioner, 62 T.C. 469, 477 (1974), affd. 536 F.2d 874 [38 AFTR 2d 76-5150] (9th Cir. 1976). Further, MRB's treatment of the NTC joint venture pursuant to GAAP does not affect whether WCI and WB Partners executed the terms of the NTC joint venture agreement. Accordingly, the NTC joint venture's failure to file a Federal income tax return is a substantive deviation from the NTC joint venture agreement. The first Luna factor weighs against finding a joint venture between WCI and WB Partners. WCI and WB Partners failed to comply with the terms of the NTC joint venture agreement with respect to the allocation of profits and tax return filing requirements. We find this failure to comply to be a significant deviation from the NTC joint venture agreement. 2. The Contributions, If Any, Which Each Party Has Made to the Venture We have held that both parties do not have to be active participants to a venture, so long as there is an intent to form a business together. 70 Acre Recognition Equip. Pship. v. Commissioner, T.C. Memo. 1996-547 [1996 RIA TC Memo ¶96,547]. Nonetheless, both parties to the common enterprise must contribute elements necessary to the business. See Beck Chem. Equip. Corp. v. Commissioner, 27 T.C. at 852; Wheeler v. Commissioner, T.C. Memo. 1978-208 [¶78,208 PH Memo TC]. The Supreme Court has indicated that the services or capital contributions of a partner need not meet an objective standard. See Commissioner v. Culbertson, 337 U.S. at 742-743. The Court further stated: If, upon a consideration of all the facts, it is found that the partners joined together in good faith to conduct a business, having agreed that the services or capital to be contributed presently by each is of such value to the partnership that the contributor should participate in the distribution of profits, that is sufficient. *** Id. at 744-745. Accordingly, the Tax Court may not substitute its judgment for that of the parties in determining the value of their contributions. Id. Petitioners and respondent agree that WCI made significant contributions to the NTC joint venture. Respondent contends, however, that WB Partners failed to contribute to and was therefore unnecessary to the NTC joint venture. WB Partners' obligations and responsibilities to the NTC joint venture are set forth in section 2.1. 2 of the NTC joint venture agreement, which provides: 2.1. 2 Obligations and Responsibilities of WB. The proposal shall provide that WB shall have responsibility for providing Indemnity and Financing Services to WCI so that WCI has the financial capability to perform the subcontract work. Petitioners argue that WB Partners fulfilled its obligations to the NTC joint venture by contributing its rights to the financing capabilities and bonding guaranty services of Barone and Watkins, which were essential to the NTC joint venture. Additionally, petitioners argue that WCI would not have been able to obtain the NTC bond without WB Partners' financial guaranties, which were necessary to securing the NTC project. Petitioners argue that because WB Partners is a legitimate entity, its contributions to the NTC joint venture must be respected pursuant to Forman v. Commissioner, 199 F.2d 881 [42 AFTR 869] (9th Cir. 1952), vacating a Memorandum Opinion of this Court. In Forman, the court held a partnership between a husband and wife to be valid. In finding the partnership to be valid, the court observed that not all business relationships between a husband and wife are shams for tax purposes and that a court must respect the valuable contributions of a wife where the facts dictate. Petitioners urge us to adopt this policy in the context of related entities. We conclude that Forman is not dispositive of the issue. The question is not whether WB Partners is capable of a valuable contribution, but rather, whether it made a valuable contribution. In other words, what was the value of WB Partners' contribution to the joint venture? Petitioners argue that WB Partners made significant contributions to the NTC joint venture by providing the financial services and expertise of Barone and Watkins, as well as providing the financial resources necessary to obtaining the NTC bond. We first analyze the value of the financial services and expertise of Barone and Watkins. As discussed above, we may not substitute our judgment for the judgment of petitioners in determining the value of the services WB Partners contributed to the NTC joint venture. Nonetheless, we must determine whether WB Partners contributed the financial services of Barone and Watkins in good faith for purposes of conducting a business. Respondent argues that WCI was entitled to the services and expertise of Barone and Watkins because of their roles as WCI corporate officers. Accordingly, respondent contends that WB Partners furnished nothing of value to WCI apart from services which WCI could have engaged directly had the NTC joint venture not been created. The rights to the services and expertise of Barone and Watkins were ostensibly contributed to WB Partners from DJB and GSW pursuant to section 1.6 of the WB Partners partnership agreement. DJB and GSW held exclusive rights to the financing, construction management, and indemnity services of Barone and Watkins pursuant to section 2.2 of their respective employment agreements. If we are to respect these agreements, Barone and Watkins were contractually forbidden from providing these services to WCI in their roles as corporate officers. As discussed above, however, it is well established that the tax consequences of transactions are governed by substance rather Frank Lyon Co. v. United States, 435 U.S. at 573. than form. Accordingly, we must determine whether Barone and Watkins conducted themselves in a manner consistent with their respective employment agreements with DJB and GSW. Throughout the NTC project, WCI had other projects in progress, projects that did not involve WB Partners, DJB, or GSW. In discussing contracts outside the NTC project at trial, Watkins testified that he “bid and got and oversaw three quarters of the rest of them.” In doing so, Watkins regularly conducted activities as an officer of WCI that he was contractually obligated to exclusively provide to GSW. Further, Barone testified that while WCI was owned by REXX, his responsibilities included “anything from managing employees to handling finance to business development.” He described these duties to include managing projects. After WCI was repurchased from REXX, Barone testified that his duties remained the same as CEO of WCI, where he mostly oversaw the NTC project but managed other projects as well. Accordingly, the exclusivity clause of the employment agreements did not prevent Barone and Watkins from providing allegedly restricted services in their capacity as officers of WCI. Because Barone and Watkins failed to respect the language of the exclusivity clauses of the employment agreements, we do the same, and we find that WB Partners' contribution of the services of Barone and Watkins to the NTC joint venture was not necessary for the purpose of conducting the NTC project. Next, petitioners argue that WB Partners contributed its financial guaranties to the NTC joint venture. In determining the value of this contribution, petitioners rely on the agreement among Barone, Watkins, and REXX for Barone and Watkins' personal guaranties to secure the bond for the IDIQ project. In return for their guaranties Barone and Watkins were given 66.66 percent of the profits from the project. Petitioners claim that this agreement was used as a model to value WB Partners' interest in the NTC joint venture. Petitioners argue that WCI could not have obtained the NTC bond without WB Partners' financial guaranties. Petitioners overlook, however, that the NTC bond was issued on the basis of the combined net worth and financial guaranties of each of WCI, WB Partners, Barone, Watkins, DJB, and GSW. In doing so, petitioners ignore the reality of WB Partners' contribution. The NTC joint venture was not necessary for WB Partners' financial guaranty, nor was it necessary for WCI to obtain the NTC bond. WB Partners was a required indemnitor under the indemnity agreements because WB Partners was related to WCI, not because WB Partners provided any unique value to the NTC joint venture. Accordingly, no different from those of Barone, Watkins, DJB, and GSW, WB Partners' financial guaranties were not intertwined with its participation in the NTC joint venture. This is a significant distinction from the agreement among Barone, Watkins, and REXX for the guaranties provided in the IDIQ project. The guaranties of Barone and Watkins required compensation from REXX. Further, despite requiring the financial guaranties of Barone, Watkins, DJB, and GSW to obtain the NTC bond, WCI did not enter into a joint venture agreement with anyone but WB Partners. Neither Barone, Watkins, DJB, nor GSW was entitled to a portion of the profits from the NTC joint venture in exchange for making contributions identical to that of WB Partners. Petitioners do not explain why the financial guaranties of these other parties were valueless while WB Partners' guaranties entitled it to a significant portion of the NTC joint venture profits. This arrangement is not indicative of an arm's-length negotiation between uncontrolled parties. The contributions of WB Partners to the NTC joint venture were of little value to the NTC project. Accordingly, this Luna factor weighs against the finding that WB Partners and WCI engaged in a joint venture. 3. The Parties' Control Over Income and Capital and the Right of Each To Make Withdrawals WCI entered into the contract for the NTC project with Harper and was entitled to all payments from the job. Pursuant to the NTC joint venture agreement, however, WCI was required to deposit the funds received from Harper into the NTC joint venture bank account. Petitioners posit that Barone and Watkins wore two hats in dealing with the income and capital received from the NTC joint venture. Specifically, petitioners argue that Barone and Watkins wore one hat to represent the best interests of WCI and another hat to represent the independent and often competing interests of WB Partners. Accordingly, petitioners argue that Barone and Watkins, on behalf of both WCI and WB Partners, exercised control over the income and capital and the right of each entity to make withdrawals. Throughout their arguments, petitioners set forth this theory that Barone and Watkins wore two hats in negotiations and transactions affecting related entities under their control. For the Court to respect this theory requires evidence that decisions affecting WCI and WB Partners were conducted at arm's length. We cannot reconcile the profit cap with petitioners' two hat theory. Petitioners contend that it was decided to cap WB Partners' share of the profits because the NTC joint venture was more profitable than expected. Without further explanation, petitioners describe this as a “valid business reason.” This justification is not sufficient. Pursuant to the NTC joint venture agreement, WB Partners was entitled to 70 percent of the profits from the NTC joint venture. Petitioners have not presented any legitimate reason why WB Partners would forfeit its contractual right to 19.6 percent of the NTC joint venture profits. Such a forfeiture is not indicative of the conduct of unrelated parties in an arm's-length agreement. 7 Accordingly, WCI and WB Partners did not exercise control over the income and capital of the NTC joint venture in a manner commensurate with their joint venture interests. This Luna factor weighs against a finding that WB Partners and WCI engaged in a joint venture. 4. Whether Each Party Was a Principal and Coproprietor, Sharing a Mutual Proprietary Interest in the Net Profits and Having an Obligation To Share Losses, or Whether One Party Was the Agent or Employee of the Other, Receiving for His Services Contingent Compensation in the Form of a Percentage of Income Since its inception WB Partners has filed financials and tax returns and has engaged in investment activities outside of the NTC joint venture. WB Partners is not a sham for tax purposes. Petitioners argue that Barone and Watkins, on behalf of WB Partners, contributed indemnity and financing services to the NTC joint venture; that WCI contributed environmental remediation, construction, and licensing services; and that section 4.4 of the NTC joint venture agreement allocates the net profit of the NTC joint venture between WCI and WB Partners accordingly. However, as discussed above, a profit cap was instituted to limit the profit share of WB Partners. This profit cap is more indicative of a contingent compensation arrangement than a mutual proprietary interest. Further, WCI does not have an obligation to share pro rata in the NTC joint venture losses. Section 4.2 of the NTC joint venture agreement provides: 4.2 Reimbursement of WCI Costs and Expenses. WCI shall be entitled to reimbursement from the NTC joint venture Account of all Direct Costs incurred by WCI in connection with the subcontract Work, plus Five Percent (5%) of all such Direct Costs. As herein, “Direct Costs” shall mean all direct costs and expenses reasonably incurred by WCI in connection with the subcontract Work, but excluding therefore any indirect costs, including without limitation, overhead and general administrative expenses as determined in accordance with Federal government cost accounting standards. WCI shall, on a monthly basis, submit to the Joint Venture an invoice for Direct Costs incurred, plus Five Percent (5%) of such costs. Petitioners concede that pursuant to this provision, any possibility of loss to WCI on the NTC project was virtually eliminated (i.e., it was guaranteed reimbursement of direct costs plus 5 percent). Petitioners argue, however, that WCI's obligation on the NTC bond left it at risk to the extent of its net worth. We do not find this risk relevant to the inquiry. WCI agreed to the NTC bond and the indemnity agreements as an entity separate from the NTC joint venture. Accordingly, any resulting risk is an independent business obligation, and not a risk resulting from WCI's participation in the NTC joint venture. WCI and WB Partners did not share in the profits of the NTC joint venture in a manner consistent with a mutual proprietary interest. Further, WCI did not share pro rata in the losses from Accordingly, this Luna factor weighs the NTC joint venture. against the finding that WB Partners and WCI engaged in a joint venture. 5. Whether Business Was Conducted in the Joint Names of the Parties The evidence with respect to this Luna factor is mixed. WCI, not the NTC joint venture, entered into the subcontract agreement. WCI billed Harper, and Harper made payments directly to WCI. Further, WCI is the principal on the NTC bond, not the NTC joint venture. On the other hand, the NTC joint venture applied for, obtained, and used its own employer identification number. The NTC joint venture also (1) used its employer identification number to open the NTC joint venture bank account,(2) signed the indemnity agreements, and (3) conducted business as a joint venture with the MRB accounting firm. Accordingly, this Luna factor is neutral with respect to whether WCI and WB Partners engaged in a joint venture. 6. Whether the Parties Filed Federal Partnership Returns or Otherwise Represented to Respondent or to Persons With Whom They Dealt That They Were Joint Venturers The NTC joint venture did not file a Federal partnership income tax return as required by the NTC joint venture agreement. Further, WCI did not represent itself as a member of the NTC joint venture in its negotiations, agreement, and dealings with Harper. At trial, Humphrey, Harper's primary representative on the NTC project, testified that he was not aware of WB Partners. In many other respects, WCI and WB Partners represented themselves as joint venturers. As discussed above, the NTC joint venture used its own employer identification number, opened a bank account, and signed the indemnity agreements. In doing so, WCI and WB Partners represented themselves as joint venturers to, among others, AIG, the Greenwich Insurance Group, the Insurance Co. of the State of Pennsylvania, and Wells Fargo Bank. The NTC joint venture did not file a Federal income tax return; however, in certain instances it was represented to third parties as a joint venture between WCI and WB Partners. Accordingly, this Luna factor is neutral with respect to whether WCI and WB Partners engaged in a joint venture. 7. Whether Separate Books of Account Were Maintained for the Venture The NTC joint venture maintained separate books for the NTC joint venture bank account. Further, the NTC joint venture created separate income statements. Other documents, such as work-in-progress reports, were created in the name of the NTC joint venture. These documents were labeled as documents of the NTC joint venture; however, they were prepared by WCI employees. Further, no other books of account that may normally be expected in the operation of a business were maintained for the NTC joint Accordingly, this Luna factor is neutral with respect venture. to whether WCI and WB Partners engaged in a joint venture. 8. Whether the Parties Exercised Mutual Control Over and Assumed Mutual Responsibilities for the Enterprise Petitioners once again set forth the theory that Barone and Watkins wore two hats in representing both WCI and WB Partners in the mutual control of the NTC joint venture. As discussed above, this theory requires evidence of arm's-length dealings between the two entities. Absent evidence of a reasonable business purpose to justify a forfeiture, the Court does not believe that WB Partners exercised mutual control over the NTC joint venture when WB Partners conceded a significant portion of the profits it was entitled to pursuant to the NTC joint venture agreement. Petitioners have failed to present such a business purpose. Accordingly, this Luna factor weighs against a finding that WB Partners and WCI engaged in a joint venture. Five of the eight Luna factors weigh against a finding of a joint venture and three Luna factors are neutral. Applying the various Luna factors, with no one factor being conclusive, we hold there was no joint venture between WCI and WB Partners during the taxable periods at issue. We reach the same conclusion using the overall intent approach set forth in Commissioner v. Culbertson, 337 U.S. 733 [37 AFTR 1391] (1949). WCI conducted all of the business of the NTC joint venture throughout the NTC project. As discussed above, WB Partners did not contribute anything of substance to the NTC joint venture. Considering all the facts and circumstances and in accordance with our analysis of the Luna factors, we find that WCI and WB Partners did not intend to join together in the conduct of a joint venture. 8 As a result, respondent has met his burden of proof for 2002 and petitioners have failed to meet their burden of proof for 2003 and 2004. Accordingly, we sustain respondent's determinations with regard to the NTC joint venture for 2002-2004. III. Sale of WCI On April 18, 2003, WCI entered into an asset purchase agreement for the sale of substantially all of the assets of WCI to Kuranda for $5,423,091. The parties allocated $3,400,000 of the purchase price to the noncompetition agreement. The proceeds of the noncompetition agreement and interest paid on the $500,000 note were included as income by WB Partners on its 2003 Federal partnership income tax return. Respondent contends that the assets sold belonged to WCI and, therefore, the proceeds of the noncompetition agreement and interest paid on the $500,000 note should be properly included as income to WCI, not WB Partners. Petitioners argue that the exclusive services of Barone and Watkins belonged to DJB and GSW through their respective employment agreements and that those rights were contributed by DJB and GSW to WB Partners. Petitioners therefore contend that because WB Partners controlled the exclusive rights to the services of Barone and Watkins and because without those services it would be impossible for an entity controlled by Barone and Watkins to compete with Kuranda, the proceeds of the noncompetition agreement were properly included in the income of WB Partners. Petitioners rely on section 1.1. 4 and 1.3 of the employment agreements, which was added by amendment on December 3, 2002. Section 1.1. 4 of each employment agreement provides that the exclusive service provided by Barone and Watkins include any and all services related to the present or future business of DJB, GSW, WB Partners, WCI, the NTC joint venture, or any party that acquires an interest in any of the above-listed entities. Section 1.3 is a noncompetition provision which prevents Barone and Watkins from engaging in any business activity which is, or could become, competitive with or adverse to the above-listed entities. Petitioners further rely on recital D of the noncompetition agreement, which provides that WB Partners, through DJB's and GSW's exclusive employment agreements, controls the services of Barone and Watkins, including the rights to enforce observation of the noncompetition requirements by each. Petitioners argue that this provision is evidence that Kuranda recognized that the rights to these services belonged to WB Partners. In our discussion of the Luna factors we held that WB Partners did not contribute the services of Barone and Watkins to the NTC joint venture because WCI was able to engage those services from Barone and Watkins in their capacities as corporate officers. In doing so, we analyzed substance over form to determine that Barone and Watkins did not conduct themselves consistently with the exclusivity clauses of their respective employment agreements. This substance over form analysis is equally applicable to determine whether WB Partners properly included the proceeds of the noncompetition agreement in its 2003 gross income. The noncompetition agreement prevents Barone and Watkins and any related entity from participating in “Competing Services.” The noncompetition agreement defines “Competing Services” as any: (i) service that has been provided, performed or offered by or on behalf of *** [WCI] (or any predecessor of *** [WCI]) at any time on or prior to the date of this Noncompetition Agreement that involves or relates to asbestos, mold, and lead abatement in residential, commercial and government properties; (ii) service that is substantially the same as, is based upon or competes in any material respect with any service referred to in clause "(i)” of this sentence. According to the subcontract agreement and the testimony of Humphrey, Barone, and Watkins, the physical work of the NTC project was performed by WCI. WCI had the proper licenses and permits to perform the necessary construction and excavation work, not WB Partners, DJB, GSW, or the NTC joint venture. Petitioners describe WB Partners, DJB, and GSW as investment vehicles, not businesses engaged in performing services. Except for WCI, nothing in the record suggests that any of the entities controlled by Barone and Watkins performed services involving or related to “asbestos, mold, and lead abatement in residential, commercial and government properties”. Despite the language of the employment agreements, the asset purchase agreement, and the noncompetition agreement, in reality WCI was the only entity involved that actively conducted the “Competing Services.” Accordingly, WCI, and not WB Partners, owned the rights to the future performance of such services, and we sustain respondent's determination with respect to the noncompetition agreement. As discussed above, WB Partners recognized interest income on its 2003 and 2004 partnership Federal income tax returns for interest paid by Kuranda on the $500,000 note. Respondent contends that because the proceeds of the noncompetition agreement properly belonged to WCI, any interest on the $500,000 note is interest income to WCI. Having sustained respondent's determination with respect to the noncompetition agreement, we further sustain respondent's determination that interest paid on the $500,000 note must be included as interest income to WCI, and not WB Partners, in 2003 and 2004. Finally, respondent contends that because WCI must recognize income from the proceeds of the noncompetition agreement and interest income from the $500,000 note, it is entitled to related deductions claimed by WB Partners. We agree. Accordingly, we sustain respondent's determination with respect to deductions related to the noncompetition agreement and $500,000 note. IV. NOL Petitioners bear the burden of establishing both the existence and amounts of NOL carrybacks and carryforwards. See Rule 142(a); Keith v. Commissioner, 115 T.C. 605, 621 (2000); Lee v. Commissioner, T.C. Memo. 2006-70 [TC Memo 2006-70]. Taxpayers are required to maintain records sufficient to establish the amounts of allowable deductions and to enable the Commissioner to determine the correct tax liability. Sec. 6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999). If a factual basis exists to do so, the Court may in some contexts approximate an allowable expense, bearing heavily against the taxpayer who failed to maintain adequate records. Cohan v. Commissioner, 39 F.2d 540, 543-544 [8 AFTR 10552] (2d Cir. 1930); see sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). However, in order for the Court to estimate the amount of an expense, the Court must have some basis upon which an estimate may be made. Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). Without such a basis, any allowance would amount to unguided largesse. Williams v. United States, 245 F.2d 559, 560-561 [51 AFTR 594] (5th Cir. 1957). In 2000 and 2001 WCI claimed NOLs of $563,485 and $1,311,424, respectively. In 2002 WCI used $443,077 of the NOL generated in 2000. In 2003, according to WCI's Federal income tax return, WCI used a balance of $159,593 from the NOL generated in 2000 and the entire $1,311,424 generated in 2001, for a total NOL deduction of $1,471,117. Respondent conceded that petitioners have substantiated the $563,485 NOL generated in 2000. As a preliminary matter, respondent argues in his reply brief for the first time that WCI miscalculated its NOL carryover from 2002, resulting in double counting in both 2002 and 2003 of a portion of the NOL generated in 2000. Respondent concedes that this issue has not been raised previously; however, respondent argues that pursuant to Rule 41(b)(1) an issue may be tried even if the issue was not raised in the pleadings. Rule 41(b)(1) provides that in appropriate circumstances, an issue that was not expressly pleaded, but was tried by express or implied consent of the parties, may be treated in all respects as if raised in the LeFever v. Commissioner, 103 T.C. 525, 538-539 pleadings. (1994), affd. 100 F.3d 778 [78 AFTR 2d 96-7335] (10th Cir. 1996). This Court, in deciding whether to apply the principle of implied consent, has considered whether the consent results in unfair surprise or prejudice to the consenting party and prevents that party from presenting evidence that might have been introduced if the issue had been timely raised. See Krist v. Commissioner, T.C. Memo. 2001-140 [TC Memo 2001-140]; McGee v. Commissioner, T.C. Memo. 2000-308 [TC Memo 2000-308]. WCI's 2002 Federal income tax return shows that WCI used $443,077 of the $563,485 NOL generated in 2000. This would leave a carryover of the NOL generated in 2000 of $120,408. However, on its 2003 Federal income tax return, WCI claimed a carryover NOL from 2000 of $159,593. Accordingly, respondent argues that WCI overstated the carryover from the NOL generated in 2000 by $39,185. The only explanation for this discrepancy on the record is found in the workpapers of MRB, which describe the $39,185 as a “contribution *** [carryover] converted into an NOL”. Because respondent raised this issue for the first time in his reply brief and because the record provides a possible explanation for the discrepancy, we find that petitioners would be unfairly prejudiced if we were to consider this issue without petitioners' having the opportunity to respond. Accordingly, we do not find implied consent pursuant to Rule 41(b)(1), and the Court will not consider whether WCI overstated the carryover by $39,185. Next, respondent contends that petitioners have failed to substantiate the $1,311,424 NOL generated in 2001 and used in 2003. Petitioners have presented evidence with respect to three items making up a portion of the NOL generated in 2001: (1) An adjustment on Schedule M-1 of $214,960; (2) professional fees of $243,199; and (3) cost of goods sold of $526,998. These items combined make up $985,157 of the $1,311,424 NOL claimed. Petitioners argue that respondent asked for information to substantiate the NOL deductions during the examination process. Petitioners contend that respondent has challenged only the three items above and conceded the balance. There is no evidence on the record to support this assertion. Petitioners' evidence respecting the $1,311,424 NOL generated in 2001 is confined to the three items listed above. Accordingly, before examining the weight of that evidence, we find that petitioners have failed to substantiate the remaining $326,267 of the NOL generated in 2001, and we sustain respondent's determination with regard to this remainder. Petitioners claim to have substantiated a $214,960 Schedule M-1 adjustment. At trial, petitioners' C.P.A. Rosner testified that the Schedule M-1 adjustment is an accounting adjustment made to reduce book income because WCI had reported an excess of book income when it was owned by REXX. Rosner further testified that the Schedule M-1 adjustment was the result of WCI's overstating its profits on three jobs in 2000. Petitioners did not describe the three jobs for which WCI overstated profits in 2000. Further, petitioners failed to explain how it was determined that profits in 2000 were overstated or provide any documentation to evidence this determination. Accordingly, petitioners have failed to meet their burden of proof, and we sustain respondent's determination with regard to the Schedule M-1 adjustment. Petitioners provided canceled checks and the testimony of Rosner to substantiate legal and professional fees of $243,199. Respondent argues that because the canceled checks do not include memo lines describing the nature of the work provided, petitioners have failed to substantiate that the amounts were paid for ordinary and necessary business expenses. We disagree with respondent. The parties have stipulated that the canceled checks reflect amounts paid by WCI to various law firms or other entities providing legal services, and Rosner testified to his discussions with the revenue agent with respect to legal and professional fees during examination. Further, the legal and professional fees were consistent with similar expenses claimed by WCI in 2000, 2002, and 2003. Accordingly, we find that WCI is entitled to $243,199 of the NOL attributable to legal and professional fees. Finally, petitioners provided the general ledger of WCI as evidence of the $526,998 attributable to cost of goods sold. Petitioners have not provided receipts, invoices, canceled checks, or any other evidence to prove the nature of these expenses or whether such expenses were paid. Accordingly, petitioners have failed to meet their burden of proof, and we sustain respondent's determination with regard to the cost of goods sold. V. Section 6662(a) Penalty Section 6662(a) and (b)(2) imposes an accuracy-related penalty upon any underpayment of tax resulting from a substantial understatement of income tax. The penalty is equal to 20 percent of the portion of any underpayment attributable to a substantial An understatement is understatement of income tax. Id. “substantial” if it exceeds the greater of: (1) 10 percent of the tax required to be shown on the return for the taxable year or (2) $5,000 ($10,000 in the case of a corporation). Sec. 6662(d)(1). Section 6662(a) and (b)(1) also imposes a penalty equal to 20 percent of the amount of an underpayment attributable to negligence or disregard of rules or regulations. Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code, including any failure to maintain adequate books and records or to substantiate items properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Respondent has the burden of production with respect to the accuracy-related penalty. To meet this burden, respondent must produce sufficient evidence indicating that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once respondent meets this burden of production, petitioners have the burden of proving that respondent's determination is incorrect. See Rule 142(a); Higbee v. Commissioner, supra at 446-447. Petitioners' underpayments of tax resulting from our determinations exceed $5,000 for each year in issue. Further, petitioners' failure to produce records substantiating their claimed NOL deductions supports the imposition of the accuracy-related penalty for negligence with respect to those deductions for the years at issue. An accuracy-related penalty is not imposed on any portion of the underpayment as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1). A taxpayer may be able to demonstrate reasonable cause and good faith (and thereby escape the accuracy-related penalty of section 6662) by showing its reliance on professional advice. See sec. 1.6664-4(b)(1), Income Tax Regs. However, reliance on professional advice is not an absolute defense to the section 6662(a) penalty. Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 [66 AFTR 2d 90-5322] (5th Cir. 1990), affd. 501 U.S. 868 [68 AFTR 2d 91-5025] (1991). A taxpayer asserting reliance on professional advice must prove: (1) That his adviser was a competent professional with sufficient expertise to justify reliance; (2) that the taxpayer provided the adviser necessary and accurate information; and (3) that the taxpayer actually relied in good faith on the adviser's judgment. See Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 [90 AFTR 2d 2002-5442] (3d Cir. 2002). As a defense to the penalty, petitioners bear the burden of proving that they acted with reasonable cause and in good faith. See Higbee v. Commissioner, supra at 446. Petitioners argue that they relied on Rosner, as a tax specialist, to determine the tax treatment of the transactions at issue. 9 Petitioners contend that they have established Rosner as a professional with the requisite expertise, he was provided necessary and accurate information, and they relied on him in good faith. We disagree. Petitioners have failed to set forth any evidence that Rosner was provided with all the necessary and accurate information. In fact, Rosner testified that he was not involved in any discussions about the structure of the transactions at issue and that he merely prepared financial statements and returns based on the information he was provided. Accordingly, petitioners have failed to show reasonable cause or any other basis for reducing the penalties, and we find them liable for the section 6662 penalty for the years at issue as commensurate with the concessions and our holding. See id. In reaching our holdings herein, we have considered all arguments made, and, to the extent not mentioned above, we conclude they are moot, irrelevant, or without merit. To reflect the foregoing, Decisions will be entered under Rule 155. ________________________________________ 2 On brief respondent conceded that: (1) A refund check for $326,574 erroneously issued by respondent to Watkins Contracting, Inc., was returned and does not constitute income to Watkins Contracting, Inc., in 2005; (2) WB Partners, DJB Holding Corporation, GSW Holding Corporation, the DJB Holding Corporation ESOP, and the GSW Holding Corporation ESOP are not shams for tax purposes; (3) DJB Holding Corporation and GSW Holding Corporation are the true partners of WB Partners; and (4) petitioners have substantiated the net operating loss (NOL) of $563,485 of Watkins Contracting, Inc., generated in 2000 and used in 2002 and 2003. ________________________________________ 3 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure. Amounts are rounded to the nearest dollar. ________________________________________ 4 Since its formation, WB Partners has invested in at least 20 business ventures, including investments in a publishing company, a medical center, a hotel in Florida, condominiums in Las Vegas, and other properties in California. ________________________________________ 5 At trial, Barone testified that he was more willing to take risks and that DJB allowed him to make investments that Watkins could not stomach. ________________________________________ 4 ________________________________________ 6 As discussed above, Acquisitions filed a consolidated tax return with WCI for taxable years 2002-2005. ________________________________________ 70 ________________________________________ 2 ________________________________________ 2 ________________________________________ 7 Petitioners argue that the profit cap is evidence that the NTC joint venture was not entered into for tax purposes. Petitioners contend that had they been motivated by tax concerns, they would not have allocated an additional $1,600,000 to WCI, subjecting that amount to an increased net tax. We decline to speculate as to the intent of WCI and WB Partners in instituting the profit cap. The end result was a forfeiture of income in a manner that fails to represent an arm's-length transaction. ________________________________________ 8 Petitioners spent significant time throughout these cases discussing the benefits of the NTC joint venture in isolating WB Partners' allocation of profits from the NTC project from WCI's other creditors. Petitioners argue that this nontax business purpose supports the economic substance of the NTC joint venture and is evidence of the parties' intent to join together. Having already held that WCI and WB Partners did not conduct a joint venture, we need not decide whether the NTC joint venture had economic substance. Insofar as the NTC joint venture isolated WB Partners' share of the NTC project profits from WCI's creditors, this result does not reflect an intent of the parties to join together to conduct a business. ________________________________________ 4 ________________________________________ 4 ________________________________________ 9 Petitioners do not argue that they relied on the professional advice of Ryder despite his role in structuring the entities controlled by B