Supreme Court to review this section 104 case whether payments received after the effective date of amendments to 26 U.S.C. §104(a)(2) based on a defamation settlement agreement executed prior to the effective date can be excluded from gross income.Gavin Polone, Petitioner v. Commissioner of Internal Revenue, Respondent.

U.S. Court of Appeals, 9th Circuit; 04-72672, October 11, 2007, 505 F3d 966.

Withdrawing 2007-1 USTC ¶50,392. Affirming the Tax Court, 86 TCM 698, Dec. 55,375(M), TC Memo. 2003-339.

[ Code Secs. 104 and 1001]

Defamation claim: Settlement payments: Nonphysical injury: Amounts received: Dispositions of property: Taxable income: Fifth Amendment: Due process: Amended statute applicable. --


Settlement payments received by a talent agent from his former employer as damages for defamation were taxable as ordinary income because amended Code Sec. 104 did not provide for the exclusion of payments for nonphysical injuries. The settlement was not subject to the exception for preexisting agreements under the amended Code Sec. 104 because it was not in effect before the date specified in the exception. The statutory language and existing case law did not support the taxpayer's argument that under Code Sec. 1001 the entire amount received was realized on the date of the settlement and, therefore, subject to the pre-amendment Code Sec. 104. Finally, the taxpayer's Fifth Amendment due process rights were not violated by the application of amended Code Sec. 104 to the payments received after the statute was amended. Although the taxpayer's settlement with his former employer antedated the amendment, the taxpayer did not receive all of the payments before the effective date of the amendment. Back references: ¶2900.31, ¶6662.521 and ¶29,226.528.







ORDER AND OPINION





ORDER


The opinion filed March 12, 2007, is withdrawn and a substituted opinion is filed concurrently with this order.

With the filing of the opinion, the panel has voted to deny the petition for rehearing. Judge Thomas voted to reject the suggestion for rehearing en banc and Judges Farris and Schiavelli so recommend.

The full court has been advised of the suggestion for rehearing en banc, and no judge of the court has requested a vote on the suggestion for rehearing en banc. Fed. R. App. P. 35(b).

The petition for rehearing is denied and the suggestion for rehearing en banc is rejected.

No further petitions for rehearing or petitions for rehearing en banc shall be filed or entertained in this case.

The motion to modify opinion is denied as moot.




OPINION


THOMAS, Circuit Judge: This appeal presents the question of whether payments received after the effective date of amendments to 26 U.S.C. §104(a)(2) based on a defamation settlement agreement executed prior to the effective date can be excluded from gross income. We conclude that the amendments apply to payments received after the effective date of the amendment, and we affirm the judgment of the Tax Court.




I


Gavin Polone worked as a talent agent at United Talent Agency ("UTA") from 1989 until April 21, 1996, when he was fired. After terminating Polone, UTA spoke with various entertainment industry trade publications, and made statements about Polone's termination. Specifically, UTA alleged that Polone was terminated for "inappropriate behavior."

Polone hired counsel, and sent UTA a demand letter on April 22, 1996. The letter alleged that UTA had made defamatory statements about Polone, and requested that UTA "cease and desist from making further defamatory statements." On April 24, 1996, Polone filed a complaint in the Los Angeles County Superior Court alleging, among other things, wrongful termination and defamation. Polone and UTA settled both claims on May 3, 1996.

Polone received $2 million as settlement of the wrongful termination claim, which is not at issue in this case. As part of the settlement of the defamation claim, UTA issued a press release retracting its previous statements about Polone's termination, and paid Polone $4 million. The $4 million was paid in four installments of $1 million, which Polone received on May 3, 1996; November 11, 1996; May 5, 1997; and November 11, 1998.

Polone, a cash basis taxpayer, did not include the May 1996 payment on his 1996 federal income tax return. He included the November 1996 payment, but later filed an amended 1996 return seeking a refund. He did not pay taxes on the May 1997 or November 1998 payments. Polone justified his failure to pay taxes on this income on our decision in Warren Jones Co. v. Comm'r [ 75-2 USTC ¶9732], 524 F.2d 788 (9th Cir. 1975), alleging that Warren Jones Co. required him "to treat his receipt of his former employer's promise to pay $4 million as an amount realized in the 1996 taxable year at the time of his receipt of the promise to pay."

In September 2000, the IRS sent Polone a deficiency notice for his failure to pay taxes on the settlement payments he received in May 1996, May 1997, and November 1998.
Polone petitioned for review in the Tax Court in December 2000. He also filed an amended petition in August 2002, claiming that the IRS should have reduced his 1996 taxable income by $1 million because he had erroneously paid taxes on the November 1996 settlement payment. The Tax Court held that Polone owed taxes on the May 1997 and November 1998 settlement payments, and that the taxes he paid on the November 1996 settlement payment were proper. Polone v. Comm'r [ CCH Dec. 55,375(M)], T.C. Memo 2003-339 (2003). The Tax Court also held that Polone did not owe any taxes on the May 1996 settlement payment. Id. He appeals.




II


Section 61(a) of the Tax Code defines "gross income" as "all income from whatever source derived." 26 U.S.C. §61(a). Thus, subject to certain exemptions, which are to be construed narrowly, §61(a) applies to all income, including settlement payments. Comm'r v. Schleier [ 95-1 USTC ¶50,309], 515 U.S. 323, 328 (1995) ("the default rule of statutory interpretation [is] that exclusions from income must be narrowly construed." (quotations omitted)); Comm'r v. Glenshaw Glass [ 55-1 USTC ¶9308], 348 U.S. 426, 431 (1955) ("The mere fact that payments were extracted from the wrongdoers as punishment for unlawful conduct can not detract from their character as taxable income to the recipients.").

In May 1996, when Polone and UTA settled, 26 U.S.C. §104 exempted "the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness" from a taxpayer's gross income. 26 U.S.C. §104(a)(2) (1995). The term "personal injuries" in §104 had been interpreted to include damages from settlements of defamation claims. Roemer v. Comm'r [ 83-2 USTC ¶9600], 716 F.2d 693, 700 (9th Cir. 1983).

Congress amended §104 in August 1996 so that it exempted "the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or periodic payments) on account of personal physical injuries or physical sickness." 26 U.S.C. §104(a)(1) (1996) (emphasis added). The amendment legislatively overruled court decisions, like Roemer, that had exempted awards for nonphysical injuries from a taxpayer's gross income. See H.R. Conf. Rep. 104-737 at 301 ("Thus, the exclusion from gross income does not apply to any damages received...based on a claim of...injury to reputation."). The effective date of the amendments was August 20, 1996, but there was an exception to the amendment for "amount[s] received under a written binding agreement, court decree, or mediation award in effect on (or issued before) September 13, 1995." 26 U.S.C. §104, Application of August 20, 1996 Amendments.

Here, the Tax Court held that pre-amendment §104 applied to Polone's May 1996 payment from UTA, but that post amendment §104 applied to the November 1996, May 1997, and November 1998 payments because Polone received those payments after the amendment's effective date. Polone [ Dec. 55,375(M)], T.C. Memo 2003-339 at 66. As a result, it held that the May 1996 payment was tax exempt, but that the other payments were not. Id. at 68. Polone argues that the pre-amendment §104 applies to all four settlement payments he received, and thus that the $4 million in its entirety is tax exempt. Whether the May 1996 version of §104 or the amended version of §104 governs the settlement payments that Polone received after the amendment's effective date is a question of statutory interpretation that we review de novo. Leslie v. Comm'r [ 98-2 USTC ¶50,494], 146 F.3d 643, 648 (9th Cir. 1998).

Applying the plain language of §104, the Tax Court properly held that the November 1996, May 1997, and November 1998 payments were taxable. The amended statute applies to any damages received after its effective date of August 20, 1996, unless the parties had contracted prior to September 13, 1995. P.L. 104-188, Title I, Subtitle F, Part 1, §1605(d). 1 Although Polone settled his claims with UTA in May 1996, he did not actually receive the three payments in question until well after the effective date of the amendments to §104. Because the settlement was not in effect before September 13, 1995, it was not subject to the exception to amended §104 for preexisting settlement agreements. Thus, the amended version of §104 applies to the payments Polone received in November 1996, May 1997, and November 1998, and the Tax Court properly sustained the IRS's deficiency notice.




III


Polone, citing our decision in Warren Jones Co., argues that under 26 U.S.C. §1001, which explains how to calculate taxable gain from the "sale or other disposition of property," his entire settlement of $4 million was realized on May 3, 1996, the date of settlement, even though UTA paid him in installments. Therefore, he argues, pre-amendment §104 applies to the entire $4 million he received from UTA. The application of §1001 to Polone's settlement with UTA is a question of statutory interpretation that we review de novo. Leslie, 146 F.3d at 648.

A straightforward reading of §104 --and a broader inquiry into the system of taxation under this section --counsels against Polone's novel proposal to import §1001 to the structured settlement context. Section 1001 provides that the "gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis." 26 U.S.C. §1001(a). It is true that, as a general matter, a legal claim can be considered property for purposes of §1001. See, e.g., United States v. Stonehill [ 96-1 USTC ¶50,318], 83 F.3d 1156, 1159 (9th Cir. 1996). But §104 specifically refers to "amounts received," and not "amounts realized" --a critical distinction in deciding whether to treat structured settlements as dispositions of property. 26 U.S.C. §104. Indeed, we have yet to find a case has treated structured settlements taxed under §104 as dispositions of property and not as ordinary income received. The cases cited by Polone for this proposition are plainly inapposite. See Herbert's Estate v. Comm'r, 138 F.2d 756 (3d Cir. 1943) (satisfaction of debt by debtor considered a "disposition"; however, taxed year received, not year obligation created); United States v. Davis [ 62-2 USTC ¶9509], 370 U.S. 65 (1962) (transfer of property in compliance with divorce settlement agreement treated as a disposition of property, rendering the transaction a taxable event); Cook v. United States [ 90-1 USTC ¶50,288], 904 F.2d 107 (1st Cir. 1990) (same); Reynolds v. Comm'r [ CCH Dec. 53,269(M)], 77 T.C.M. 1479 (1999) (same). These divorce settlements determined that divorce transactions were taxable events in the first instance; the cases were later legislatively overruled by enactment of section 1041 of the Internal Revenue Code, 26 U.S.C. §1041. Cook [ 90-1 USTC ¶50,288], 904 F.2d at 109 n.1. Such holdings are irrelevant to structured settlements taxed under §104, which clearly contemplates that payments be taxed the year in which they are received.

Warren Jones Co. does require a taxpayer to report the amount realized the year property is disposed of under §1001; however, for the reasons just explained, there is no reason to apply §1001 to personal injury settlements in the first place. We should also note that decisions of the Tax Court support this conclusion. See, e.g., Alexander v. Comm'r [ CCH Dec. 50,458(M)], 69 T.C.M. (CCH) 1792 (1995); Nahey v. Comm'r [ CCH Dec. 52,926], 111 T.C. 256 (1998).

Were we to adopt Polone's interpretation of the tax code, payees of structured settlements would be forced to pay taxes on the full prospective amount of the settlement on the date of the settlement, sometimes years before receiving that amount. This would subvert congressional policy to encourage structured settlement as opposed to lump-sum schemes. See Staff of Joint Comm. on Taxation, 106th Cong., Tax Treatment of Structured Settlement Arrangements (Comm. Print 1999) (available at http://www.house.gov/jct/x-15-99.htm). Moreover, in order to alleviate this burdensome result, we would have no choice but to also import the opt-out provision available for income received from installment sales, 26 U.S.C. §453(d). Cf. Warren Jones Co. [ 75-2 USTC ¶9732], 524 F.3d at 792-93 (determining that Congress enacted the opt-out provision to alleviate the "hardships" associated with reporting an installment sale as the full fair market value of the property, received on the date contracted). We have found no congressional support for such overreaching. Congressional intent is clear: structured settlements are to be taxed as payments are received.




IV


Polone also argues that pre-amendment §104 should apply to the settlement payments he received in November 1996, May 1997, and November 1998 because applying amended §104 to those payments would amount to retroactive legislation in violation of his Fifth Amendment due process rights. 2 We review this constitutional claim de novo. Quarty v. United States [ 99-1 USTC ¶60,338], 170 F.3d 961, 965 (9th Cir. 1999).

Retroactive legislation runs the risk of offending the Due Process Clause of the Fifth Amendment, Landgraf v. USI Film Prods., 511 U.S. 244 (1994), and the Supreme Court has provided various formulas for determining whether a particular statute applies retroactively. For example, the Court has considered whether a statute "takes away or impairs vested rights acquired under existing laws," id. at 269 (quoting Society for Propagation of the Gospel v. Wheeler, 22 F. Cas. 756 (CC NH 1814)), or whether a law "changes the legal consequences of acts completed before its effective date," id. at 269 n.23 (quoting Miller v. Florida, 482 U.S. 423, 430 (1987)).

The thrust of the various tests is that to operate retroactively, a statute must actually "attach[] new legal consequences" to completed, past conduct. Id. at 270. It is not enough that a statute "is applied in a case arising from conduct antedating the statute's enactment," or that a statute "upsets expectations based in prior law." Id. at 269-270. Thus, for example, even though "a new property tax or zoning regulation may upset the reasonable expectations that prompted those affected to acquire property," a change in the property tax regime would not be considered retroactive with respect to all who had purchased property prior to the effective date of the amendment. See id. at 270 n.24.

Applying this test to §104, we hold that amended §104 was constitutionally applied to the payments Polone received in November 1996, May 1997, and November 1998. As explained above, the amendment to §104 explicitly applied only to amounts received after its effective date, which was August 20, 1996. 26 U.S.C. §104, Application of August 20, 1996 Amendments. Although it is possible for a statute with a seemingly prospective application to apply retroactively in some circumstances, Landgraf, 511 U.S. at 258-59, the amendments to §104 did not because they did not attach new legal consequences to completed payments. On the contrary, the amendments applied only prospectively, to payments made after their date of enactment. Compare with Untermeyer v. Anderson [ 1 USTC ¶297], 276 U.S. 440, 445 (1928) (a tax was retroactive where it applied to "bona fide gifts not made in anticipation of death and fully consummated prior to" the statute's effective date) (emphasis added); Blodgett v. Holden [ 1 USTC ¶261], 275 U.S. 142, 147 (1927) (same).

Polone argues that the amendments to §104 apply retroactively because his settlement with UTA was "finalized on May 3, 1996, more than three months before the enactment of the statute." This argument is unconvincing for two reasons. First, although the settlement contract may have been "finalized" in the sense that both parties signed it, settlement of Polone's defamation claim was nowhere near complete as of August 20, 1996. On the contrary, UTA still had to make three payments to Polone, and he had to honor his promise to guard UTA's confidential information. Thus, the Tax Court did not apply amended §104 to a contract that was "fully consummated" prior to the amendment's effective date, as was the case in Untermeyer and Blodgett. Rather, amended §104 was applied to a contract whose fulfillment was still a work in progress. Second, Polone's argument falls squarely into the Supreme Court's warning that "[a] statute does not operate 'retrospectively' merely because it is applied in a case arising from conduct antedating the statute's enactment." Landgraf, 511 U.S. at 269. The fact that Polone's tax dispute stemmed from his settlement with UTA --conduct that antedated the revisions to §104 --does not mean that §104 operates retrospectively when it is applied to settlement payments that Polone received after its effective date.




V


For the reasons explained above, we agree with the Tax Court that the settlement payments received by Polone after August, 1996 are taxable as ordinary income.

AFFIRMED.

* The Honorable George Schiavelli, United States District Judge for the Central District of California, sitting by designation.

1 September 13, 1995 was the date upon which Congress first proposed to amend §104. H.R. 2491 (104th Cong., 1995).

2 We do not address whether amended §104(a)(2) violates the Sixteenth Amendment of the Constitution, as Polone failed to raise the issue on appeal. The power of Congress to tax income is provided in the Sixteenth Amendment: "The Congress shall have power to law and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."

Whether the expenses of compensatory stock options constitute intangible development costs that must be included in the costs to be shared in a qualified cost sharing arrangement under Treas. Reg. §1.482-7. The IRS disagrees with the result in Xilinx Inc. v. Commissioner , 125 T.C. 37 (2005),



Qualified cost-sharing arrangement : Intangible development costs : Stock options .



Internal Revenue Service



United States Department of the Treasury



Cost Sharing Stock Based Compensation



LMSB-04-0208-005



Effective Date: March 20, 2008




COORDINATED ISSUE PAPER





ALL INDUSTRIES





COST SHARING STOCK BASED COMPENSATION





UIL 482.11-13




LEGAL QUESTION:

Whether the expenses of compensatory stock options constitute intangible development costs that must be included in the costs to be shared in a qualified cost sharing arrangement under Treas. Reg. §1.482-7.



FACTS:

The taxpayer, a U.S. corporation, is the parent of an affiliated group of domestic and foreign corporations (USP). USP enters into a qualified cost-sharing arrangement (QCSA) with a foreign subsidiary pursuant to Treas. Reg. §1.482-7. The QCSA provides that the parties will share all costs related to intangible development of the covered intangibles, including but not limited to, salaries, bonuses, and other payroll costs and benefits. The taxpayer includes all forms of compensation in the cost pool except those costs related to stock-based compensation.



LAW AND DISCUSSION:



BACKGROUND OF THE 1995 COST SHARING REGULATIONS

I.R.C. §482 consists of two sentences. The first sentence authorizes the Secretary to allocate income and deductions among commonly controlled organizations as necessary to clearly reflect the income of such organizations. The second sentence prescribes that, "[i]n the case of any transfer or license of intangible property, the income with respect to the transfer or license shall be commensurate with the income attributable to the intangible(s)."1 Congress added this second sentence in 1986, after noting the recurrent problem of the absence of comparable arm's length transactions between unrelated parties. The purpose for the 1986 commensurate with income amendment was to ensure an allocation of intangibles income between commonly controlled entities that reasonably reflects the relative economic activity undertaken by each and thus remedy the inappropriate reliance on comparables. H.R. Conf. Rep. No. 841, 99\th/ Cong., 2d Sess. (1986).

The 1986 addition of the second sentence to I.R.C. §482 was part of the impetus behind Notice 88-123 (the "White Paper"), the 1992 proposed cost sharing regulations,2 and ultimately, the final 1995 cost sharing regulations.3 Under the 1995 regulations, a cost sharing arrangement is an agreement under which the parties (1) allocate economic exploitation rights with respect to any intangibles that may be jointly developed under the agreement, and (2) agree to share costs of such development in proportion to the benefits each party reasonable expects to realize from its economic exploitation of those rights.4 Controlled parties must share all costs (except as specifically excluded by the regulations) related to the applicable intangible development activity in order for Treas. Reg. §1.482-7 to apply.5 Transactions wherein parties share only some costs of the applicable intangible development are not qualified cost sharing arrangements and may be evaluated under Treas. Reg. §§1.482-4 through 1.482-6.6

Under the 1995 regulations, whether stock-based compensation (SBC) is a cost to be shared under Treas. Reg. §1.482-7 depends on whether SBC is in fact a cost, and whether the SBC is related to the intangible development activity. The Service has consistently considered SBC to be a cost under Treas. Reg. §1.482-7. While taxpayers often argue that SBC is not a cost to be shared, it is quite clear that the regulations include all operating expenses, as defined by Treas. Reg. §1.482-5(d)(3), except depreciation or amortization expense. Employee compensation is an expense under Treas. Reg. §1.482-5(d)(3). To the extent a taxpayer offers employee stock options as part of its compensation package, such employee stock options are also includible as employee compensation expenses under Treas. Reg. §1.482-5(d)(3). For employees whose services were related to the intangible development at issue in the cost sharing arrangement, the SBC costs must be included in the pool of costs to be shared.

In general, the Service has measured SBC expense for compensatory stock options under the 1995 regulations in terms of the "spread" value (the amount of the "spread" between the fair market value on the date of exercise and option's exercise price) or the "grant date" value (using the "fair value" approach of Statement of Financial Accounting Standards No. 123 (SFAS 123)). Other methods could be used to measure the SBC expense, if the taxpayer is able to establish the reasonableness of such method and consistently applies such method.7



XILINX AND THE 1995 REGULATIONS

In Xilinx Inc. v. Commissioner , 125 T.C. 37 (2005), the taxpayer prevailed in the Tax Court in a case of first impression involving the 1995 cost sharing regulations. The Tax Court held that the Commissioner's adjustments to include SBC in the pool of shared costs pursuant to a QCSA were "arbitrary and capricious" because they were contrary to the arm's length standard mandated by Treas. Reg. §1.482-1(b). On the basis of expert testimony, the Tax Court opined that uncontrolled parties would not share the spread or the grant date value of SBC. In reaching its conclusion, the Court assumed for the purposes of its opinion that SBC was a "cost."

The Commissioner disagrees with the Tax Court's interpretation of Treas. Reg. §§1.482-1(b) and 1.482-7, and has appealed the Tax Court's decision to the U.S. Court of Appeals for the Ninth Circuit (Ninth Circuit). The Commissioner believes that its adjustments to include SBC costs under Xilinx's QCSA were in accordance with the requirements of Treas. Reg. §§1.482-1(b) and 1.482-7. In the event of a "final" Ninth Circuit decision holding that the Commissioner's adjustments to include SBC in the pool of Xilinx's shared costs were improper, such decision would be binding only on cases that involve the application of the 1995 cost sharing regulations and that are within the appellate jurisdiction of the Ninth Circuit. For cases under the 2003 SBC Regulations, such a decision would not be controlling. For controversies subject to the appellate jurisdiction of circuits other than the Ninth, such a decision would not be controlling.



THE 2003 STOCK BASED COMPENSATION REGULATIONS

The 1995 cost sharing regulations, while requiring all intangible development costs (except as specifically excluded by the regulations) to be included in the cost pool, did not affirmatively include SBC. Final regulations promulgated on August 26, 2003, T.D. 9088 (the 2003 SBC Regulations) clarified that SBC must be taken into account in determining the operating expenses treated as intangible development costs of a controlled participant in a QCSA under Treas. Reg. §1.482-7.

The preamble to the 2003 SBC Regulations described Congress's intent with respect to cost sharing arrangements.

The legislative history of the Tax Reform Act of 1986 expressed Congress's intent to respect cost sharing arrangements as consistent with the commensurate with income standard, and therefore consistent with the arm's length standard, if and to the extent that the participants' shares of income "reasonably reflect the actual economic activity undertaken by each." See H.R. Conf. Rep. No. 99-481, at II-638 (1986)....In order for the costs incurred by a participant to reasonably reflect its actual economic activity, the costs must be determined on a comprehensive basis. Therefore, in order for a QCSA to reach an arm's length result consistent with legislative intent, the QCSA must reflect all relevant costs, including such critical elements of cost as the cost of compensating employees for providing services related to the development of the intangibles pursuant to the QCSA.

See T.D. 9088 (August 26, 2003).

In other words, a QCSA produces an arm's length result if, and only if, the requirements of Treas. Reg. §1.482-7 are met.8 Consequently, the 2003 SBC Regulations clarified the existing 1995 regulations by stating directly that parties to a QCSA must share all intangible development costs, including SBC. To wit, stock based compensation was specifically listed as a cost to be shared.9

The 2003 SBC Regulations further clarify that under Treas. Reg. §1.482-1(b)(2)(i), relating to arm's length methods, that Treas. Reg. §1.482-7 is the specific method to be used to evaluate whether a QCSA produces results consistent with an arm's length result.10

The determination of whether stock-based compensation is related to the intangible development area within the meaning of Treas. Reg. §1.482-7(d)(1) is generally made as of the date of grant.11 Accordingly, all stock-based compensation that is granted during the term of the qualified cost sharing arrangement and is related (at date of grant) to the development of intangibles covered by the arrangement is generally included as an intangible development cost under Treas. Reg. §1.482-7(d)(1).12

The regulations provide guidance concerning the measurement and timing of the SBC expense. Generally, the amount of the SBC includible as intangible development costs under a QCSA is the amount allowable as a federal income tax deduction with respect to the SBC.13 As discussed above, with respect to compensatory stock options, this amount is generally referred to as the "spread at exercise."14 With respect to statutory stock options (i.e., incentive stock options and employee stock purchase plan stock options), the spread generally is taken into account for QCSA purposes on exercise, even though I.R.C. §421 denies a deduction.15

Alternatively, taxpayers may elect to take into account all operating expenses attributable to SBC on publicly traded stock in the same amount, and at the same time, as the fair value of the stock options reflected as a charge against income in audited financial statements or disclosed in footnotes to such financial statements.16 In Notice 2005-99, the IRS extended this elective method to restricted shares and restricted share units within the meaning of Statement of Financial Accounting Standards No. 123 (revised 2004, SFAS 123R).



CONCLUSION

On January 12, 2004, Communications, Technology and Media Industry Director issued an Industry Director Directive ("IDD") that reinforces the Service's long-standing position of including SBC in the pool of costs to be shared. For the reasons set forth in this coordinated issue paper and the 2004 IDD, the audit approach set forth in the directive should continue to be followed.

1 I.R.C. §482.

2 Prop. Treas. Reg. §1.482-2(g) (1992).

3 See T.D. 8632, 1996-1 C.B. 85.

4 See Treas. Reg. §1.482-7(a)(1) (1995).

5 Treas. Reg. §1.482-7(b)(2) and (d)(1).

6 Alternatively, Treas. Reg. §1.482-7(a)(1) permits the Commissioner to apply Treas. Reg. §1.482-7 to arrangements that in substance constitute cost sharing arrangements, notwithstanding a failure to comply with any of that section's requirements.

7 See FSA 200003010 .

8 Treas. Reg. §1.482-7(a)(3) states: Coordination with §1.482-1 . A qualified cost sharing arrangement produces results that are consistent with an arm's length result within the meaning of §1.482-1(b)(1) if, and only if, each controlled participant's share of the costs (as determined under paragraph (d) of this section) of intangible development under the qualified cost sharing arrangement equals its share of reasonably anticipated benefits attributable to such development (as required by paragraph (a)(2) of this section) and all other requirements of this section are satisfied.

9 Treas. Reg. §1.482-7(d)(2)(i).

10 Treas. Reg. §1.482-1(c)(1).

11 Treas. Reg. §1.482-7(d)(2)(ii). Cf . Notice 2005-99, 2005-2 C.B. 1214.

12 Id.

13 Treas. Reg. §1.482-7(d)(2)(iii)(A).

14 See I.R.C. §83.

15 Treas. Reg. §1.482-7(d)(2)(iii)(A)(1).

16 Treas. Reg. §1.482-7(d)(2)(iii)(B).

Section 7122 - Offer in Compromise


An offer in compromise (OIC) is a contractual agreement between the IRS and a taxpayer under which the taxpayer agrees to pay a specified amount in full settlement of assessed tax liabilities, including interest and most penalties (Code Sec. 7122(a)). The compromise process is primarily used by taxpayers experiencing financial difficulties, as a means by which they can have their tax liability reduced and settled without resorting to expensive litigation. While closing agreements relate to the agreed-upon tax liability of the taxpayer, offers in compromise are agreements between the taxpayer and the IRS as to the amount of tax liability that will be paid and how that amount will be paid.

The IRS has authority to compromise any civil or criminal case arising under the internal revenue laws. A taxpayer's offer to compromise tax liability must be based on one or all of the following grounds:
(1) doubt as to liability for the amount of taxes assessed;

(2) doubt as to the collectibility of the full amount of tax, penalty and interest assessed


7122(a) AUTHORIZATION. --The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.

7122(b) RECORD. --Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of --

7122(b)(1) The amount of tax assessed,

7122(b)(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and

7122(b)(3) The amount actually paid in accordance with the terms of the compromise.

Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.

7122(c) RULES FOR SUBMISSION OF OFFERS-IN-COMPROMISE. --

7122(c)(1) PARTIAL PAYMENT REQUIRED WITH SUBMISSION. --

7122(c)(1)(A) LUMP-SUM OFFERS. --

7122(c)(1)(A)(i) IN GENERAL. --The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.

7122(c)(1)(A)(ii) LUMP-SUM OFFER-IN-COMPROMISE. --For purposes of this section, the term "lump-sum offer-in-compromise" means any offer of payments made in 5 or fewer installments.

7122(c)(1)(B) PERIODIC PAYMENT OFFERS. --

7122(c)(1)(B)(i) IN GENERAL. --The submission of any periodic payment offer-in-compromise shall be accompanied by the payment of the amount of the first proposed installment.

7122(c)(1)(B)(ii) FAILURE TO MAKE INSTALLMENT DURING PENDENCY OF OFFER. --Any failure to make an installment (other than the first installment) due under such offer-in-compromise during the period such offer is being evaluated by the Secretary may be treated by the Secretary as a withdrawal of such offer-in-compromise.

7122(c)(2) RULES OF APPLICATION. --

7122(c)(2)(A) USE OF PAYMENT. --The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.

7122(c)(2)(B) APPLICATION OF USER FEE. --In the case of any assessed tax or other amounts imposed under this title with respect to such tax which is the subject of an offer-in-compromise to which this subsection applies, such tax or other amounts shall be reduced by any user fee imposed under this title with respect to such offer-in-compromise.

7122(c)(2)(C) WAIVER AUTHORITY. --The Secretary may issue regulations waiving any payment required under paragraph (1) in a manner consistent with the practices established in accordance with the requirements under subsection (d)(3).

7122(d) STANDARDS FOR EVALUATION OF OFFERS. --

7122(d)(1) IN GENERAL. --The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.

7122(d)(2) ALLOWANCES FOR BASIC LIVING EXPENSES. --

7122(d)(2)(A) IN GENERAL. --In prescribing guidelines under paragraph (1), the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.

7122(d)(2)(B) USE OF SCHEDULES. --The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.

7122(d)(3) SPECIAL RULES RELATING TO TREATMENT OF OFFERS. --The guidelines under paragraph (1) shall provide that --

7122(d)(3)(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer,

7122(d)(3)(B) in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer --

7122(d)(3)(B)(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer's return or return information for verification of such liability; and

7122(d)(3)(B)(ii) the taxpayer shall not be required to provide a financial statement, and

7122(d)(3)(C) any offer-in-compromise which does not meet the requirements of subparagraph (A)(i) or (B)(i), as the case may be, of subsection (c)(1) may be returned to the taxpayer as unprocessable.

7122(e) ADMINISTRATIVE REVIEW. --The Secretary shall establish procedures --

7122(e)(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and

7122(e)(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Office of Appeals.

7122(f) DEEMED ACCEPTANCE OF OFFER NOT REJECTED WITHIN CERTAIN PERIOD. --Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.


7122(f)[(g)] FRIVOLOUS SUBMISSIONS, ETC. --Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.

.01 Amended by P.L. 109-432, P.L. 109-222, P.L. 105-206 and P.L. 104-168. For details, see the Code Volumes.


(Reg. §301.7122-1(b));
Compromises
In general

(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary's discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.

(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.

(b) Grounds for compromise

(1) Doubt as to liability. --Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for special rules applicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer's return or return information to verify the liability.

(2) Doubt as to collectibility. --Doubt as to collectibility exists in any case where the taxpayer's assets and income are less than the full amount of the liability.
(3) Promote effective tax administration

(i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship within the meaning of §301.6343-1.

(ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. A taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full.

(iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by taxpayers with the tax laws.
(c) Special rules for evaluating offers to compromise

(1) In general. --Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary's policies and procedures.

(2) Doubt as to collectibility

(i) Allowable Expenses. --A determination of doubt as to collectibility will include a determination of ability to pay. In determining ability to pay, the Secretary will permit taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the taxpayer's case. To guide this determination, guidelines published by the Secretary on national and local living expense standards will be taken into account.

(ii) Nonliable spouses

(A) In general. --Where a taxpayer is offering to compromise a liability for which the taxpayer's spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer's liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the taxpayer to the nonliable spouse for the purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may request information regarding the assets and income of the nonliable spouse for the purpose of verifying the amount of and responsibility for expenses claimed by the taxpayer.

(B) Exception. --Where collection of the taxpayer's liability from the assets and income of the nonliable spouse is permitted by applicable state law (e.g., under state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the taxpayer, the nonliable spouse, and their dependents.
(3) Compromises to promote effective tax administration

(i) Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to --

(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer's financial resources will be exhausted providing for care and support during the course of the condition;

(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and

(C) Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to --

(A) Taxpayer has a history of noncompliance with the filing and payment requirements of the Internal Revenue Code;

(B) Taxpayer has taken deliberate actions to avoid the payment of taxes; and

(C) Taxpayer has encouraged others to refuse to comply with the tax laws.

(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:

Example 1. The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is retired and his only income is from a pension. The taxpayer's only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer's overall compliance history does not weigh against compromise.

Example 3. The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer's equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer's home has been specially equipped to accommodate his disability, forced sale of the taxpayer's residence would create severe adverse consequences for the taxpayer. The taxpayer's overall compliance history does not weigh against compromise.

(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary's discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:

Example 1. In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer's medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer's health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer's overall compliance history does not weigh against compromise.

Example 2. The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer's retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer's overall compliance history does not weigh against compromise.

(d) Procedures for submission and consideration of offers

(1) In general. --An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a tax liability must be made in writing, must be signed by the taxpayer under penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However, taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.
(2) When offers become pending and return of offers. --An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Attorney General for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the taxpayer provide the needed additional information. If the taxpayer does not submit the additional information that the IRS has requested within a reasonable time period after such a request, the IRS may return the offer to the taxpayer. The IRS may also return an offer to compromise a tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.
(3) Withdrawal. --An offer to compromise a tax liability may be withdrawn by the taxpayer or the taxpayer's representative at any time prior to the IRS' acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS' receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon issuance of a letter by the IRS confirming the taxpayer's intent to withdraw the offer.

(e) Acceptance of an offer to compromise a tax liability

(1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayer or the taxpayer's representative.

(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that taxpayer enter into any collateral agreement or post any security which is deemed necessary for the protection of the interests of the United States.

(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.

(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a tax lien in whole or in part, such payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.

(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one taxpayer does not extinguish the liability of, nor prevent the IRS from taking action to collect from, any person not named in the offer who is also liable for the tax to which the compromise relates. Neither the taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where --

(i) False information or documents are supplied in conjunction with the offer;

(ii) The ability to pay or the assets of the taxpayer are concealed; or

(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.

(6) Opinion of Chief Counsel. --Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of --

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.
(f) Rejection of an offer to compromise

(1) An offer to compromise has not been rejected until the IRS issues a written notice to the taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.

(2) The IRS may not notify a taxpayer or taxpayer's representative of the rejection of an offer to compromise until an independent administrative review of the proposed rejection is completed.

(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary's policies and procedures regarding the compromise of cases.

(4) Offers based upon doubt as to liability. --Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer's return or return information for verification of the liability.
(5) Appeal of rejection of an offer to compromise

(i) In general. --The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the taxpayer requests such an administrative review in the manner provided by the Secretary.

(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. --Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the taxpayer failed to provide requested information, or because the IRS determined that the offer to compromise was submitted solely for purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for purposes of this provision and does not entitle the taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the taxpayer failed to provide requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.

(g) Effect of offer to compromise on collection activity

(1) In general. --The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.
(2) Revised offers submitted following rejection. --If, following the rejection of an offer to compromise, the taxpayer makes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending. (3) Jeopardy. --The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.

(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. --If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the taxpayer.

(5) Offsets under section 6402. --Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the taxpayer to the extent authorized by section 6402.

(6) Proceedings in court. --Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that person in any other proceeding in which liability for the tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United States under 28 U.S.C. 2410. In addition, the United States may file a claim in any bankruptcy proceeding or insolvency action brought by or against such person.

(h) Deposits. --Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for purposes of delay and returned to the taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.

(i) Statute of limitations
(1) Suspension of the statute of limitations on collection. --The statute of limitations on collection will be suspended while levy is prohibited under paragraph (g)(1) of this section.
(2) Extension of the statute of limitations on assessment. --For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of limitations on assessment is sought, the taxpayer must be notified of the right to refuse to extend the period of limitations or to limit the extension to particular issues or particular periods of time.
(j) Inspection with respect to accepted offers to compromise. --For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).

(k) Effective date. --This section applies to offers to compromise pending on or submitted on or after July 18, 2002. [Reg. §301.7122-1.]

.01 Historical Comment: Adopted 7/18/2002 by T.D. 9007. [Reg. §301.7122-1 does not reflect P.L. 109-222 (2006).




and/or

(3) promotion of an effective tax administration (Reg. §301.7122-1(b)(3)).


The IRS Restructuring and Reform Act of 1998 (P.L. 105-206) required the IRS to develop employee guidelines for determining whether a proposed offer in compromise is adequate and should be accepted to resolve a dispute (Code Sec. 7122(d)(1), as redesignated by the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222)). As a result, the IRS revised its procedures in this area, as set forth in regulations (Reg. §301.7122-1), the Internal Revenue Manual (see CCH IRS OFFER IN COMPROMISE HANDBOOK; Internal Revenue Manual 5.8, 09-01-2005), and Rev. Proc. 2003-71. These guidelines include national and local allowances under which IRS employees may determine the basic living expenses of a taxpayer entering into a compromise. The IRS was directed to determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the standard allowances is appropriate. Local and national standards are not to be used to the extent that they would result in a taxpayer not having adequate means to provide for basic living expenses (Code Secs. 7122(d)(1) and (2), as redesignated by P.L. 109-222).

Under the offer-in-compromise guidelines, IRS employees may not reject an offer from a low-income taxpayer solely on the basis of the amount of the offer. If an offer in compromise is based on doubt as to liability, the IRS may not reject an offer solely because the IRS cannot locate a taxpayer's return or return information for verification purposes. Moreover, anyone seeking an offer in compromise based on doubt as to liability is not required to provide a financial statement (Code Sec. 7122(d)(3), as redesignated and amended by P.L. 109-222).

The Conference Committee Report to P.L. 105-206 contemplates that the IRS will consider factors such as equity and hardship when determining whether to accept an offer in compromise. The conferees urge the IRS to be flexible in finding ways to work with taxpayers who are sincerely trying to meet their tax obligations. This could be accomplished, for example, by forgoing penalties and interest amounts that have accumulated while determinations of taxpayer liability were being made.

A compromise may be entered into before a case is referred to the Department of Justice for prosecution or defense. The Attorney General or delegate may compromise a case after it has been referred to the Department of Justice (Code Sec. 7122(a)).

The IRS views an offer in compromise as a legitimate alternative to declaring a case currently uncollectible or to participating in a protracted installment agreement, and it has provided guidelines that set forth the procedures to be followed by taxpayers and IRS personnel when accepting an offer in compromise (Internal Revenue Manual 5.8, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

The IRS's objectives in accepting offers in compromise are:
(1) to effect collection of what could reasonably be collected at the earliest time possible and at the least cost to the government;

(2) to achieve a resolution that is in the best interest of both the individual taxpayer and the government;

(3) to give taxpayers a fresh start toward future voluntarily compliance with all filing and payment requirements; and

(4) to collect funds which may not be collectible through any other means (Internal Revenue Manual 5.8.1.1.4, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

As a contract, the offer in compromise is subject to the rules governing general contract law (Walker v. Alamo Foods Co., 1 USTC ¶207, and Ely & Walker Dry Goods Co., 1 USTC ¶423, at ¶41,130.50, as well as R.C. Lane, 62-1 USTC ¶9467, and B.R. Kurio, 71-1 USTC ¶9112, at ¶41,130.25).

The contract spells out the terms for payment of the tax liability. The underlying assessment is not abated, and interest accrues even if the offer in compromise is accepted by the IRS. The original liability can be revived if the taxpayer defaults on the terms of the compromise agreement (Instructions to Form 656, Offer in Compromise (Rev. February 2007), p. 16).

The IRS does not have the authority to accept an offer in compromise (OIC) when:
(1) questions concerning the amount of the taxpayers liability or the collection of a liability for all or part of the periods the taxpayer owes is in litigation;

(2) the federal tax liability for all or part of the periods the taxpayer owes has been reduced to a judgment;

(3) the IRS has a civil or criminal prosecution pending against the taxpayer in the Department of Justice (DOJ) or United States Attorneys Office;

(4) acceptance of the offer is dependent upon the acceptance of a related offer or upon a settlement under the authority of the Department of Justice (Internal Revenue Manual 5.8.1.2.1, 09-01-2005).

Offers in compromise must be submitted using Form 656, Offer in Compromise (Rev. February 2007). The offer should include all information necessary to verify the grounds for compromise. If the offer is based on doubt as to collectibility, the taxpayer must include a completed financial statement on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B, Collection Information Statement for Businesses, or any other financial statement prepared by the taxpayer, as long as it conforms with the information requested on either of the forms and is signed by the taxpayer under penalties of perjury. If a taxpayer is self-employed, both financial statements are required (Instructions to Form 656, Offer in Compromise). The offer must also include the required partial payment of 20 percent of the amount offered or the first proposed installment, depending on the type of offer submitted on or after July 16, 2006.

If the offer is based on doubt as to liability, submission of a financial statement is not required, but the taxpayer must submit a detailed statement as to why the amount is not owed to the IRS.

Fixed monthly payment option. A simplified method of settling taxpayer debts under the offer in compromise program will allow taxpayers a fixed monthly payment option and will assist taxpayers and practitioners in situations where the full amount of the debt cannot be met. Under the program, the IRS will calculate the exact amount an individual will owe during the life of the offer in compromise payments (Instructions to Form 656, Offer in Compromise (Rev. February 2007); IRS News Release, IR-1999-105, December 29, 1999).
An offer in compromise based on Doubt as to Collectibility (DATC) amount must generally equal or exceed a taxpayers reasonable collection potential (RCP) in order to be considered for acceptance (Internal Revenue Manual 5.8.1.1.3, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK). There may be exceptions for cases with unusual or special circumstances, such as advanced age, serious illness from which recovery is unlikely, or unusual circumstances that impact the ability to pay the tax and continue to provide for the taxpayer's family. If special circumstances apply, the taxpayer should fill out the "Explanation of Circumstances" portion of Form 656, Offer in Compromise.

A taxpayer's reasonable collection potential is the net equity of the taxpayer's assets plus the amount that the IRS could collect from the taxpayer's future income. If the IRS's analysis indicates that the taxpayer has the ability to pay the tax liability in full, either immediately or through an installment arrangement, then the IRS will not accept the offer in compromise.

The IRS provides a worksheet for the taxpayer to use to estimate the amount that the IRS will view as the taxpayer's reasonable collection potential (Instructions to Form 656, Offer in Compromise). The worksheet indicates that the IRS will generally expect to collect all of a taxpayer's financial assets, plus 80 percent of the taxpayer's equity in cars and real estate, plus 80 percent of the taxpayer's equity in other personal assets, reduced by a small allowance (less than $10,000). The IRS will also expect to collect an additional amount based on the taxpayer's income. The amount the IRS expects to collect from a taxpayer is made up of the following components:
(1) the amount collectible from the taxpayer's assets;

(2) the amount collectible from the taxpayer's future income;

(3) the amount collectible from third parties, such as transferees; and

(4) the amount collectible from the taxpayer that the taxpayer should reasonably be expected to raise from assets in which he has an interest that is beyond the reach of the government, such as property located outside the United States or property owned by tenancy by the entirety.

The starting point in the consideration of an offer submitted based on doubt as to collectibility is the value of the taxpayer's assets less encumbrances that have priority over the federal tax lien. Ordinarily, the liquidating or quick sale value of assets is to be used. In some cases, it is reasonable to consider minimum bid price in determining collection potential. All assets must be considered in determining the amount collectible from the taxpayer (Internal Revenue Manual 5.8.5, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

A taxpayer's education, profession or trade, age and experience, health, and past and present income will be considered in evaluating his future income prospects for purposes of determining collectibility. An evaluation must be made of the likelihood that any increase in real income will be available to pay the delinquent taxes. Cost of living increases must also be taken into account in determining amounts potentially collectible from future income (Internal Revenue Manual 5.8.5, 09-01-2005, CCH IRS OFFER IN COMPROMISE HANDBOOK).

Frivolous submissions. The civil penalty for frivolous tax returns has been increased from $500 to $5,000, and now applies to all taxpayers and all types of federal taxes and submissions (Code Sec. 6702(a), as amended by the Tax Relief and Health Care Act of 2006 (P.L. 109-432)). Therefore, the $5,000 civil penalty now also applies to any request for a collection due process hearing, an installment agreement, or an offer-in-compromise that raises frivolous arguments. The Secretary will prescribe, and periodically revise, a list of positions identified as frivolous.

As extended, the penalty applies to any "person" who files a return, not just to an "individual" (Code Sec. 6702(a), as amended by P.L. 109-432). The definition of the term "person" includes an individual, a trust, estate, partnership, association, company or corporation, as defined in Code Sec. 7701(a)(1).

A "specified frivolous submission" is a specified submission that either:
-- based on a position that the Secretary has identified as frivolous in his prescribed frivolous positions list; or

-- reflects a desire to delay or impede the administration of federal tax laws

(Code Sec. 6702(b)(2)(A), as added by P.L. 109-432). A "specified submission" is:
(1) a request for a hearing after --

(a) the IRS files a notice of lien under Code Sec. 6320, or

(b) the taxpayer receives a pre-levy Collection Due Process Hearing Notice under Code Sec. 6330,

and
(2) an application relating to --

(a) agreements for payment of tax liability in installments under Code Sec. 6159;

(b) compromises under Code Sec. 7122; or

(c) taxpayer assistance orders under Code Sec. 7811

(Code Sec. 6702(b)(2)(B), as added by P.L. 109-432). Any portion of an application for an offer-in-compromise under Code Sec. 7122 or for an installment agreement under Code Sec. 6159 will be treated as if it were never submitted and will not be subjected to any further administrative or judicial review, if that portion of the application meets either requirement for a specified frivolous submission (Code Sec. 7122(f)[(g)], as added by P.L. 109-432).

The IRS has issued a news release announcing updated guidance which describes and rebuts frivolous arguments that taxpayers should avoid when filing their tax returns (IRS News Release, IR-2006-45, March 16, 2006). The IRS has also updated the document entitled "The Truth About Frivolous Tax Arguments" (November 30, 2006; available at www.irs.com), that addresses false arguments about the legality of not paying taxes or filing returns.

Section 6694 - Noticez 2008-13, IRB 2008-3, January 22, 2008

Return preparer penalty interim guidance



The Treasury Department and the IRS have issued guidance providing interim rules implementing and interpreting the legislatively expanded tax return preparer penalty under Code Sec. 6694 and Code Sec. 7701(a)(36), as amended by the Small Business and Work Opportunity Act of 2007, P.L. 110-28, 121 Stat. 190.

Unreasonable positions, whether disclosed to the IRS or not disclosed, will need legal analysis in a legal memorandum from a tax attorney.

Until further guidance is issued, solely for purposes of section 6694, a tax return preparer is considered reasonably to believe that the tax treatment of an item is more likely than not the proper tax treatment (without taking into account the possibility that the tax return will not be audited, that an issue will not be raised on audit, or that an issue will be settled) if the tax return preparer analyzes the pertinent facts and authorities in the manner described in §1.6662-4(d)(3)(ii) and, in reliance upon that analysis, reasonably concludes in good faith that there is a greater than fifty percent likelihood that the tax treatment of the item will be upheld if challenged by the IRS. For purposes of interim guidance, the standard described in this section will apply instead of §1.6694-2(b).

This notice provides guidance regarding implementation of the tax return preparer penalty provisions under section 6694 and the related definitional provisions under section 7701(a)(36) of the Internal Revenue Code (Code), as amended by the Small Business and Work Opportunity Tax Act of 2007 (the Act), Pub. L. No. 110-28, 121 Stat. 190.

In 2008, the Treasury Department and the IRS intend to revise the regulatory scheme governing tax return preparer penalties, which has remained substantially unchanged since the late 1970's. Until then, this notice provides interim guidance on the application of the tax return preparer penalties as amended by the Act. This notice also solicits public comments regarding the revision of the regulatory scheme governing tax return preparer penalties in order to enable the Treasury Department and the IRS to complete their work on the overhaul of these rules by the end of 2008.



BACKGROUND

Section 8246 of the Act amended several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the section 6694(a) penalty for preparing a return which reflects an understatement of liability, and increase applicable penalties under section 6694(a) and (b). The amendments made by the Act to section 6694 are effective for tax returns and claims for refund prepared after May 25, 2007. The Treasury Department and the IRS issued Notice 2007-54, 2007-27 I.R.B. 12, on June 11, 2007, which provided transitional relief under section 6694(a). Concurrent with the issuance of this notice, the Treasury Department and the IRS are issuing additional guidance clarifying Notice 2007-54. See Notice 2008-11.

Prior to amendment by the Act, section 7701(a)(36) defined income tax return preparer as any person who prepared for compensation an income tax return or claim for refund, or a substantial portion of an income tax return or claim for refund. As amended by the Act, section 7701(a)(36) now defines tax return preparer as any person that prepares for compensation a tax return or claim for refund, or a substantial portion of a tax return or claim for refund, and is no longer limited to persons who prepare income tax returns.

Section 301.7701-15 of the current Procedure and Administration Regulations defines the term income tax return preparer to include any person who prepares for compensation all or a substantial portion of a tax return or claim for refund under Subtitle A of the Code. Operation of the current regulations brings into the preparer penalty regime a wide range of activities performed by persons who do not sign the tax return or claim for refund, who may have no knowledge of how their work is ultimately reported on the tax return or claim for refund, or who may have no knowledge of the size or complexity of the schedule, entry, or other portion of a tax return or claim for refund relative to the entire tax return. For example, current regulations broadly define the term substantial portion using a facts and circumstances test that compares the relative length, complexity, and tax liability of a particular schedule, entry, or other portion of a tax return or claim for refund to the length, complexity, and tax liability of the tax return or claim for refund as a whole. Case law, including Goulding v. United States, 717 F. Supp. 545 (N.D. Ill. 1989), aff'd, 957 F.2d 1420 (7th Cir. 1992), supports the current regulations which deem the preparer of a Schedule K-1 for a partnership to be the preparer of a partner's income tax return on which the partnership items were reported, if the Schedule K-1 constitutes a substantial portion of the partner's tax return.

The Act also amended section 6694(a) by raising the standards of conduct for tax return preparers. For undisclosed positions, the Act replaced the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. For disclosed positions, the Act replaced the nonfrivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.

The amendments made by the Act did not modify the exception to liability under section 6694 that is applicable when it is shown, considering all the facts and circumstances, that the tax return preparer has acted in good faith and there is reasonable cause for the understatement.

As part of the regulatory rulemaking process, the Treasury Department and IRS will determine the appropriate modifications to the existing regulatory framework, given the complexities and anomalies created by the inter-relationship of the amendments to section 6694 applicable to tax return preparers and the various accuracy-related penalty provisions applicable to taxpayers, as well as the inter-relationship of the amendments to section 6694 and the regulations governing the practice before the IRS in Circular 230 (31 CFR part 10). In advance of publication of regulations in 2008, this notice provides interim guidance to tax return preparers regarding the definitions and standards of conduct that must be met by a tax return preparer to avoid a penalty under section 6694(a). Tax return preparers may rely on the interim guidance in this notice until further guidance is issued. It is important to note that the regulations expected to be finalized in 2008 may be substantially different from the rules described in this notice, and in some cases more stringent.

Section 7805(a) provides the Treasury Department and the IRS with authority to issue regulations and other published guidance interpreting the Code, including sections 6694 and 7701(a)(36). Consistent with the legislative history of section 6694, the Treasury Department and the IRS promulgated regulations dating back to 1977 that interpreted the statutory term disclosed in section 6694(a)(3), as applied to nonsigning preparers, to include making statements, either orally or in writing. See Treas. Reg. §1.6694-2(c)(3)(ii)(A) and (B). Section 6694(a)(3) provides the Treasury Department and the IRS with authority to grant relief from penalty liability if a tax return preparer has acted in good faith and there is reasonable cause for any understatement of tax that may result from a position taken on a return. In addition, in the past, reasonable cause relief (such as in section 6694(a)) has been provided to implement appropriate transitional rules for a new or revised statutory provision.

This interim guidance discusses the following issues: (1) relevant categories of tax returns or claims for refund for purposes of section 6694; (2) the definition of tax return preparer under sections 6694 and 7701(a)(36); (3) standards of conduct applicable to tax return preparers for disclosed and undisclosed positions taken on tax returns; and (4) interim penalty compliance obligations applicable to tax return preparers. It is the IRS's intent to administer these provisions in a fair and equitable manner that will promote compliance with the requirements of the Code and effective tax administration.



INTERIM GUIDANCE UNDER SECTION 6694

Except to the extent modified by the interim guidance in this notice, and until further guidance is issued, existing regulations and guidance under sections 6694 and 7701(a)(36) will remain in effect.



A. Returns and Claims for Refund Subject to 6694 Penalty

Interim guidance discussed below describes categories of returns to which section 6694 could apply and includes associated exhibits to this notice. The Treasury Department and the IRS may choose to add or remove documents from any of the categories or exhibits to this notice in future guidance as they gain experience in implementing the provisions of the Act and receive public comments.

1. Tax Returns Reporting Tax Liability

Until further guidance is issued, solely for purposes of section 6694, a return or claim for refund includes the tax returns listed on Exhibit 1 or a claim for refund with respect to any such return. A claim for refund of tax includes a claim for credit against any tax. A person who for compensation prepares all or a substantial portion of a tax return listed on Exhibit 1, or a claim for refund with respect to any such tax return, is a tax return preparer who is subject to section 6694.

2. Information Returns and Other Documents

Under current regulations, a person who for compensation prepares information returns or other documents that include information that is or may be reported on a taxpayer's tax return is subject to section 6694 if the information reported on the information return or other document constitutes a substantial portion of the taxpayer's tax return, notwithstanding the fact that the information return or other document may not be reporting the liability of the taxpayer. The current regulatory definitions of substantial portion and substantial preparation require a facts and circumstances analysis of each document prepared and a comparison of the items included on that document with the tax return that actually reports a tax liability. Section 301.7701-15(b). Thus, for example, under current regulations, the preparer of a Form 1065, U.S. Return of Partnership Income, may be deemed to be the preparer of any of the partners' individual income tax return ( e.g., Form 1040, U.S. Individual Income Tax Return), if the items on the partnership return constitute a substantial portion of that partner's income tax return. Section 301.7701-15(b)(3).

(a) Information Returns Constituting a Substantial Portion of a Taxpayer's Tax Return

Until further guidance is issued, solely for purposes of section 6694, an information return listed on Exhibit 2 that includes information that is or may be reported on a taxpayer's tax return or claim for refund is a return to which section 6694 could apply if the information reported constitutes a substantial portion of that taxpayer's tax return or claim for refund. A person who for compensation prepares any of the forms listed on Exhibit 2, which form does not report a tax liability but affects an entry or entries on a tax return and constitutes a substantial portion of the tax return or claim for refund that does report a tax liability, is a tax return preparer who is subject to section 6694.

(b) Other Documents Constituting a Substantial Portion of a Taxpayer's Tax Return

Until further guidance is issued, solely for purposes of section 6694, a document that includes information that is or may be reported on a taxpayer's tax return or claim for refund is treated as a return to which section 6694 could apply if the information reported constitutes a substantial portion of that taxpayer's tax return or claim for refund. For example, a person who for compensation prepares documents, such as depreciation schedules or cost, expense or income allocation studies, that do not report a tax liability but which will affect an entry or entries on a tax return that does report a tax liability, and that constitute a substantial portion of such tax return, is a tax return preparer who is subject to section 6694.

(c) Other Documents Not Constituting a Substantial Portion of a Taxpayer's Tax Return Unless Prepared Willfully to Understate Tax or in Reckless or Intentional Disregard of the Rules or Regulations

Until further guidance is issued, solely for purposes of section 6694, a document listed on Exhibit 3 that includes information that is or may be reported on a taxpayer's tax return or claim for refund (and that constitutes a substantial portion of such tax return or claim for refund) will not subject the preparer to a penalty under section 6694(a). A document listed on Exhibit 3, however, may subject the preparer to a willful or reckless conduct penalty under section 6694(b) if the information reported on the document constitutes a substantial portion of the tax return or claim for refund and is prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund, or in reckless or intentional disregard of rules or regulations. For example, preparation of a Form W-2, Wage and Tax Statement, reporting certain executive compensation may constitute preparation of a substantial portion of the Form 1040 return on which the compensation is reported if it is prepared willfully in a manner to understate the liability of tax. A person who for compensation prepares all or a substantial portion of any of the forms or other documents listed on Exhibit 3 is not a tax return preparer subject to section 6694(a) unless the form or document was prepared willfully in any manner to understate the liability of tax on a tax return or claim for refund or in reckless or intentional disregard of rules or regulations.



B. Definition of Tax Return Preparer

Until further guidance is issued, solely for purposes of section 6694, the term tax return preparer in section 7701(a)(36) is defined by using the definitions in §§1.6694-1, 1.6694-3 and 301.7701-15, with the following modifications:


1. Eliminating the word income as a modifier to tax return preparer throughout §§1.6694-1, 1.6694-3, and 301.7701-15. This modification conforms the current regulations to amendments made by the Act.



2. Expanding the definition of returns and claims for refund from returns of tax under subtitle A, claims for refund under subtitle A, or similar language, to include returns of tax and claims for refund under subtitles A through E of the Code throughout §§1.6694-1, 1.6694-3, and 301.7701-15. This modification conforms the current regulations to amendments made by the Act.



3. Interpreting the term substantial portion in §301.7701-15(b)(1) to mean a schedule, entry, or other portion of a tax return or claim for refund that, if adjusted or disallowed, could result in a deficiency determination (or disallowance of refund claim) that the preparer knows or reasonably should know is a significant portion of the tax liability reported on the tax return (or, in the case of a claim for refund, a significant portion of the tax originally reported or previously adjusted). This clarifies that any determination as to whether a person has prepared a substantial portion of a tax return and thus is considered a tax return preparer will depend on the relative size of the deficiency attributable to the schedule, entry, or other portion.


For examples illustrating the provisions of this section B, see section H below.



C. Date Return is Prepared

Until further guidance is issued, solely for purposes of section 6694, a return or claim for refund is deemed prepared on the date reflected by the tax return preparer's signature. If a signing preparer fails to sign the tax return, the tax return is deemed prepared on the date the tax return is filed. In the case of a nonsigning preparer, the relevant date is the date the person provides the advice, which date will be determined based on all the facts and circumstances. For purposes of this interim guidance, the rules described in this section will apply instead of §1.6694-2(b)(5).



D. Reasonable Belief that the Tax Treatment of the Position Would More Likely Than Not Be Sustained on the Merits

Until further guidance is issued, solely for purposes of section 6694, a tax return preparer is considered reasonably to believe that the tax treatment of an item is more likely than not the proper tax treatment (without taking into account the possibility that the tax return will not be audited, that an issue will not be raised on audit, or that an issue will be settled) if the tax return preparer analyzes the pertinent facts and authorities in the manner described in §1.6662-4(d)(3)(ii) and, in reliance upon that analysis, reasonably concludes in good faith that there is a greater than fifty percent likelihood that the tax treatment of the item will be upheld if challenged by the IRS. For purposes of interim guidance, the standard described in this section will apply instead of §1.6694-2(b).

For purposes of determining whether the tax return preparer has a reasonable belief that the position would more likely than not to be sustained on the merits, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer, as provided in §1.6694-1(e). In addition, a tax return preparer may rely in good faith and without verification upon information furnished by another advisor, tax return preparer or other third party. Thus, a tax return preparer is not required to independently verify or review the items reported on tax returns, schedules or other third party documents to determine if the items meet the standard requiring a reasonable belief that the position would more likely than not be sustained on the merits. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer. The tax return preparer also must make reasonable inquiries if the information furnished by another tax return preparer or a third party appears to be incorrect or incomplete.

For examples illustrating the provisions of this section D, see section H below.



E. Reasonable Basis

Until further guidance is issued, solely for purposes of section 6694, reasonable basis will be interpreted in accordance with §1.6662-3(b)(3). For purposes of this interim guidance, the standards described in this section will apply instead of §1.6694-2(c). The reasonable basis standard will also apply for purposes of §1.6694-3(c)(2).

For purposes of determining whether the tax return preparer has a reasonable basis for a position, a tax return preparer may rely in good faith without verification upon information furnished by the taxpayer, as provided in §1.6694-1(e). In addition, a tax return preparer may rely in good faith and without verification upon information furnished by another tax return preparer or other third party. Thus, a tax return preparer is not required to independently verify or review the items reported on tax returns, schedules or other third party documents to determine if the items meet the standard requiring a reasonable basis for a position. The tax return preparer, however, may not ignore the implications of information furnished to the tax return preparer or actually known to the tax return preparer. The tax return preparer also must make reasonable inquiries if the information furnished by another tax return preparer or a third party appears to be incorrect or incomplete.

For examples illustrating the provisions of this section E, see section H below.



F. Reasonable Cause and Good Faith

Until further guidance is issued, solely for purposes of section 6694, the IRS will continue to consider the factors described in §§1.6694-2(d)(1) to - 2(d)(4), but the factor regarding reliance on advice found in §1.6694-2(d)(5) is replaced by the rules described in this section F. For purposes of this interim guidance, a tax return preparer will be found to have acted in good faith when the tax return preparer relied on the advice of a third party who is not in the same firm as the tax return preparer and who the tax return preparer had reason to believe was competent to render the advice. The advice may be written or oral, but in either case the burden of establishing that the advice was received is on the tax return preparer. A tax return preparer is not considered to have relied in good faith if --

(i) The advice is unreasonable on its face;

(ii) The tax return preparer knew or should have known that the third party advisor was not aware of all relevant facts; or

(iii) The tax return preparer knew or should have known (given the nature of the tax return preparer's practice), at the time the tax return or claim for refund was prepared, that the advice was no longer reliable due to developments in the law since the time the advice was given.

For examples illustrating the provisions of this section F, see section H below.



G. Interim Penalty Compliance Rules

Until further guidance is issued, solely for purposes of section 6694, a signing tax return preparer shall be deemed to meet the requirements of section 6694 with respect to a position for which there is a reasonable basis but for which the tax return preparer does not have a reasonable belief that the position would more likely than not be sustained on the merits, if the tax return preparer meets any of the following requirements:


1. The position is disclosed in accordance with §1.6662-4(f) (which permits disclosure on a properly completed and filed Form 8275, Disclosure Statement, or 8275-R, Regulation Disclosure Statement, as appropriate, or on the tax return in accordance with the annual revenue procedure described in §1.6662-4(f)(2));



2. If the position would not meet the standard for the taxpayer to avoid a penalty under section 6662(d)(2)(B) without disclosure, the tax return preparer provides the taxpayer with the prepared tax return that includes the disclosure in accordance with §1.6662-4(f);



3. If the position would otherwise meet the requirement for nondisclosure under section 6662(d)(2)(B)(i), the tax return preparer advises the taxpayer of the difference between the penalty standards applicable to the taxpayer under section 6662 and the penalty standards applicable to the tax return preparer under section 6694, and contemporaneously documents in the tax return preparer's files that this advice was provided; or



4. If section 6662(d)(2)(B) does not apply because the position may be described in section 6662(d)(2)(C), the tax return preparer advises the taxpayer of the penalty standards applicable to the taxpayer under section 6662(d)(2)(C) and the difference, if any, between these standards and the standards under section 6694, and contemporaneously documents in the tax return preparer's files that this advice was provided.


For purposes of this interim guidance, the rules applicable to signing tax return preparers described in this section will apply instead of §1.6694-2(c)(3)(i).

Until further guidance is issued, solely for purposes of section 6694, a nonsigning tax return preparer shall be deemed to meet the requirements of section 6694 with respect to a position for which there is a reasonable basis but for which the nonsigning tax return preparer does not have a reasonable belief that the position would more likely than not be sustained on the merits, if the advice to the taxpayer includes a statement informing the taxpayer of any opportunity to avoid penalties under section 6662 that could apply to the position as a result of disclosure, if relevant, and of the requirements for disclosure. If a nonsigning tax return preparer provides advice to another tax return preparer, a nonsigning tax return preparer shall be deemed to meet the requirements of section 6694 with respect to a position for which there is a reasonable basis but for which the nonsigning tax return preparer does not have a reasonable belief that the position would more likely than not be sustained on the merits, if the advice to the tax return preparer includes a statement that disclosure under section 6694(a) may be required. If the advice with respect to a position is in writing, the statement must be in writing. If the advice with respect to a position is oral, the statement also may be oral. Contemporaneously prepared documentation in the nonsigning tax return preparer's files is sufficient to establish that the statement was given to the taxpayer or other tax return preparer. For purposes of this interim guidance, the rules applicable to nonsigning tax return preparers described in this section will apply instead of §1.6694-2(c)(3)(ii).

For examples illustrating the provisions of this section G, see section H below.



H. Examples

Examples illustrating the provisions of this notice and existing rules under current regulations:


Example 1. Accountant A prepares a Form 8886, Reportable Transaction Disclosure Statement, that is used to disclose reportable transactions. Accountant A does not prepare the tax return or advise the taxpayer regarding the tax return reporting position of the transaction to which the Form 8886 relates. The preparation of the Form 8886 is not directly relevant to the determination of the existence, characterization, or the amount of an entry on a tax return or claim for refund. Rather, the Form 8886 is prepared by Accountant A to disclose a reportable transaction. Accountant A has not prepared a substantial portion of the tax return and is not considered a tax return preparer under section 6694.



Example 2. Accountant B prepares a partnership's Form 1065 (including Schedules K-1) allocating the partnership's losses among its partners in proportion to their original investment. Accountant B is not an employee of either the partnership or the general partner. Accountant B knows that the loss deduction calculated by Accountant B and claimed by one of the partners on that partner's tax return, if disallowed, is the most significant portion of the liability on that partner's tax return. Accountant B has prepared a substantial portion of that partner's tax return and is considered a tax return preparer under section 6694.



Example 3. Attorney C, an attorney in a law firm, advises a large corporate taxpayer on specific issues of law regarding the tax consequences of a proposed corporate transaction. Based upon this advice, the corporate taxpayer enters into the transaction. Once the transaction is completed, the corporate taxpayer does not receive any additional advice from Attorney C or anyone in Attorney C's firm with respect to the proposed corporate transaction. Six months later, the corporate taxpayer hires Preparer D, who is not associated with the same firm as Attorney C, to prepare its entire tax return. Attorney C has not prepared a substantial portion of the corporation's tax return and is not considered a tax return preparer under section 6694.



Example 4. Attorney D, an attorney in a law firm, advises a large corporate taxpayer concerning the proper treatment and amount of a single entry on the corporate taxpayer's tax return. The tax liability involved in this entry is an insignificant portion of the tax liability for the corporate tax return as a whole. Neither Attorney D nor any other attorney associated with Attorney D's firm signs the corporate taxpayer's tax return as a tax return preparer. Attorney D has not prepared a substantial portion of the corporation's tax return and is not considered a tax return preparer under section 6694.



Example 5. Attorney E specializes in tax planning at a law firm and develops Strategy Y, a plan with a significant purpose of tax avoidance. Attorney E provides advice with respect to Strategy Y to 50 taxpayers. The 50 taxpayers implement Strategy Y in a manner that significantly reduces the Federal tax liability that would otherwise be reported on their tax returns. After Strategy Y is entered into, Attorney E advises each of the 50 taxpayers on the reporting of specific amounts that Attorney E knows will be placed on the tax return of each of the 50 taxpayers. Attorney E knows that the tax liability involved in this entry, if disallowed, is a significant portion of the tax liability for each of the tax returns. Neither Attorney E nor any other person associated with Attorney E's firm signs the taxpayers' tax returns as a tax return preparer. The advice relating to Strategy Y constitutes preparation of a substantial portion of each of the 50 taxpayers' tax returns. Thus, Attorney E is a tax return preparer under section 6694.



Example 6. During an interview conducted by Preparer F, the taxpayer provided a schedule prepared by another advisor in Preparer F's firm for use in preparing the taxpayer's tax return. The schedule did not appear to be incorrect or incomplete. On the basis of this information, Preparer F completed the tax return. It is later determined that there is an understatement of liability for tax that resulted from incorrect information on the schedule. Preparer F is not required to audit, examine or review the schedule in order to verify independently that the information on the schedule met the standard requiring a reasonable belief that the position would more likely than not sustained on the merits. Preparer F is not subject to a penalty under section 6694.



Example 7. In preparing a tax return, Accountant G relies on the advice of an actuary concerning the limit on deductibility under section 404(a)(1)(A) of a contribution by an employer to a qualified pension trust. The actuary providing the advice was not associated with Accountant G's firm. On the basis of this advice, Accountant G completed the tax return. It is later determined that there is an understatement of liability for tax that resulted from incorrect advice provided by the actuary. Accountant G had no reason to believe that the advice was incorrect or incomplete, and the advice appeared reasonable on its face. Accountant G was also not aware of any reason why the actuary did not know all of the relevant facts or that the advice was no longer reliable due to developments in the law since the time the advice was given. Accountant G is not subject to a penalty under section 6694.



Example 8. During an interview conducted by Preparer H, a taxpayer stated that he had made a charitable contribution of real estate in the amount of $50,000 during the tax year, when in fact he had not made this charitable contribution. Preparer H did not inquire about the existence of a qualified appraisal or complete a Form 8283 in accordance with the reporting and substantiation requirements under section 170(f)(11). Preparer H reported deductions on the tax return for the charitable contribution which resulted in an understatement of liability for tax. Preparer H is subject to a penalty under section 6694.



Example 9. Preparer I prepared the tax returns of a taxpayer for each of the past three years. While preparing this year's tax return, Preparer I realizes that the taxpayer did not provide a Form 1099 for a bank account that produced significant taxable income in each of the previous three years. When Preparer I asked the taxpayer about any other existing income and the lack of this Form 1099, the taxpayer furnishes the Form 1099 to Preparer I for use in preparation of the tax return. Preparer I did not know that the taxpayer owned an additional bank account this past year that generated taxable income and the taxpayer did not reveal this information to the tax return preparer. Preparer I is not subject to a penalty under section 6694.



Example 10. A corporate taxpayer hires Accountant J to prepare its tax return. Accountant J encounters an issue regarding various small asset expenditures. Accountant J researches the issue and concludes that there is a reasonable basis for a particular treatment of the issue. Accountant J cannot, however, reach a reasonable belief whether the position would more likely than not be sustained on the merits because it was impossible to make a precise quantification regarding whether the position would more likely than not be sustained on the merits. The position is not disclosed on the tax return. Accountant J signs the tax return as the tax return preparer. The IRS later disagrees with this position taken on the tax return. Accountant J is not subject to a penalty under section 6694.



Example 11. A corporate taxpayer hires Accountant K to prepare its income tax return. Accountant K does not reasonably believe that a particular position taken on the tax return would more likely than not be sustained on its merits although there is substantial authority for the position. Accountant K prepares and signs the tax return without disclosing the position taken on the tax return, but advises the corporate taxpayer of the difference between the penalty standards applicable to the taxpayer under section 6662 and to the tax return preparer under section 6694, and contemporaneously documents in the tax return preparer's files that this advice was provided. The corporate taxpayer signs and files the tax return without disclosing the position because the position meets the requirements for nondisclosure under section 6662(d)(2)(B)(i). The IRS later disagrees with the position taken on the tax return, resulting in an understatement of liability reported on the tax return. Accountant K is not subject to a penalty under section 6694.



Example 12. Attorney L advises a large corporate taxpayer in writing concerning the proper treatment of complex entries on the corporate taxpayer's tax return. Attorney L has reason to know that the tax liability involved in these entries, if disallowed, is a significant portion of the tax liability for the tax return. When providing the advice, Attorney L concludes that one position with respect to these entries does not meet the reasonable belief that the position would more likely than not be sustained on the merits standard and also does not have substantial authority, although the position meets the reasonable basis standard. Attorney L, in good faith, advises the corporate taxpayer in writing that the position lacks substantial authority and the taxpayer will be subject to an accuracy-related penalty under section 6662 unless the position is disclosed in a disclosure statement included in the return. Attorney L also documents the fact that this advice was contemporaneously provided to the corporate taxpayer in writing at the time the advice was provided. The corporate taxpayer decides not to include a disclosure statement in the return. Neither Attorney L nor any other attorney associated with Attorney L's firm signs the corporate taxpayer's return as a tax return preparer, but the advice by Attorney L constitutes preparation of a substantial portion of the tax return. Thus, Attorney L is a tax return preparer for purposes of section 6694. Attorney L, however, will not be subject to a penalty under section 6694.




REQUESTS FOR COMMENTS

Interested parties are invited to submit comments on this notice by March 24, 2008. Comments should be submitted to: Internal Revenue Service, CC:PA:LPD:PR ( Notice 2008-13), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20224. Alternatively, comments may be hand delivered Monday through Friday between the hours of 8:00 a.m. to 4:00 p.m. to: CC:PA:LPD:PR ( Notice 2008-13), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC. Comments may also be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov. Please include Notice 2008-13 in the subject line of any electronic submissions.

Specifically, this notice requests comments with respect to the definition of a tax return preparer. The Treasury Department and the IRS are considering various modifications to the regulations defining tax return preparer for purposes of sections 6694 and 7701(a)(36). These modifications may include limiting the definition or keeping a broader definition in order to clarify the definition of nonsigning tax return preparers in such a manner that nonsigning tax return preparers can more easily identify the circumstances under which they would be subject to section 6694. This may involve the addition of examples or changes to the current de minimis safe harbor in §301.7701-15(b)(2).

This notice also requests comments with respect to providing additional guidance on defining both the reasonable belief and more likely than not concepts included in section 6694, as amended by the Act. Comments are requested whether the Treasury Department and the IRS should promulgate rules specifically tailored to common situations when reaching a more likely than not level of certainty on a position is not possible or practical as either a legal or factual matter and, specifically, whether disclosure should be necessary to avoid penalties under section 6694(a) and how disclosure should be made in those situations.



EFFECTIVE DATE

This notice is effective as of: (1) January 1, 2008, for all tax returns, amended tax returns, and claims for refund (other than 2007 employment and excise tax returns) filed on after that date with respect to advice provided on or after that date; and (2) February 1, 2008, for all 2007 employment and excise tax returns filed on after that date with respect to advice provided on or after that date.



CONTACT INFORMATION

The principal authors of this notice are Matthew S. Cooper and Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Cooper at (202) 622-4940 or Mr. Hara at (202) 622-4910 (not toll-free calls).



EXHIBIT 1 - Tax Returns Reporting Tax Liability



Income Tax Returns - Subtitle A


Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation;



Form 990T, Exempt Organization Business Income Tax Return;



Form 1040, U.S. Individual Income Tax Return;



Form 1040A, U.S. Individual Income Tax Return;



Form 1040-EZ, Income Tax Return for Single Filers and Joint Filers With No Dependents;



Form 1040-EZT, Claim for Refund of Federal Telephone Excise Tax;



Form 1040X, Amended U.S. Individual Income Tax Return;



Form 1040-PR (Anexo H-PR), Contribuciones sobre el Empleo de Empleados Domesticos;



Form 1041, U.S. Income Tax Return for Estates and Trusts;



Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons;



Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return;



Form 1120, U.S. Corporation Income Tax Return;



Form 1120-C, U.S. Income Tax Return for Cooperative Associations;



Form 1120-IC DISC, Interest Charge Domestic International Sales -Corporation Return;



Form 1120-F, U.S. Income Tax Return of a Foreign Corporation;



Form 1120S, U.S. Income Tax Return for an S Corporation;



Form 1120X, Amended U.S. Corporation Income Tax Return;



Form 8831, Excise Taxes on Excess Inclusions of REMIC Residual Interests ( I.R.C. §860E); and



Form 8924, Excise Tax on Certain Transfers of Qualifying Geothermal or Mineral Interests (New Form, Exclusion from Capital Gains).




Estate and Gift Tax Returns - Subtitle B


Form 706, U.S. Estate Tax Return;



Form 706-A, United States Additional Estate Tax Return;



Form 706-D, United States Additional Estate Tax Return Under Code Section 2057;



Form 706-GS(D) Generation-Skipping Transfer Tax Return for Distributions;



Form 706-GS(T) Generation-Skipping Transfer Tax Return for Terminations;



Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return - Estate of nonresident not a citizen of the United States ;



Form 706-QDT, United States Estate Tax Return for Qualified Domestic Trusts;



Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return; and



Form 843, Claim For Refund and Request for Abatement (also used to claim refunds for employment and certain excise tax returns).




Employment Tax Returns - Subtitle C


Form CT-1, Employer's Annual Railroad Retirement Tax Return;



Form CT-2, Employee Representative's Quarterly Railroad Tax Return;



Form 940, Employer's Annual Federal Unemployment Tax Return;



Form 940-PR, Planilla para la Declaración Federal ANUAL del Patrono de la Contribución Federal para el Desempleo (FUTA);



Form 941, Employer's QUARTERLY Federal Tax Return;



Form 941-PR, Planilla para la Declaración Federal TRIMESTRAL del Patrono;



Form 941-SS, Employer's QUARTERLY Federal Tax Return;



Form 941-M, Employer's MONTHLY Federal Tax Return;



Form 943, Employer's Annual Federal Tax Return for Agricultural Employees;



Form 943-PR, Planilla Para la Declaración ANUAL de la Contribución Federal del Patrono De Empleados Agrícolas;



Form 944, Employer's ANNUAL Federal Tax Return;



Form 944-PR, Planilla para la Declaración ANUAL de la Contribución Federal del Patrono;



Form 944(SP), Declaración Federal ANUAL de Impuestos del Patrono o Empleador;



Form 944-SS, Employer's ANNUAL Federal Tax Return;



Form 945, Annual Return of Withheld Federal Income Tax;



Form 1040-SS, U.S. Self-Employment Tax Return.




Miscellaneous Excise Tax Returns - Subtitle D


Form 11-C, Occupational Tax and Registration Return for Wagering;



Form 720, Quarterly Federal Excise Tax Return;



Form 720X, Amended Quarterly Federal Excise Tax Return;



Form 730, Monthly Tax Return for Wagers;



Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation (with respect to the excise tax based on investment income);



Form 2290, Heavy Highway Vehicle Use Tax Return;



Form 2290(FR), Declaration d'Impot sur L'utilisation des Vehicules Lourds sur les Routes;



Form 2290(SP), Declaración del Impuesto sobre el Uso de Vehículos Pesados en las Carreteras;



Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code;



Form 5330, Return of Excise Taxes Related to Employee Benefit Plans;



Form 8612, Return of Excise Tax on Undistributed Income of Real Estate Investment Trusts;



Form 8613, Return of Excise Tax on Undistributed Income of Regulated Investment Companies; and



Form 8849, Claim for Refund of Excise Taxes.




Alcohol, Tobacco, and Certain Other Excise Taxes - Subtitle E


Form 8725, Excise Tax on Greenmail; and



Form 8876, Excise Tax on Structured Settlement Factoring Transactions.




Exhibit 2 - Information Returns That Report Information That is or May be Reported on Another Tax Return That May Subject a Tax Return Preparer to the Section 6694(a) Penalty if the Information Reported Constitutes a Substantial Portion of the Other Tax Return


Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding;



Form 1065, U.S. Return of Partnership Income (including Schedules K-1);



Form 1120S, U.S. Income Tax Return for an S Corporation (including Schedules K-1);



Form 5500, Annual Return/Report of Employee Benefit Plan;



Form 8038, Information Return for Tax-Exempt Private Activity Bond Issues;



Form 8038-G, Information Return for Government Purpose Tax-Exempt Bond Issues; and



Form 8038-GC, Consolidated Information Return for Small Tax-Exempt Government Bond Issues.




Exhibit 3 - Forms That Would Not Subject a Tax Return Preparer to the Section 6694(a) Penalty Unless Prepared Willfully in any Manner to Understate the Liability of Tax on a Return or Claim for Refund or in Reckless or Intentional Disregard of Rules or Regulations


Form 1099 series of returns;



Form W-2 series of returns;



Form W-8BEN, Beneficial Owner's Certificate of Foreign Status for U.S. Tax Withholding;



Form SS-8, Determination of Worker Status;



Form 990, Return of Organization Exempt from Income Tax;



Form 990-EZ, Short Form Return of Organization Exempt From Income Tax;



Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations not Required To File Form 990 or 990-EZ;



Form 1040-ES, Estimated Tax for Individuals;



Form 1120-W, Estimated Tax for Corporations;



Form 2350, Application for Extension of Time to File U.S. Income Tax Return;



Form 2350 (SP), Application for Extension of Time to File U.S. Income tax Return (Spanish Version);



Form 4137, Social Security and Medicare Tax on Unreported Tip Income;



Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes;



Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return;



Form 4868 (SP), Application for Automatic Extension of Time to File U.S. Individual Income Tax Return (Spanish Version);



Form 5558, Application for Extension of Time to File Certain Employee Plan Returns;



Form 7004, Application for Automatic 6-Month Extension of Time To File Certain Business Income Tax, Information, and Other Returns;



Form 8109, Federal Tax Deposit Coupon;



Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips;



Form 8809, Application for Extension of Time to File Information Returns;



Form 8868, Application for Extension of Time To File an Exempt Organization Return;



Form 8892, Application for Automatic Extension of Time to File Form 709 and/or Payment of Gift/Generation-Skipping Transfer Tax; and



Form 8919, Uncollected Social Security and Medicare Tax on Wages.


Treasury, IRS Implement Enhanced Standards of Conduct for Tax Return Preparers; Plan Overhaul of Tax Return Preparer Regulatory Regime

IR-2007-213, Dec. 31, 2007

WASHINGTON — The Treasury Department and the Internal Revenue Service today issued Notice 2008-13 that implements a May 2007 law that expanded the tax return preparer penalty and heightened the standards of conduct that must be met by tax return preparers in order to avoid that penalty.

Notice 2008-13 also solicits input from the tax return preparer community on a planned overhaul of the tax return preparer penalty regime anticipated to be completed by the end of 2008.

“The plan to take a fresh look at the preparer penalty regulations will be a top priority for us in 2008,” said IRS Chief Counsel Don Korb. “We look forward to receiving comments from all interested parties on their recommendations for the final regulations. Our goal is to complete our work on the overhaul of these rules by the end of 2008,” he said.

For undisclosed positions on a tax return, the new law replaced the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. In cases in which the taxpayer discloses the position on the tax return, the notice implements the new law that states there must be a reasonable basis for the tax treatment of the position taken on the tax return.

The notice provides interim rules to implement and interpret these heightened standards. The interim rules will be in effect until the overhaul of the current return preparer penalty regulations is complete. The interim rules emphasize the importance to preparers of understanding the legal basis for positions taken on tax returns, the requirement for taxpayers to disclose certain positions, and the need for preparers to advise taxpayers on the various penalties that can apply when a position is taken on a return that may not be supported by existing law.

Under the notice, preparers generally can continue to rely on taxpayer representations in preparing returns and can also generally rely on representations of third parties, unless the preparer has reason to know they are wrong.

The new law also expanded the return preparer penalty to cover all tax return preparers, not just income tax return preparers. Under the notice, preparers of many information returns, however, will not be subject to the new penalty provision unless they willfully understate tax or act in reckless or intentional disregard of the law. The notice also includes examples illustrating how the new standards would apply.

In addition to Notice 2008-13, additional guidance has been provided in Notice 2008-12 with respect to the implementation of the tax return preparer signature requirement, and in Notice 2008-11, which clarifies the transition relief provided in Notice 2007-54, issued earlier this year.


Notice 2008-12 , I.R.B. 2008-3, December 31, 2007.

[ Code Sec. 6695]


Penalties: Failure by preparer to sign return. --
The IRS has issued guidance to identify the returns and claims for refunds required to be signed by a tax return preparer in order to avoid the penalty for failure to sign a return which has been extended to all tax returns and claims for refund. An individual who is a tax return preparer must sign the return or claim for refund after it is completed and before it is presented to the taxpayer for signature. If the preparer is unavailable for signature, another tax return preparer must review the entire preparation of the return or claim for refund and sign it before it is presented to the taxpayer. If more than one preparer is involved in the preparation of the return or claim for refund, the individual tax return preparer who has the primary responsibility for the overall substantive accuracy in preparing the return must sign the return. Back references: ¶39,970.60 and ¶39,970.75.




This notice provides guidance to the public regarding implementation of the tax return preparer signature requirement penalty provisions under section 6695(b) of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Tax Act of 2007.



BACKGROUND

The Small Business and Work Opportunity Tax Act of 2007 (the Act), Pub. L. No. 110-28, 121 Stat. 190, was enacted on May 25, 2007. Section 8246 of the Act amended several provisions of the Code, including section 6695(b), to extend the application of the income tax return preparer penalties to all tax return preparers. As amended by the Act, section 6695(b) imposes a penalty on a tax return preparer of any return or claim for refund who fails to sign a return when required by regulations prescribed by the Secretary, unless it is shown that the failure is due to reasonable cause and not due to willful neglect. The penalty under section 6695(b) is $50 for each failure to sign, with a maximum of $25,000 per person imposed with respect to each calendar year. The amendments to section 6695(b) made by section 8246 of the Act are effective for tax returns and claims for refund prepared after May 25, 2007.



INTERIM AND PLANNED GUIDANCE

The Treasury Department and the Internal Revenue Service intend to issue regulations that implement the signature requirements under section 6695(b) for certain 2008 tax year returns and claims for refund. In advance of these regulations, guidance is being issued to (1) identify the returns and claims for refund required to be signed by a tax return preparer in order to avoid a section 6695(b) penalty under current regulations, and (2) identify the returns and claims for refund that will be required to be signed by a tax return preparer in order to avoid a section 6695(b) penalty under future regulations published by the Treasury Department and IRS. This interim guidance will apply until further guidance is issued and tax return preparers may rely on the interim guidance in this notice.



A. Signing Tax Return Preparer

For purposes of section 6695(b), an individual who is a tax return preparer with respect to a return of tax or claim for refund of tax listed below in paragraph (B)(1) of this notice shall sign the return or claim for refund after it is completed and before it is presented to the taxpayer (or nontaxable entity) for signature. If the tax return preparer is unavailable for signature, another tax return preparer shall review the entire preparation of the return or claim for refund, and then shall sign the return or claim for refund.

If more than one tax return preparer is involved in the preparation of the return or claim for refund, the individual tax return preparer who has the primary responsibility as between or among the preparers for the overall substantive accuracy of the preparation of such return or claim for refund shall be considered to be the tax return preparer for purposes of section 6695(b).



B. Forms Requiring Signature of Tax Return Preparer

(1) Consistent with existing regulations, in order to avoid the imposition of a penalty under section 6695(b), a signing tax return preparer described above in paragraph (A) of this notice must provide a signature on any income tax returns or claim for refund of income tax that are filed after December 31, 2007, including but not limited to the following:


Ÿ Form 990-T, Exempt Organization Business Income Tax Return



Ÿ Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation



Ÿ Form 1040, U.S. Individual Income Tax Return



Ÿ Form 1040A, U.S. Individual Income Tax Return



Ÿ Form 1040-C, U.S. Departing Alien Income Tax Return



Ÿ Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents



Ÿ Form 1040NR, U.S. Nonresident Alien Income Tax Return



Ÿ Form 1040NR-EZ, U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents



Ÿ Form 1040-PR, Planilla para la Declaración de la Contribución Federal sobre el Trabajo por Cuenta Propia (Incluyendo el Crédito Tributario Adicional por Hijos para Residentes Bona fide de Puerto Rico)



Ÿ Form 1040-SS, U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico)



Ÿ Form 1040X, Amended U.S. Individual Income Tax Return



Ÿ Form 1041, U.S. Income Tax Return for Estates and Trusts



Ÿ Form 1041-N, U.S. Income Tax Return for Electing Alaska Native Settlement Trusts



Ÿ Form 1041-QFT, U.S. Income Tax Return for Qualified Funeral Trusts



Ÿ Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons



Ÿ Form 1065, U.S. Return of Partnership Income



Ÿ Form 1065-B, U.S. Return of Income for Electing Large Partnerships



Ÿ Form 1066, U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return



Ÿ Form 1120, U.S. Corporation Income Tax Return



Ÿ Form 1120-C, U.S. Income Tax Return for Cooperative Associations



Ÿ Form 1120-F, U.S. Income Tax Return of a Foreign Corporation



Ÿ Form 1120-FSC, U.S. Income Tax Return of a Foreign Sales Corporation



Ÿ Form 1120-H, U.S. Income Tax Return for Homeowners Associations



Ÿ Form 1120IC-DISC, Interest Charge Domestic International



Ÿ Sales Corporation Return



Ÿ Form 1120-L, U.S. Life Insurance Company Income Tax Return



Ÿ Form 1120-ND, Return for Nuclear Decommissioning Funds and Certain Related Persons



Ÿ Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return



Ÿ Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations



Ÿ Form 1120-REIT, U.S. Income Tax Return for Real Estate Investment Trusts



Ÿ Form 1120-RIC, U.S. Income Tax Return For Regulated Investment Companies



Ÿ Form 1120S, U.S. Income Tax Return for an S Corporation



Ÿ Form 1120-SF, U.S. Income Tax Return for Settlement Funds (Under Section 468B)



Ÿ Form 1120X, Amended U.S. Corporation Income Tax Return



Ÿ Form 2438, Undistributed Capital Gains Tax Return


(2) In the absence of Treasury regulations requiring signature, a signing tax return preparer described above in paragraph (A) of this notice will not be subject to the penalty under section 6695(b) with respect to tax returns or refund claims for taxes other than income taxes that are filed after December 31, 2007 but on or before December 31, 2008, including the filing of the following returns:


Ÿ Form CT-1, Employer's Annual Railroad Retirement Tax Return



Ÿ Form CT-2, Employee Representative's Quarterly Railroad Tax Return



Ÿ Form 11-C, Occupational Tax and Registration Return for Wagering



Ÿ Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return



Ÿ Form 706-A, United States Additional Estate Tax Return



Ÿ Form 706-D, United States Additional Estate Tax Return Under Code Section



Ÿ Form 706-GS(D), Generation-Skipping Transfer Tax Return For Distributions



Ÿ Form 706-GS(T), Generation-Skipping Transfer Tax Return For Terminations



Ÿ Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return - Estate of nonresident not a citizen of the United States Trusts



Ÿ Form 706-QDT, United States Estate Tax Return for Qualified Domestic Trusts



Ÿ Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return



Ÿ Form 720, Quarterly Federal Excise Tax Return



Ÿ Form 720X, Amended Quarterly Federal Excise Tax Return



Ÿ Form 730, Monthly Tax Return for Wagers



Ÿ Form 843, Claim for Refund and Request for Abatement



Ÿ Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return



Ÿ Form 940-PR, Planilla para la Declaración Federal ANUAL del Patrono de la Contribución Federal para el Desempleo (FUTA)



Ÿ Form 941, Employer's QUARTERLY Federal Tax Return



Ÿ Form 941-PR, Planilla para la Declaración Federal TRIMESTRAL del Patrono



Ÿ Form 941-SS, Employer's QUARTERLY Federal Tax Return



Ÿ Form 941-M, Employer's MONTHLY Federal Tax Return



Ÿ Form 943, Employer's Annual Federal Tax Return for Agricultural Employees



Ÿ Form 943(PR), Planilla Para la Declaración ANUAL De La Contribución Del Patrono De Empleados Agrícolas



Ÿ Form 944, Employer's ANNUAL Federal Tax Return



Ÿ Form 944-PR, Planilla para la Declaración ANUAL de la Contribución Federal del Patrono 944(SP), Declaración Federal ANUAL de Impuestos del Patrono o Empleador



Ÿ Form 944-SS, Employer's ANNUAL Federal Tax Return



Ÿ Form 945, Annual Return of Withheld Federal Income Tax



Ÿ Form 1040 (Schedule H), Household Employment Taxes



Ÿ Form 1040-PR (Anexo H-PR), Contribuciones sobre el Empleo de Empleados Domesticos



Ÿ Form 2290, Heavy Highway Vehicle Use Tax Return



Ÿ Form 2290(FR), Declaration d'Impot sur L'utilisation des Vehicules Lourds sur les Routes



Ÿ Form 2290(SP), Declaración del Impuesto sobre el Uso de Vehículos Pesados en las Carreteras



Ÿ Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code



Ÿ Form 5330, Return of Excise Taxes Related to Employee Benefit Plans



Ÿ Form 8612, Return of Excise Tax on Undistributed Income of Real Estate Investment Trusts



Ÿ Form 8613, Return of Excise Tax on Undistributed Income of Regulated Investment Companies



Ÿ Form 8725, Excise Tax on Greenmail



Ÿ Form 8831, Excise Taxes on Excess Inclusions of REMIC Residual Interests



Ÿ Form 8849, Claim for Refund of Excise Taxes



Ÿ Form 8876, Excise Tax on Structured Settlement Factoring Transactions



Ÿ Form 8924, Excise Tax on Certain Transfers of Qualifying Geothermal or Mineral Interests


The tax return preparer shall sign the return in the manner prescribed by the Commissioner in forms, instructions, or other appropriate guidance.

The Treasury Department and IRS intend to issue regulations on or before December 31, 2008 requiring signatures under section 6695(b) for all the above listed forms that are filed after December 31, 2008.

Information on the preparer signature requirement for electronically filed returns will be announced in IRS publications, instructions, and information posted electronically on the IRS.gov website.



EFFECTIVE DATE

This Notice is effective as of January 1, 2008 .



CONTACT INFORMATION

The principal authors of this notice are Matthew S. Cooper and Michael E. Hara of the Office of the Associate Chief Counsel (Procedure and Administration). For further information regarding this notice contact Mr. Cooper at 202-622-4940 or Mr. Hara at (202) 622-4910 (not toll-free calls).


Notice 2008-11,IRB 2008-3 January 22, 2008.

[ Code Secs. 6662 and 6694]


Estate, gift, generation-skipping transfer and income taxes: Returns and procedures: Return preparer penalties: Interim relief. --
The preparer penalty transitional relief provided by Notice 2007-54, I.R.B. 2007-27, 12, relating to adequate disclosure and the reasonable basis standard, has been clarified to provide that certain original and amended returns and refund claims will qualify for such transitional relief. The relief is extended to timely amended returns or claims for refund filed on or before December 31, 2007 and original returns due on extension after December 31, 2007 but filed on or before December 31, 2007. The guidance also clarifies that transitional relief is available for advice rendered by nonsigning preparers for advice provided on or before December 31, 2007. The transitional relief clarification is effective as of May 25, 2007. Back references: ¶21,790.20 and ¶21,864.50.




This notice clarifies Notice 2007-54, 2007-27 I.R.B. 12, which provided guidance and transitional relief for the tax return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Tax Act of 2007.



BACKGROUND

The Small Business and Work Opportunity Tax Act of 2007 (the Act), Pub. L. No. 110-28, 121 Stat. 190, was enacted on May 25, 2007. Section 8246 of the Act amended several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.

In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Treasury Department and the IRS issued Notice 2007-54 on June 11, 2007, and which provided the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the IRS will impose a penalty under section 6694(a), as amended by the Act. Notice 2007-54 provided that generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

Notice 2007-54 further provided that for all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the IRS will impose a penalty under section 6694(a).

Notice 2007-54 provided that the transitional relief applies to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing), and to 2007 employment and excise tax returns due on or before January 31, 2008. Notice 2007-54 also provided that no transitional relief was provided under section 6694(b) as transitional relief is not appropriate for tax return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.



TRANSITIONAL RELIEF CLARIFICATIONS

Questions have arisen regarding the extent to which amended returns or claims for refund qualify for transitional relief under Notice 2007-54. There is no set due date for such returns and claims other than prior to the expiration of the period proscribed by the applicable statute of limitations. The transitional relief described in Notice 2007-54 applies to timely amended returns or claims for refund (other than 2007 employment and excise tax returns) filed on or before December 31, 2007, and to timely amended employment and excise tax returns or claims for refund filed on or before January 31, 2008 .

Questions have arisen regarding the extent to which original tax returns due on extension after December 31, 2007, but filed before December 31, 2007, qualify for transitional relief. The transitional relief described in Notice 2007-54 applies to original returns (other than 2007 employment and excise tax returns) filed on or before December 31, 2007, and to original employment and excise returns filed on or before January 31, 2008.

Questions have also arisen regarding the extent to which advice rendered by nonsigning preparers qualifies for transitional relief under Notice 2007-54. The transitional relief described in Notice 2007-54, as clarified by this notice, applies to nonsigning preparers for advice provided on or before December 31, 2007.

In future guidance, the Treasury Department and the IRS intend to provide transitional rules to address amended returns filed after the expiration of the transitional relief period described in Notice 2007-54 that relate to original returns filed under previous law or during the transitional relief period, as clarified by this notice.



EFFECTIVE DATE

This notice is effective as of May 25, 2007.



EFFECT ON OTHER DOCUMENTS

Notice 2007-54, 2007-27 I.R.B. 12, is clarified.



CONTACT INFORMATION

The principal authors of this notice are Matthew S. Cooper and Michael E. Hara of the Office of the Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Cooper at (202) 622-4940 or Mr. Hara at (202) 622-4910 (not toll-free calls).