Economic substance - Son of Boss case

Klamath Strategic Investment Fund, by and through St Croix Ventures (Managing member), Plaintiff-Appellee-Cross-Appellant v. United States of America Defendant-Appellant-Cross-Appellee; Kinabalu Strategic Investment Fund, by and through Rogue Ventures LLC (Managing member), Plaintiff-Appellee-Cross-Appellant v. United States of America, Defendant-Appellant-Cross-Appellee.

U.S. Court of Appeals, 5th Circuit; 07-4086, May 15, 2009.

Affirming in part, vacating and remanding in part, a DC Tex. decision, 2007-1 USTC ¶50,223.





Before: Garwood, Garza and Owen, Circuit Judges.

GARZA, Circuit Judge: In this tax case, Plaintiffs Klamath Strategic Investment Fund ("Klamath") and Kinabalu Strategic Investment Fund ("Kinabalu") (collectively, the "Partnerships") filed suit against defendant the United States of America for readjustment of partnership items. Both parties appeal various aspects of the district court's readjustment determination. For the following reasons, we affirm in part, vacate in part, and remand.


I


This case involves a highly complex series of financial transactions, which the district court categorized as a tax shelter known as Bond Linked Issue Premium Structure ("BLIPS"). The transactions were undertaken by two law partners, Cary Patterson and Harold Nix. Patterson and Nix's law firm represented the State of Texas in litigation against the tobacco industry and each partner earned around $30 million between 1998 and 2000. Interested in managing this wealth, Patterson and Nix requested their long-time accounting firm, Pollans & Cohen, to investigate investment opportunities.

The accountants identified Presidio Advisory Services ("Presidio"), an investment advisory firm purporting to specialize in foreign currency trading. Presidio advocated a complex plan involving strategic investments in foreign currencies pegged to the U.S. dollar. Patterson and Nix agreed to invest in Presidio's plan. Generally, the Presidio strategy was structured as a three-stage, seven-year investment program. Stage I lasted 60 days and entailed relatively low risk investments. Stage II lasted from day 60 through day 180, and the risk was somewhat higher. Stage III extended from day 180 through the end of the seventh year and involved the highest risk as well as potentially the highest return. At each stage of the plan, Presidio required the investors to contribute significantly more capital. The investors retained the right to exit the plan at the end of Stage I and at each 60-day period thereafter.

To implement the strategy Presidio formed Klamath and Kinabalu as limited liability companies, taxed as partnerships. Next, Presidio formed two single-member LLCs, which are disregarded for tax purposes: St. Croix for Patterson and Rogue for Nix. Patterson owned 100% of St. Croix, and St. Croix became a 90% partner of Klamath. The other 10% partners of Klamath were Presidio Resources LLC and Presidio Growth LLC. Presidio Growth was the managing partner. Kinabalu had a similar structure. Nix owned 100% of Rogue, and Rogue was a 90% partner of Kinabalu. The other 10% partners of Kinabalu were Presidio Growth and Presidio Resources, with Presidio Growth acting as the managing partner.

To fund Klamath and Kinabalu, Patterson and Nix (acting through St. Croix and Rogue) made two distinct contributions. First, they each contributed $1.5 million to their respective partnership. Second, they entered into loan transactions with National Westminster Bank ("NatWest"), where the bank loaned each company $66.7 million. This included $41.7 million denominated as the "Stated Principal Amount" and $25 million as a "loan premium." The classification of the $25 million as something different than the principal loan amount is central to this case. The loan premium was given in exchange for Patterson and Nix paying NatWest a higher than market interest rate on the principal: 17.97%. To protect NatWest from the possibility that the loans would be repaid early and the benefit of the higher interest rate would not be realized, the credit agreements required that a prepayment amount be paid if the loans were paid off early. The prepayment amount would vary depending on when the loan was repaid, starting at about $25 million and decreasing over seven years. After year seven, no prepayment amount would apply.

Patterson and Nix each contributed the $66.7 million to Klamath and Kinabalu and assigned the corresponding loan obligations to the Partnerships. The Partnerships deposited the funds into accounts controlled by NatWest. Presidio directed Klamath and Kinabalu to use these funds to purchase very low risk contracts on U.S. dollars and Euros. They also made small, short 60- to 90-day term forward contract trades in foreign currencies. These were the only investments the Partnerships ever made, and Patterson and Nix elected to withdraw from Klamath and Kinabalu before the end of Stage I. They received cash and Euros on liquidation, and they sold the Euros in 2000, 2001, and 2002.

On their income tax returns for 2000, 2001, and 2002, Patterson claimed total losses of $25,277,202 arising from Klamath's activities and Nix claimed total losses of $25,272,344 arising from Kinabalu's. These massive losses occurred because each partner claimed a significant tax basis in their respective partnership. Generally, a partner's basis in a partnership is determined by the amount of capital he contributes to the partnership, and when a partnership loses money the partners can only deduct the losses from their taxable income to the extent of their basis in the partnership. When a partnership assumes a partner's individual liabilities, the liability amount is subtracted from the partner's basis. 1 Patterson and Nix were able to report such high losses because when they each calculated their basis in the partnership, they did not reduce it by the $25 million loan premium amount. When Patterson and Nix contributed the $66.7 million plus the $1.5 million to Klamath and Kinabalu, they would have each had a $68.2 million basis in their partnership. However, the Partnerships also assumed the loan obligations, so Patterson and Nix's bases had to be reduced by the amount of the liabilities. Patterson and Nix did not consider the loan premiums to be liabilities, so they only subtracted the $41.7 million principal amount. Therefore, each claimed a taxable basis in the partnership in excess of $25 million. This meant that when Patterson and Nix sold the Euros, they were able to deduct over $25 million from their taxable income. 2

The IRS disagreed with this basis calculation, and in 2004 issued Final Partnership Administrative Adjustments ("FPAAs") to Klamath and Kinabalu stating that under 26 U.S.C. § 752 of the Internal Revenue Code (the "Code"), the partners should have treated the entire $66.7 million as a liability. Alternatively, the IRS argued that the transactions were shams or lacked economic substance and should be disregarded for tax purposes. The FPAAs also made adjustments to operational expenses reported by the Partnerships and asserted accuracy-related penalties. Patterson and Nix paid the taxes owed based on the FPAAs, and then re-formed the partnerships in order to seek readjustment in the district court.

The Partnerships filed suit against the Government under 26 U.S.C. § 6226 for readjustment of partnership items. The Partnerships moved for partial summary judgment, and the Government cross-moved for summary judgment on the issue of whether the partners' tax bases were properly calculated; specifically, whether the loan premiums constituted liabilities under § 752 of the Code. The district court granted the Partnerships' motion and denied the Government's, holding that the loan premiums were not liabilities under § 752 and therefore the partners' bases were properly calculated under the Code. However, following a bench trial the district court held that the loan transactions must nonetheless be disregarded for federal tax purposes because they lacked economic substance. The district court also concluded that the penalties asserted by the IRS did not apply and the Partnerships' operational expenses were deductible. The Government moved the court to reconsider and vacate its summary judgment decision, arguing that the decision was mooted by the bench trial judgment. The court denied this motion. Finally, the court issued an order holding that it had jurisdiction to order a refund to the Partnerships, and that Patterson and Nix could deduct the $250,000 management fee paid to their accountants.

The Government appeals the district court's partial summary judgment in favor of the Partnerships, arguing that the "loan premiums" constitute liabilities under § 752. The Government also argues that the Partnerships are liable for penalties, that operating expenses and fees may not be deducted, and that the district court lacked jurisdiction to order a refund to the Partnerships. The Partnerships cross-appeal the district court's bench trial judgment, arguing that the loan transactions had economic substance.


II


We review the district court's grant of summary judgment de novo, applying the same standard as the district court. Kornman & Assocs. v. United States, 527 F.3d 443, 450 (5th Cir. 2008). On appeal from a bench trial, we review findings of fact for clear error and legal issues de novo. Houston Exploration Co. v. Halliburton Energy Servs., Inc., 359 F.3d 777, 779 (5th Cir. 2004). Specifically, we have held that a district court's characterization of a transaction for tax purposes is a question of law subject to de novo review, but the particular facts from which that characterization is made are reviewed for clear error. See Compaq Computer Corp. and Subsidiaries v. Comm'r, 277 F.3d 778, 780 (5th Cir. 2001) (citing Frank Lyon Co. v. United States, 435 U.S. 561, 581 n.16 (1978)).


III


We first consider the Partnerships' cross-appeal, namely whether the district court erred in determining that the loan transactions lacked economic substance and must be disregarded for tax purposes.

The economic substance doctrine allows courts to enforce the legislative purpose of the Code by preventing taxpayers from reaping tax benefits from transactions lacking in economic reality. See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1353-54 (Fed. Cir. 2006). As the Supreme Court has recognized, taxpayers have the right to decrease or avoid taxes by legally permissible means. See Gregory v. Helvering, 293 U.S. 465, 469 (1935). However,"transactions[ ] which do not vary control or change the flow of economic benefits[ ] are to be dismissed from consideration." See Higgins v. Smith, 308 U.S. 473, 476 (1940). In a more recent pronouncement, the Supreme Court held that "[w]here ... there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties." Frank Lyon, 435 U.S. at 583-84.

The law regarding whether a transaction should be disregarded as lacking economic reality is somewhat unsettled in the Fifth Circuit, and a split exists among other Circuits. The Fourth Circuit applies a rigid two-prong test, where a transaction will only be invalidated if it lacks economic substance and the taxpayer's sole motive is tax avoidance. See Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91-92 (4th Cir. 1985). The majority view, however, is that a lack of economic substance is sufficient to invalidate the transaction regardless of whether the taxpayer has motives other than tax avoidance. See, e.g., Coltec, 454 F.3d at 1355; United Parcel Serv. of Am., Inc. v. Comm'r, 254 F.3d 1014, 1018 (11th Cir. 2001); ACM Partnership v. Comm'r, 157 F.3d 231, 247 (3d Cir. 1998); James v. Comm'r, 899 F.2d 905, 908-09 (10th Cir. 1990). We have previously declined to explicitly adopt either approach. See Compaq, 277 F.3d at 781-82 (finding that the transaction in question had both economic substance and a legitimate business purpose, so it would be recognized for tax purposes under either the minority or majority approach).

We conclude that the majority view more accurately interprets the Supreme Court's prescript in Frank Lyon. The Court essentially set up a multifactor test for when a transaction must be honored as legitimate for tax purposes, with factors including whether the transaction (1) has economic substance compelled by business or regulatory realities, (2) is imbued with taxindependent considerations, and (3) is not shaped totally by tax-avoidance features. See Frank Lyon, 435 U.S. at 583-84. Importantly, these factors are phrased in the conjunctive, meaning that the absence of any one of them will render the transaction void for tax purposes. Thus, if a transaction lacks economic substance compelled by business or regulatory realities, the transaction must be disregarded even if the taxpayers profess a genuine business purpose without tax-avoidance motivations.

The following facts found by the district court are critical to this issue: Presidio and NatWest understood that the transactions would not last beyond Stage I, despite the purported seven-year term --meaning that the high risk foreign currency transactions were never intended to occur. If the investors failed to withdraw voluntarily, NatWest could use economic pressure to force them out because the credit agreements required the borrowers to maintain collateral on deposit at NatWest that exceeded the value of the maximum obligations owed to the bank by some varying amount. At the time the loans were issued, this amount was at least 101.25% of the total $66.7 million. NatWest had the discretion to determine whether the ratio was satisfied and could accelerate the ratio to declare a default if the bank wished to force an investor to withdraw. This requirement also meant that none of the $66.7 million loan could ever be used for investments --it had to stay in the accounts at NatWest. NatWest and Presidio understood that the bank would hold the money in relatively risk-free time deposits. Presidio's management fee was calculated as a percentage of the tax losses generated by the investment plan. The district court determined, however, that Patterson and Nix pursued the transactions with a genuine profit motive and were not solely driven by the desire to avoid taxes.

Here, the evidence supports the district court's conclusion that the loan transactions lacked economic substance. Numerous bank documents stated that despite the purported seven-year term, the loans would only be outstanding for about 70 days. NatWest's profit in the loan transactions was calculated based on a 72-day period. In the event that the investors wanted to remain with the plan beyond 72 days, NatWest would force them out. The bank noted in an internal memo that it "had no legal or moral obligation to deal [with the investors] after Day 60." During that 60- to 70-day window the loan funds could not be used to facilitate the investment strategy that Presidio designed. The requirement of keeping at least 101.25% of the $66.7 million in the NatWest account meant, as the Government's expert testified, that the Partnerships could not make any investments without supplying their own funds in excess of the loan amount.

The Partnerships contend that the loan funds were critical to the high-risk foreign currency transactions even if the funding amount could not be spent because the money provided the necessary security for the high-risk transactions. However, the structure of the plan shows that these high-risk transactions could not occur until Stage III, which was never intended to be reached. As the district court found, NatWest would force the investors out long before Stage III, so the loan transactions served no real purpose beyond creating a massive tax benefit for Nix and Patterson.

The Partnerships further argue that the loan transactions had a reasonable possibility of profit, as evidenced by the fact that two small, low-risk investments were actually made in foreign currencies. However, these investments were made using the $1.5 million that Patterson and Nix contributed to the Partnerships, not the funding amounts of the loans. Various courts have held that when applying the economic substance doctrine, the proper focus is on the particular transaction that gives rise to the tax benefit, not collateral transactions that do not produce tax benefits. See Coltec, 454 F.3d at 1356-57; Nicole Rose Corp. v. Comm'r, 320 F.3d 282, 284 (2d Cir. 2002). Here, the transactions that provided the tax benefits at issue were the loans from NatWest. Therefore, the proper focus is on whether the loan transactions presented a reasonable possibility of profit, not whether the capital contributions from Patterson and Nix could have produced a profit. The loan transactions could never have been profitable because the funding amount could not actually be used for investments, and the high-risk investments for which the funding amount might have provided security were never intended to occur.

The evidence clearly shows that Presidio and NatWest designed the loan transactions and the investment strategy so that no reasonable possibility of profit existed and so that the funding amount would create massive tax benefits but would never actually be at risk. Regardless of Patterson and Nix's desire to make money, they entered into transactions controlled by Presidio and NatWest that were not structured or implemented to make a profit. This particular situation highlights the logic of following the majority approach to the economic substance doctrine, because the minority approach would allow tax benefits to flow from transactions totally lacking in economic substance as long as the taxpayers offered some conceivable profit motive. In cases such as the instant one, this approach would essentially reward a "head in the sand" defense where taxpayers can profess a profit motive but agree to a scheme structured and controlled by parties with the sole purpose of achieving tax benefits for them. We therefore agree with the district court that since the loan transactions lacked economic substance, they must be disregarded for tax purposes.


IV


Next we consider the Government's appeal, namely whether the district court properly granted the Partnerships' motion for partial summary judgment, declined to impose various penalties on the Partnerships, allowed the Partnerships to deduct operational expenses and fees, and ordered a refund.


A


The Government argues that the district court erred in granting the Partnership's motion for partial summary judgment, determining that the loan premiums were not liabilities for purposes of § 752. The Government states in its brief that they are appealing this issue "as a protective matter, due to possible collateral estoppel implications" in several lawsuits pending against Presidio in California.

Despite this adverse summary judgment ruling, the Government ultimately prevailed at trial on economic substance grounds and received the relief it requested when the loan transactions were disregarded for tax purposes. As a general matter, a party who is not aggrieved by a judgment does not have standing to appeal it. See Ward v. Santa Fe Indep. Sch. Dist., 393 F.3d 599, 603 (5th Cir. 2004). In some situations, adverse collateral estoppel implications may show that a party is aggrieved by a particular ruling. See In re DES Litig., 7 F.3d 20, 23 (5th Cir. 1993). However, an interlocutory ruling will only have collateral estoppel effect in subsequent litigation if the ultimate judgment in the case was dependent upon the interlocutory ruling. Id. (finding that a prevailing party had no standing to appeal adverse interlocutory rulings, regarding jurisdiction and choice of law, because the ultimate judgment in the case was not dependent on those rulings). Accordingly, where a party who ultimately prevails in a case attempts to show they have standing to appeal an earlier adverse ruling by arguing that the earlier ruling could have collateral estoppel effect in other pending cases, standing will only exist where the ultimate judgment in the case was "dependent" on the earlier adverse ruling. Id.

Here, the district court's summary judgment ruling has no collateral estoppel effect. The judgment following the bench trial was entirely based on the district court's conclusion that the loan transactions lacked economic substance and must be disregarded for tax purposes. This determination was totally independent of the partial summary judgment ruling that the loan premiums were not liabilities under § 752. Though the Government further argues that "[i]t could be concluded that [it] is aggrieved by the [summary] judgment [ruling] to the extent it played a part in the District Court's rejection of the IRS's imposition of penalties," we conclude that the district court's penalty decision was likewise not dependent on the partial summary judgment determination. Therefore, we hold that the Government lacks standing to appeal the district court's partial summary judgment ruling that neither § 752 nor Treas. Reg. § 1.752-6 operates to eliminate the claimed tax benefits arising from the Partnerships' participation in the loan transactions.


B


The Government also appeals the district court's ruling that no penalties may be imposed on the Partnerships. 3 The district court found that the Partnerships' actions did not meet the statutory requirements for imposition of the penalties, and that even if they were met, none of these penalties apply because the Partnerships acted in good faith and with reasonable cause. Specifically, the Government argues that the district court erred in finding that the Partnerships' actions did not meet the statutory requirements for the imposition of penalties, and that the district court lacked jurisdiction to consider the reasonable cause and good faith defenses. Since the issue of whether the Partnerships' conduct met the requirements for the penalties is moot if the district court had jurisdiction to consider the reasonable cause and good faith defenses, we first consider the jurisdictional issue.

This issue is governed by the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), 26 U.S.C. § § 6221-6233. Under TEFRA, "the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level." 26 U.S.C. § 6221. TEFRA specifically sets forth the scope of judicial review:
A court with which a petition is filed in accordance with this section shall have jurisdiction to determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates; the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.

26 U.S.C. § 6226(f) (emphasis added). This provision clearly grants the district court jurisdiction to determine the applicability of any penalty relating to an adjustment of a partnership item. The Code also makes clear that if a taxpayer acts in good faith and with reasonable cause in the calculation of his or her taxes, penalties may not be applied: "[n]o penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion." 26 U.S.C. § 6664(c)(1).

The Government argues that the district court lacked jurisdiction to consider the reasonable cause and good faith defense because the court's jurisdiction in a TEFRA proceeding is limited to assessment of partnership-level items. Here, the Government claims, reasonable cause and good faith is a partner-level defense that can only be asserted in separate refund proceedings. To support this argument, the Government cites Temporary Treasury Regulation § 301.6221-1T, which states that assessment of penalties or any addition to tax related to partnership items is determined at the partnership level, and "[p]artner-level defenses to any penalty, addition to tax, or additional amount that relates to an adjustment to a partnership item may not be asserted in the partnership-level proceeding, but may be asserted through separate refund actions following assessment and payment." Temp. Treas. Reg. § 301.6221-1T(c)-(d) (1999). 4 The regulation defines partner-level defenses as "those that are personal to the partner or are dependent upon the partner's separate return and cannot be determined at the partnership level ... [including] ... whether the partner has met the criteria of ... section 6664(c)(1) (reasonable cause exception)." Temp. Treas. Reg. § 301.6221-1T(d).

The TEFRA structure enacted by Congress does not permit a partner to raise an individual defense during a partnership-level proceeding, but when considering the determination of penalties at the partnership level the court may consider the defenses of the partnership. See New Millennium Trading, LLC v. Comm'r, 131 T.C. No. 18, 2008 WL 5330940 at * 7 (2008). Though Temp. Treas. Reg. § 301.6221-1T(d) lists the reasonable cause exception as an example of a partner-level defense, it does not indicate that reasonable cause and good faith may never be considered at the partnership level. Several courts have found that a reasonable cause and good faith defense may be considered during partnership-level proceedings if the defense is presented on behalf of the partnership. See Santa Monica Pictures v. Comm'r, 89 T.C.M. 1157, 1229-30 (2005) (considering the reasonable cause and good faith defense asserted by the partnership to determine whether accuracy-related penalties should apply); See also Stobie Creek Investments, LLC v. United States, 82 Fed. Cl. 636, 703-04, 717-21 (2008) (considering the reasonable cause defense at the partnership level). Here, reasonable cause and good faith were asserted on behalf of Klamath and Kinabalu, by the current managing partners. Accordingly, we hold that the district court did not err in considering the defenses.

The plaintiff bears the burden of proof on a reasonable cause defense. See Montgomery v. Comm'r, 127 T.C. 43, 66 (2006). The most important factor is the extent of the taxpayer's effort to assess his proper liability in light of all the circumstances. Treas. Reg. § 1.6664-4(b). Reliance on the advice of a professional tax adviser does not necessarily demonstrate reasonable cause and good faith; rather, the validity of this reliance turns on "the quality and objectivity of the professional advice which they obtained." Swayze v. United States, 785 F.2d 715, 719 (9th Cir. 1986). The district court found that Patterson and Nix sought legal advice from qualified accountants and tax attorneys concerning the legal implications of their investments and the resulting tax deductions. They hired attorneys to write a detailed tax opinion, providing the attorneys with access to all relevant transactional documents. This tax opinion concluded that the tax treatment at issue complied with reasonable interpretations of the tax laws. At trial, the Partnerships' tax expert concluded that the opinion complied with standards established by Treasury Circular 230, which addresses conduct of practitioners who provide tax opinions. Overall, the district court found that the Partnerships proved by a preponderance of the evidence that they relied in good faith on the advice of qualified accountants and tax lawyers.

The Government argues only that the district court lacked jurisdiction to consider the reasonable cause and good faith defense; it has not alleged error in the substance of the district court's finding that Patterson and Nix acted with reasonable cause and in good faith. Therefore, having concluded that the district court had jurisdiction to consider this defense, we affirm the district court's conclusion that no penalties should apply.


C


The Government also appeals the district court's order that the Partnerships may deduct "operational expenses" associated with the loan and foreign currency transactions. These operational expenses include interest on the loans, a breakage fee, a management fee paid to Presidio, and a $250,000 fee paid to Pollans & Cohen. 5 The Government argues that the district court erred because no deduction may be taken for expenses related to a sham transaction.

The Code governs the deductibility of actual economic expenditures. Although the district court did not specify the provision under which the operating expenses are deductible, the Partnerships argue that they are entitled to the deductions under 26 U.S.C. §§ 163, 165(c)(2), and 212. Section 163 governs the deductibility of interest expenses, stating generally that "[t]here shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness." 26 U.S.C. § 163(a). Under § 165, deductions are permitted for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." 26 U.S.C. § 165(a). Particularly, deductions for losses of individuals are limited to "losses incurred in any transaction entered into for profit ...." 26 U.S.C. § 165(c)(2). Section 212 allows deductions for "all the ordinary and necessary expenses paid or incurred during the taxable year [ ] for the production or collection of income." 26 U.S.C. § 212.

Generally, when a transaction is disregarded for lack of economic substance, deductions for costs expended in furtherance of the transaction are prohibited. See Winn-Dixie Stores, Inc. v. Comm'r, 113 T.C. 254, 294 (1999) (observing that "a transaction that lacks economic substance is not recognized for Federal tax purposes" and that "denial of recognition means that such a transaction cannot be the basis for a deductible expense") ; see also Salley v. Comm'r, 464 F.2d 479, 483 (5th Cir. 1972); Lerman v. Comm'r, 939 F.2d 44, 45 (3d Cir. 1991); Kirchman v. Comm'r, 862 F.2d 1486, 1490 (11th Cir. 1989). This makes sense in light of the fact that the effect of disregarding a transaction for lack of economic substance is that, for taxation purposes, the transaction is viewed to have never occurred at all. 6 Courts have determined that they may not disregard a transaction for some purposes but not for others. See ACM P'ship, 157 F.3d at 261 (observing that "we are not aware of any cases applying the economic substance doctrine selectively to recognize the consequences of a taxpayer's actions for some tax purposes but not others"). This also supports the idea that a transaction may not be disregarded under the economic substance doctrine for purposes of determining a partner's tax basis in a partnership, yet still support the deduction of operational expenses and fees. However, courts have upheld deductions based on genuine debts, where the debts are elements of a transaction that overall is lacking in economic substance. See Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 95-96 (4th Cir. 1985) (allowing deductions based on recourse note debt that was an element of a sham purchase transaction, because the notes represented actual indebtedness).

Here, the district court concluded that the interest payments were deductible because they were real economic losses. However, § 163 does not base the deductibility of interest on whether or not the interest paid was a real economic loss. Rather, the test is simply whether the interest was paid or accrued on indebtedness. See Salley, 464 F.2d at 485 (disallowing interest deductions under § 163 because the taxpayers did not take on actual indebtedness: "[i]n no sense can it be said that taxpayers paid any interest ... as compensation for the use or forbearance of money ... which is the standard business test of indebtedness") (internal quotations and citation omitted). Further, "the fact that an enforceable debt exists between the borrower and lender is not dispositive of whether interest arising from that debt is deductible under section 163." Winn-Dixie Stores, 113 T.C. at 279. The overall transaction must have economic substance in order to show genuine indebtedness, otherwise "every tax shelter ... could qualify for an interest expense deduction as long as there was a real creditor in the transaction that demanded repayment." Id.

In concluding that the loan transactions in this case lacked economic substance, the district court found that "[i]n truth, NatWest did not make any loans" and "[t]he loans ... were not loans at all." These findings preclude the conclusion that the Partnerships took on actual indebtedness. As we found above, the loan transactions in this case lacked economic substance partly because they were structured such that the Partnerships could never actually spend the loaned funds --101.25% of the funding amount had to stay in the accounts at NatWest to prevent a default. Therefore, despite the appearance of a loan, functionally the Partnerships never took on any actual debt. Since the loans did not constitute indebtedness, the Partnerships may not deduct the interest paid under § 163. 7

Presumably, though not specified, the district court found the remainder of the operating expenses and fees deductible under § 212 as necessary expenses incurred. This provision requires a profit motive. See Agro Science, 934 F.2d at 576 (noting that an expenditure is deductible under § 212 "only ... if the facts and circumstances indicate that the taxpayer made them primarily in furtherance of a bona fide profit objective independent of tax consequences"). The Government argues that the profit motive must be determined based on Presidio's subjective intentions because Presidio acted as managing partner when the transactions occurred. The district court, however, determined that the proper focus is on the motives of Patterson and Nix. Having concluded that Patterson and Nix entered into the transactions genuinely seeking to make a profit, the district court allowed the deductions.

The profit motive of a partnership is determined at the partnership level. Id.; Simon v. Comm'r, 830 F.2d 499, 507 (3d Cir. 1987). We have previously observed that the "testimony of general partners and promoters taken as a whole is relevant in determining a partnership's profit motive, because these individuals control a partnership's activities." Agro Science, 934 F.2d at 576 (internal citations omitted). Here, the district court concluded that the partners had different motivations: Nix and Patterson at all times pursued the investment strategy with a genuine profit motive, while Presidio's primary intent was to achieve a tax benefit. The crucial inquiry, then is which partner's intentions should be attributed to the Partnership. Under Agro Science, this answer depends on which partner effectively controlled the partnership's activities. Id.; Simon, 830 F.2d at 507 (observing that "a determination of [a partnership's] profit objective can only be made with reference to the actions of those ... who manage the partnership affairs").

During the time of the transactions in question, Presidio acted as the managing partner but had less than 10% ownership of Klamath and Kinabalu. Patterson and Nix each had 90% ownership. After reforming the Partnerships to bring this lawsuit they became managing partners. Though Patterson and Nix were never limited partners, the LLC agreements state that "the overall management and control of the business and affairs of the Company shall be vested solely in the Managing Member." The district court, however, did not analyze which partner retained control over the partnership. The district court appears to have concluded, with little explanation, that Patterson and Nix's motives must be attributed to the Partnerships because they paid the expenses at issue here and reported them on their individual tax returns. 8 However, for purposes of determining the deductibility of expenses it is the motive of the Partnership that matters, regardless of whether certain operating expenses were borne by one partner or another. None of the arguments articulated by the Partnerships or the district court persuade us that the motives of Patterson and Nix, to whom the overall control and management of the Partnerships was expressly denied under the LLC agreements, should be attributed to the Partnerships. We therefore hold that the district court erred as a matter of law by failing to consider which partners effectively controlled the management of the Partnerships' affairs, at the time the transactions occurred, in determining whether the operating expenses and fees are deductible.


D


We turn now to the Government's argument that the district court lacked jurisdiction to order a refund.

The district court based its authority to order the refund on its jurisdiction to order readjustment of partnership items, see 26 U.S.C. § 6226(f), and the Code provision stating that a partner should not have to file a claim for a refund following this readjustment. See 26 U.S.C. § 6230(d)(5) ("any overpayment by a partner which is attributable to a partnership item (or an affected item) and which may be refunded under this subchapter [26 U.S.C. §§ 6221 et seq.], to the extent practicable credit or refund of such overpayment shall be allowed or made without any requirement that the partner file a claim therefor"). The district court interpreted this provision to mean that it may order a refund following a readjustment of partnership items under § 6226, since the refund is permitted without the taxpayers filing a claim.

The Government argues, however, that the Code imposes a strict "exhaustion of administrative remedies" jurisdictional prerequisite with respect to tax refund actions, and that nothing in the Code grants the district court the authority to eliminate this prerequisite by ordering a refund as part of readjustment proceedings under § 6226. As the Government contends, § 6230(d)(5) only grants the IRS the authority to provide a refund attributable to partnership items without requiring the party to file a claim first --it does not expand the district court's specifically defined jurisdiction to include the authority to order a refund.

We have not previously confronted this question, and the few cases available reach mixed conclusions. The Government cites an unpublished opinion from the Ninth Circuit holding that "a district court does not have jurisdiction to order a refund in an action brought pursuant to 26 U.S.C. § 6226." See Gold Coast Hotel and Casino v. United States, 139 F.3d 904, 1998 WL 74991, at *2 (9th Cir. 1998) (unpublished). Another court has ordered refunds in a § 6226 action, though it did not explain its jurisdictional basis for doing so, and the Second Circuit reversed on appeal such that no refund was ultimately awarded. See TIFD III-E Inc. v. United States, 342 F. Supp. 2d 94, 121-22 (D. Conn. 2004), rev'd on other grounds, 459 F.3d 220 (2d Cir. 2006).

We conclude that the Code does not grant the district jurisdiction to order a refund in a readjustment action brought pursuant to § 6226. This provision specifically sets forth the scope of the district court's jurisdiction in readjustment proceedings. See § 6226(f). Though the provision specifies the district court's jurisdiction to determine partnership items, allocate those items to individual partners, and apply penalties, taxes, or additional amounts, it does not grant jurisdiction to order a refund.

Generally, no suit or proceeding may be maintained for the recovery of a refund "until a claim for refund or credit has been duly filed with the Secretary ...." See § 7422(a). Section 7422(h) provides a special rule for refund actions with respect to partnership items: "No action may be brought for a refund attributable to partnership items ... except as provided in section 6228(b) or section 6230(c)." The applicable provision here, § 6230(c), does not grant refund authority to the district court; rather, it sets forth the grounds on which a partner of a TEFRA partnership may file an administrative refund claim following a final partnership administrative adjustment. Specifically, a partner may file a claim for refund on the grounds that (1) the Secretary failed to allow a credit or to make a refund to the partner in the amount of the overpayment attributable to the application to the partner of a settlement, a final partnership administrative adjustment, or the decision of a court in an action brought under § 6226, or (2) the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item. See § 6230(c)(1)(B)-(C).

We agree with the Government that the provision upon which the district court based its jurisdiction, § 6230(d)(5), merely contemplates that "to the extent practicable" the IRS may grant a refund for an overpayment attributable to partnership items without any requirement that the partner file an administrative claim. Nothing in § 6230(d)(5) authorizes the district court to grant a refund pursuant to readjustment proceedings under § 6226, and it would be unreasonable to conclude that this provision --which is not referenced in § 6226(f) and is placed under the heading "Additional administrative proceedings" --alters the clearly defined limits of a district court's jurisdiction in readjustment proceedings.

We accordingly hold that the district court was without jurisdiction to order a refund. The Partnerships may seek a refund through administrative proceedings, as governed by § 7422.


V


For the foregoing reasons, we AFFIRM the district court's judgment that the loan transactions lacked economic substance and must be disregarded for tax purposes. We also AFFIRM the district court's judgment that no penalties apply. We VACATE the district court's order allowing the deduction of interest and operating expenses and REMAND for reconsideration in accordance with this opinion. We also VACATE the district court's order directing the IRS to grant the Partnerships a refund.

1 These rules are defined in 26 U.S.C. § 752 et seq. of the Internal Revenue Code, described more fully below.

2 Specifically, the losses occurred from the following. Patterson received 67,341.88 Euros when Klamath liquidated. He treated these Euros as having a tax basis of $25,316,393, calculated as:
Premium amount 25,000,000
Cash contributions 1,500,000
Interest income 91,307
Advisory fee to Pollans & Cohen 250,000
Cash distributions from Klamath (359,635)
Klamath partnership loss (1,165,279)
_________________________
Basis 25,316,393


This meant that since Patterson was able to treat the loan premium as money he had put into the partnership (i.e. not a liability that the partnership had to repay), he could claim a tax basis of $365.94 in each Euro he received from Klamath. When he sold the Euros for much less than this amount, large losses were created. Nix's basis calculation was nearly identical.

3 In the FPAAs, the IRS asserted four penalties against the Partnerships, all based on § 6662 of the Code: (1) a 40% penalty for gross valuation misstatement; (2) a 20% penalty for substantial valuation misstatement; (3) a 20% penalty for substantial understatement of income tax; and (4) a 20% penalty for negligence or disregard of rules and regulations. See 26 U.S.C. § 6662(a), (b)(1), (2), (3).

4 This regulation was temporary for the taxable years at issue. See Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999). However, it was made final and applicable to partnership taxable years beginning on or after Oct. 4, 2001. See § 301.6221-1(f), Proced. & Admin. Regs.

5 The Government concedes the deductibility of the trading losses suffered by the Partnerships in the foreign currency transactions.

6 The Partnerships rely extensively on Fabreeka Prods. Co. v. Comm'r, 34 T.C. 290, 299-300 (1960), vacated on other grounds by 294 F.2d 876 (1st Cir. 1961), for the proposition that operational expenses incurred in connection with a sham transaction may be deducted as long as they are "separable" from the underlying transaction. To the extent that this proposition can be supported by the since-vacated opinion in Fabreeka, we conclude that the Tax Court has subsequently failed to follow Fabreeka's approach to the deduction of operational expenses, and has instead maintained that expenses incurred in connection with a sham transaction are generally not deductible. See Winn-Dixie, 113 T.C. at 294 (finding that administrative fees "were incurred in connection with, and were an integral part of, a sham transaction and, as a result, were not deductible").

7 The Partnerships may likewise not deduct interest under other provisions of the Code as a business expense or an expense paid for the production of income. See Salley, 464 F.2d at 483 (noting that if lack of economic substance prevents the deduction of interest under § 163, the interest is likewise not deductible under §§ 162(a) or 212).

8 In its brief, the Government contends that it was the Partnerships that paid the expenses, citing to Plaintiff's Exhibits 49, 50, 142, and 143. Since these exhibits have apparently not made it into the record on appeal, and have not been able to be obtained from the district court, we cannot verify the Government's contention. Nonetheless, whether it was an individual partner or the Partnership that paid the expenses is not dispositive of the issue of who effectively controlled the Partnerships' activities, and we conclude that the district court erred in relying on this fact to allow the deductions.

United States of America, Plaintiff v. Darrell L. Kadunce, Defendant.

U.S. District Court, West. Dist. Pa.; Civ. 07-1704, USTC October 20, 2008.

[Code Secs. 7122 and 7401]

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. The individual's claim that the IRS had selectively prosecuted the action against him was rejected because he did not provide evidence that the government had singled him out for prosecution. The individual also did not show that the decision to prosecute was made on the basis of an unjustifiable standard or that the prosecution was intended to prevent his exericse of a fundamental right. Furthermore, because the individual did not timely appeal the denial of his offer in compromise to the IRS Office of Appeals, he could not later request a review of that denial in the district court.

Procedure. --Compromises: Procedure

The IRS has released procedures applicable to the submission and processing of offers to compromise a tax liability under Code Sec. 7122. The procedures reflect IRS imposition of an offer in compromise application fee, effective November 1, 2003.
[Full Text --Rev. Proc. 2003-71]




SECTION 1. PURPOSE

The purpose of this revenue procedure is to explain the procedures applicable to the submission and processing of offers to compromise a tax liability under section 7122 of the Internal Revenue Code. These procedures reflect changes to the law made by the Internal Revenue Service Restructuring and Reform Act of 1998, Public Law 105-206 (112 Stat. 685, 764).



SECTION 2. BACKGROUND

.01 Section 7122 permits the Secretary of the Treasury or his delegate to compromise any civil or criminal liability arising under the internal revenue laws before the case is referred to the Department of Justice for prosecution or defense.

.02 The Secretary has developed guidelines and procedures for the submission and evaluation of offers to compromise under section 7122. These guidelines can be found in § 301.7122-1 of the Regulations on Procedure and Administration, the Internal Revenue Manual, and various forms and publications issued by the Internal Revenue Service (Service). This revenue procedure supplements and clarifies the procedures identified in § 301.7122-1.

.03 This revenue procedure includes provisions relating to the offer in compromise application fee, required under § 300.3 of the Regulations on User Fees and effective November 1, 2003.



SECTION 3. SCOPE

This revenue procedure applies to all offers to compromise a civil or criminal liability under section 7122 submitted to the Service, except for those offers submitted directly to the Office of Appeals. This revenue procedure does not apply to offers to compromise a tax liability after a case involving a civil or criminal liability has been referred to the Department of Justice for prosecution or defense.



SECTION 4. SUBMITTING AN OFFER TO COMPROMISE

.01 An offer to compromise a tax liability must be submitted in writing on the Service's Form 656, Offer in Compromise. None of the standard terms may be stricken or altered, and the form must be signed under penalty of perjury. The offer should include all liabilities to be covered by the compromise, the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms. Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656. The Service occasionally revises Form 656 and may require offers to be submitted on the most recent version of the form. The most recent version of the form and instructions are available on the Service's website at www.irs.gov.

.02 An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies.

(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 of the liability.

An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer's assets and income cannot satisfy the full amount of the liability.

An offer to compromise based on doubt as to collectibility generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer's reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.

(3) Promotion of effective tax administration.

(a) The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer's individual facts and circumstances.

(b) If there are no other grounds for compromise, the Service 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. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.

.03 The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.

.04 An offer to compromise a tax liability should be mailed to the appropriate address listed on Form 656. The Service may, in its discretion, receive offers to compromise in other manners. Simply because the Service has received an offer does not mean that it has accepted the offer for processing such that the offer is considered pending within the meaning of section 6331(k)(1). Accepting an offer for processing is addressed in Section 5.01 of this revenue procedure.

.05 If a deposit is submitted with the offer to compromise and the taxpayer authorizes application of a deposit to tax liabilities, it will be credited to the taxpayer's account as of the day the deposit is first received.



SECTION 5. WHEN AN OFFER BECOMES PENDING AND RETURN OF OFFERS

.01 Section 6331(k)(1) generally prohibits the Service from making a levy on a taxpayer's property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.

.02 A determination is made to accept an offer to compromise for processing when a Service official with delegated authority to accept an offer for processing signs the Form 656. The date the Service official signs the Form 656 is recorded on the Service's computers. As of this date, levy is prohibited unless the Service determines that collection of the liability is in jeopardy.

.03 If the Service determines that an offer to compromise a liability does not meet the minimum requirements the Service has established for a processable offer, the offer to compromise is not processable and may be returned to the taxpayer. Because the offer to compromise was never accepted for processing, it was never pending and levy was never prohibited.

.04 If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information. These requests for information are described in Section 6 below. If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:

(1) The Service determines that the offer was submitted solely to delay collection;

(2) The taxpayer fails to file a return or pay a liability;

(3) The taxpayer files for bankruptcy;

(4) The offer is no longer processable; or

(5) The offer was accepted for processing in error.

When an offer is returned under this Section 5.04, the Service will not refund the application fee submitted with the offer unless the offer was accepted for processing in error.

.05 If a determination is made to return the offer to compromise as described in Sections 5.03 and 5.04, the return of the offer does not constitute a rejection. The taxpayer is not entitled to appeal the matter to Appeals under the provisions of § 301.7122-1(f)(5). If the Service initiates collection action following a return of an offer to compromise, the taxpayer may be able to appeal the collection action under section 6320, section 6330, or under the Collection Appeals Program.

.06 An offer to compromise is considered to be returned on the day the Service mails, or personally delivers, a written letter to the taxpayer informing the taxpayer of the decision to return the offer. 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 offer is returned. The Service may levy to collect the liability that was the subject of the offer anytime after it returns the offer to the taxpayer.



SECTION 6. CASE BUILDING, INVESTIGATION, AND EVALUATION

.01 Once the Service accepts an offer to compromise for processing, it begins to gather the basic information necessary to begin evaluating the offer. During this initial processing, the Service may contact the taxpayer to secure information or documentation that was incorrect or omitted from the offer documents.

.02 After all of the basic information has been obtained from the taxpayer, the Service evaluates the information and determines whether the taxpayer's offer is acceptable. In the course of evaluating the offer to compromise, the Service may request additional information or documentation from the taxpayer.

.03 The decision whether and when to accept an offer to compromise a liability is within the discretion of the Service. In keeping with Policy Statement P-5-100, an offer will only be accepted if it is determined to be in the best interest of both the taxpayer and the Service. In addition to the criteria discussed in Section 4.02, the Service may take into account public policy and tax administration concerns in determining whether an offer to compromise is acceptable.

.04 For all offers to compromise, except for those based solely on doubt as to liability, the Service verifies the taxpayer's income and assets according to the Service's policies and procedures. Verification allows the Service to determine whether or not the taxpayer can fully pay the liability and, if not, to determine the reasonable collection potential of the liability.

(1) The Service uses a variety of sources to verify the taxpayer's valuation of the taxpayer's property. The Service relies on internal sources, such as its computer databases or other records, public and electronic sources, such as state motor vehicle records and credit bureau reports, and taxpayer supplied documentation.

(2) Section 7122 requires the Service to prescribe and publish guidelines to ensure that taxpayers entering into a compromise have an adequate means to provide for basic living expenses. The amount of basic living expenses will be determined based on an evaluation of the individual facts and circumstances presented by the taxpayer's case. The Service maintains a schedule of national and local allowances to account for the basic living expenses of taxpayers seeking to compromise. To determine whether an offer is adequate, the Service uses these schedules to analyze the income and expenses of the taxpayer to determine the monthly income available to pay the liability. These schedules are available in the Financial Analysis Handbook, IRM 5.15, and on the Service's website at www.irs.gov. The schedules are not applied when doing so would leave the taxpayer without adequate means to provide for basic living expenses.

(3) For purposes of evaluating an offer to compromise, the Service allows expenses only to the extent it determines they are necessary for the health and welfare of the taxpayer or the taxpayer's family or are necessary for the production of income.



SECTION 7. WITHDRAWING AN OFFER TO COMPROMISE

.01 The taxpayer may withdraw an offer to compromise a liability anytime prior to acceptance of the offer. An offer that has been withdrawn is no longer pending and the Service may levy to collect the liability that was the subject of the offer. When an offer is withdrawn the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may withdraw an offer to compromise by delivery of written notification of the withdrawal in person, by mail, or by fax. An offer assigned to Centralized Offer in Compromise Units, however, may not be withdrawn by personal delivery, because documents cannot be personally delivered to these units. A taxpayer may also request withdrawal of an offer telephonically. A notice of intent to withdraw an offer should be directed to the Service office assigned to the case.

(1) If the taxpayer withdraws an offer to compromise by personal delivery, the offer will be considered withdrawn when written notification of the withdrawal is received by the Service.

(2) If the taxpayer withdraws an offer to compromise by mailing written notification of the withdrawal via U.S. certified mail, the offer will be considered withdrawn on the date the Service receives the certified mail.

(3) In all other cases, including withdrawal by non-certified mail, fax, or phone, the offer will be considered withdrawn on the date the Service mails, or personally delivers, a written letter to the taxpayer acknowledging the withdrawal.



SECTION 8. ACCEPTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been accepted until the Service issues written notification of acceptance to the taxpayer. Acceptance is effective as of the date on the acceptance letter.

.02 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 any person not named in the offer who is also liable for the tax to which the offer relates. The Service may take action to collect from any person not named in the offer.



SECTION 9. REJECTING AN OFFER TO COMPROMISE

.01 An offer to compromise has not been rejected until the Service issues written notification of rejection to the taxpayer. Section 7122(d) requires the Service to conduct an independent administrative review before the rejection of an offer to compromise is communicated to the taxpayer. The Service reviews each case to determine if the proposed rejection is reasonable based on the facts and circumstances of the case. Rejection is effective as of the date on the rejection letter. When an offer is rejected the Service will not refund the application fee submitted with the offer.

.02 The taxpayer may appeal the rejection of an offer to compromise to Appeals. The taxpayer must timely file the appeal with the Service office that rejected the offer. An appeal is timely filed if it is delivered to the Service or postmarked within thirty days from the date of the letter of rejection.

.03 Pursuant to section 6331, the Service may not make a levy on the taxpayer's property or rights to property for thirty days following the rejection of an offer to compromise or while an appeal of a rejection is pending.



SECTION 10. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 96-38 is obsoleted.



SECTION 11. EFFECTIVE DATE

This revenue procedure is effective August 21, 2003, the date this revenue procedure was announced by news release, except that the provisions relating to the offer in compromise application fee are not effective for offers submitted prior to November 1, 2003.



SECTION 12. DRAFTING INFORMATION

The principal author of this revenue procedure is Sheara L. Krvaric of the Office of the Associate Chief Counsel (Procedure and Administration), Collection, Bankruptcy & Summonses Division. For further information regarding this revenue procedure contact Branch 2 of Collection, Bankruptcy & Summonses on (202) 622-3620 (not a toll free call).

Rev. Proc. 2003-71, 2003-2 CB 517 , obsoleting Rev. Proc. 96-38, 1996-2 CB 44.

The IRS Commissioner did not abuse his discretion by rejecting a married couple's offer-in-compromise based on economic hardship and exceptional circumstances. The couple's considerable accumulation of wealth and the speculative nature of their medical expenses did not support their argument that medical expenses for the husband's progressive dementia would bankrupt them in about a decade. The couple's ability to pay basic living expenses would not be impaired by significantly greater health care expenses. Further, the legislative history did not support the conclusion that denial of the offer was an abuse of discretion nor was the IRS Appeals officer required to negotiate with the couple on their offer.

C.G. Fargo, CA-9, 2006-1 USTC ¶50,326, 447 F3d 706.

Followed.

The IRS was not arbitrary and capricious when it rejected an offer in compromise made with respect to a deficiency arising from the taxpayers' participation in a Hoyt partnership. The IRS properly followed its guidelines when it determined that the taxpayers' offer did not qualify as an offer to promote effective tax administration because the taxpayers did not have sufficient assets to pay the full amount of their liability; and that the offer was too low, in relation to the deficiency and to the taxpayers' assets, to qualify as an offer due to doubts as to collectibility with special circumstances. The taxpayers' case was not a "longstanding" case that was entitled to special treatment with respect to interest and penalties; C.G. Fargo, CA-9, 2006-1 USTC ¶50,326, 447 F3d 706, followed. The IRS Appeals Officer who rejected the offer did not fail to consider the taxpayers' alleged unique circumstances; fail to balance efficient collection against the use of the least intrusive means possible; or fail to consider their request to abate interest. She was not required to discuss her decision with the taxpayers before she issued her notice of determination. The taxpayers failed to support their claim that they would suffer severe economic hardship if they had to pay more than the offered amount. Their claim that they were the victims of fraud did not obligate the IRS to accept their offer based on public policy, especially since acceptance would tend to undermine voluntary tax compliance. Finally, the taxpayers' claim that their assessment was untimely was frivolous.

R.D. Catlow, 93 TCM 946, Dec. 56,850(M), TC Memo. 2007-47.

The IRS did not abuse its discretion when it rejected a delinquent corporation's proposed offer in compromise. An IRS agent properly considered the taxpayer's other tax liabilities in assessing its ability to pay its federal liabilities, and she did not abuse her discretion when she concluded that the taxpayer did not demonstrate the ability to make the payments proposed in the offer, despite its improving financial condition.

Action Employment Resources, Inc., CA-9, 2006-1 USTC ¶50,130, 158 FedAppx 67.

The trial court properly determined that the IRS did not abuse its discretion when it attempted to collect unpaid employment taxes and penalties owed by an individual through the levy process. Although the taxpayer filed a formal offer in compromise to settle his tax liability, he did not supply the financial information that the IRS requested and believed necessary to evaluate the offer in compromise. The IRS was also justified in requesting financial information about the taxpayer's spouse since it appeared that the taxpayer may have transferred some of his assets to his spouse and since the IRS needed to verify each spouse's responsibility for the couple's living expenses. Further, the IRS's failure to negotiate and make a counteroffer during consideration of the compromise offer did not violate the taxpayer's due process rights since the taxpayer did not provide requested financial information.

R.E. Olsen, CA-1, 2005-2 USTC ¶50,637, 414 F3d 144.

An individual could not overcome the government's motion for summary judgment on his claim that an IRS Appeals officer was not aware of the taxpayer's "separate property" contention with respect to levied property. The officer's decision to proceed with collection was based on the taxpayer's failure to make an offer in compromise. That the Appeals officer insisted on the filing of returns for the tax years at issue as a condition for processing and considering an offer in compromise did not create a genuine issue of material fact as to whether the IRS abused its discretion in issuing notice of determination. The taxpayer was charged with the knowledge that the officer's oral representations were not binding, and that a written offer was necessary.

A. Richter, DC Calif., 2002-2 USTC ¶50,607.

The IRS was entitled to reject married taxpayers' offer in compromise of their tax liability because under Code Sec. 7122 it has discretion as to whether it will accept such an offer.

A.C. Addington, DC W.Va., 99-1 USTC ¶50,441.

The IRS Appeals Office did not abuse its discretion by rejecting a married couple's offer-in-compromise where the taxpayers had underreported their income for several tax years due to claimed losses and credits from Hoyt partnership tax shelter investments. The taxpayers argued that their offer should have been accepted because of their age, health and anticipated postretirement earnings. However, the court found that the taxpayers failed to show that payment of more than they offered would render them unable to meet their basis living expenses in retirement.

R. Bergevin, 95 TCM 1031, Dec. 57,307(M) , TC Memo. 2008-6.

A taxpayer and his late wife's estate failed to establish that the IRS abused its discretion by refusing to grant them additional time to submit an offer in compromise (OIC) because the Commissioner is not required to wait a certain length of time before proceeding with a levy. The IRS also did not abuse its discretion in proceeding with a levy because the taxpayers repeatedly delayed the proceedings and failed to remit the necessary financial information required for an installment agreement or OIC.

M.A. Gazi, 94 TCM 474, Dec. 57,176(M), TC Memo. 2007-342.

The IRS Appeals Office did not abuse its discretion in rejecting a married couple's offer-in-compromise where the taxpayers had underreported their income for several tax years due to claimed losses and credits from Hoyt partnership tax shelter investments. The IRS Appeals officer considered all of the evidence submitted, and reasonably applied the guidelines for evaluating an offer-in-compromise. The offer was unacceptable because, among other reasons, the taxpayers were not forthcoming in establishing their financial status, acceptance of the offer would undermine compliance with the tax laws by taxpayers in general, and the taxpayers had the financial wherewithal to pay more than the offered amount. The officer adequately considered the taxpayers' unique facts and circumstances, and the taxpayers did not show that requiring them to pay more than the offer amount would result in an economic hardship. Public policy did not demand that the taxpayers' offer be accepted because they were victims of fraud, and acceptance of the offer would not enhance voluntary compliance by other taxpayers.

M. Smith, 93 TCM 1047, Dec. 56,880(M), TC Memo. 2007-73.

The IRS did not abuse its discretion when it rejected an elderly couple's compromise offer that amounted to less than half of their estimated tax liability. The IRS was not required to compromise the couple's tax liability in order to promote effective tax administration based on economic hardship or public policy or equity grounds because the taxpayers were able to pay more than the amount that they offered. The IRS determined that the taxpayers had sufficient equity in their assets to pay the tax amounts owed and still meet their necessary living expenses for the foreseeable future. Further, it did not abuse its discretion in disregarding the couple's speculative future medical expenses. In addition, the IRS was not required to accept the offer based on the taxpayers' claim that they were the victims of fraud because the couple's situation was typical of many tax shelter participants who claimed deductions, obtained tax advantages and were now required to pay their tax liability. Thus, the IRS's determination to reject the offer-in-compromise was not arbitrary, capricious, or without a sound basis in fact or law, and it was not abusive or unfair to the taxpayers.

D. Clayton, 92 TCM 222, Dec. 56,612(M), TC Memo. 2006-188.

An IRS Appeals officer's refusal to accept a married couple's offer in compromise regarding tax liabilities arising from a tax shelter investment was sustained. His determination that the taxpayers' resources were sufficient to warrant collection of the entire outstanding liability was not an abuse of discretion. The possibility that they might sustain a substantial economic hardship in the future did not bar a finding that they could pay their taxes. The delay in informing the taxpayers of their pending tax liability was attributable to the deliberate pace at which the TEFRA partnership audit of their tax shelter progressed. The IRS was not compelled to accept their settlement offer because it is generally their tax matters partner's responsibility to keep them informed. Finally, the mere fact that one participant in the same tax shelter was granted an interest abatement did not establish that the Appeals officer acted improperly in denying this offer in compromise.

C.G. Fargo, 87 TCM 815 , Dec. 55,514(M), TC Memo. 2004-13.

An IRS Appeals officer properly rejected an individual's offer in compromise for $100 to settle his unpaid tax liabilities in three years. The taxpayer offered no evidence to indicate that a rejection of his offer was an abuse of discretion. The Appeals officer properly reviewed the financial records of the taxpayer and his mother, whom the taxpayer supported. Moreover, the Appeals officer's refusal to refer the taxpayer's offer to IRS collection personnel for further evaluation did not constitute an abuse of discretion. As a result, the Tax Court upheld the IRS's Collection Due Process determination.

J.L. Tillman, 87 TCM 806, Dec. 55,509(M), TC Memo. 2004-8.

In consolidated cases, the IRS did not abuse its discretion in rejecting offers in compromise submitted by individuals who challenged their underlying tax liabilities as transferees of a corporation for its tax liability. Each taxpayer previously had entered into a stipulated decision agreeing to transferee liability and there was no doubt as to the taxpayers' liabilities within the meaning of the applicable regulations or otherwise. Thus, the IRS reasonably rejected the offers in compromise on grounds that the transferee liabilities had been determined in the transferee liability cases and that the taxpayers did not comply with filing requirements.

D.L. Oyer, 85 TCM 1510, Dec. 55,193(M), TC Memo. 2003-178.

Individual taxpayers were not entitled to loss deductions on account of their book tax shelters notwithstanding an IRS policy statement that, according to the taxpayers, gave them the right to settle the book shelter issue by being allowed deductions to the extent of their cash investment. The policy statement issue was not timely raised. Furthermore, the policy statement did not grant settlement rights to taxpayers but rather described procedures for arriving at such settlements.

R. Helstoski, 60 TCM 233, Dec. 46,748(M), TC Memo. 1990-382.

The IRS has identified 43 frivolous positions that have been deemed frivolous by courts or have no basis for validity in existing law. These positions are determined to be frivolous for purposes of the Code Sec. 6702(a) penalty for filing frivolous tax returns, and the Code Sec. 6702(b) penalty for filing specified frivolous submissions, which include applications for offers in compromise. Included in the list are four new positions that relate to a misinterpretation of the Ninth Amendment regarding objections to military spending, erroneous claims that taxes are owed only by persons with a fiduciary relationship to the U.S. or IRS, a nonexistent "Mariner's Tax Deduction," or something similar, related to invalid deductions for meals and misuse or excessive use of the credit for fuels under Code Sec. 6421.

Notice 2008-14, I.R.B. 2008-4, 310; modifying and superseding Notice 2007-30, I.R.B. 2007-14, 883.

IRS News Release, IR-2008-8, January 14, 2008.

The IRS has announced that a revised taxpayer application for an offer in compromise (OIC), the Form 656 package, is now available. The new form reflects procedural changes to the OIC program made by the Tax Increase Prevention and Reconciliation Act of 2005 ( P.L. 109-222). The changes to the Form 656 package include new payment terms and offer submission rules, a processability checklist, a matrix to assist taxpayers in determining the number of forms and payments that must be submitted to the IRS, a checklist of items and documents that must be completed prior to submitting an OIC, and a new payment voucher to be used to remit required partial payments to the IRS.

IRS News Release, IR-2007-50, March 5, 2007.

IRS Fact Sheet FS-2007-16, March 5, 2007.

The IRS has issued guidance outlining the protections in place for the new private debt collection program in connection with administrative review. If the taxpayer proposes an installment agreement to the private collection agency (PCA) and the IRS rejects the proposed installment agreement, the taxpayer may appeal the rejection to the IRS. If the IRS assigns a PCA to monitor an installment agreement and the PCA determines the taxpayer is in default, the taxpayer may appeal to the IRS if the installment agreement is terminated. In both situations, the taxpayer must first appeal to the IRS office supervising the PCA's day-to-day work, but if not satisfied the taxpayer may continue the appeal to the IRS Office of Appeals, pursuant to the IRS review procedures for installment agreements and compromises.

Announcement 2006-63, I.R.B. 2006-37, 445.

The IRS issued information and guidance on the major changes made to the offer in compromise program by the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) which tightened the rules for lump-sum and periodic payment offers received by the IRS on or after July 16, 2006. Taxpayers submitting requests for lump-sum OICs must include a payment of 20 percent of the amount offered. A lump-sum OIC is an offer of payments made in five or fewer installments. Taxpayers submitting requests for periodic-payment OICs must include the first proposed installment payment with their application and continue making payments under the terms proposed while the offer is being evaluated. The IRS will treat the payments as payments of tax, rather than refundable deposits under Code Sec. 7809(b) or Reg. §301.7122-1(h). Unless a waiver applies, failure to pay the 20 percent on a lump-sum offer, or the first installment payment on a periodic payment offer may result in the IRS returning the offer to the taxpayer as nonprocessable. Taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability can receive a waiver of the new partial payment requirements. The IRS will deem an OIC accepted that is not withdrawn, returned or rejected within 24 months after receipt of the offer. When submitting Form 656, taxpayers must include user fee of $150 unless they qualify for a waiver. Offers are submitted using Form 656, Offers in Compromise. Taxpayers may continue to use the 2004 revision of the form until the new version, revised to reflect the new law, is available.

Notice 2006-68, I.R.B. 2006-31, 105.

IRS News Release, IR-2006-106, July 11, 2006.

IRS Fact Sheet FS-2006-22, July 11, 2006.

A new check-the-box disclosure authorization for the appointment of a third party to discuss and obtain information to facilitate the initial processing of an offer in compromise was added July 2004 to Form 656. This authorization is limited to this specific purpose and does not authorize the designated party to represent the taxpayer before the IRS or during a Collection Due Process hearing.

Announcement 2005-6, I.R.B. 2005-4, 377.

The IRS is warning taxpayers to beware of tax practitioners who encourage the use of an offer in compromise as a way to settle tax claims for "pennies on the dollar." The IRS's warning targets the actions of "unscrupulous promoters" who charge excessive fees when there is no chance that the taxpayer will qualify for the offer in compromise. Although the IRS has the authority to settle tax claims for less than their full amount, an offer in compromise may be considered only after other options, such as an installment agreement, are considered.

IRS News Release, IR-2004-130, October 25, 2004.

A revised taxpayer application for an offer in compromise (OIC), the Form 656 package, is now available. The revised form provides a signature block for paid preparers and also includes a Form 656-A, Income Certification for OIC Application Fee, and a worksheet to help taxpayers determine if they qualify for the income exception to $150 application fee. Other features of the new package include a checklist to determine eligibility for an OIC, an OIC process step-by-step guide, a third-party designee section and a summary checklist. The package can be obtained from the IRS by calling 1-800-829-3676 or by going to the IRS website "www.irs.gov.".

IRS News Release, IR-2004-129, October 25, 2004.

The IRS has issued a consumer alert advising taxpayers to beware of promoters' claims that tax debts can be settled for "pennies on the dollar" through the IRS Offer in Compromise Program. According to the IRS, some promoters are inappropriately advising indebted taxpayers to apply for an offer in compromise before exhausting other payment options, such as monthly installment agreements.

IRS News Release, IR-2004-17, February 3, 2004.

Beginning on November 1, 2003, the IRS will charge, with certain exceptions, a $150 application fee for the processing of offers in compromise (OICs). Individuals whose monthly income falls at or below levels based on the Department of Health and Human Services guidelines, and taxpayers that file OICs based solely on doubt as to liability, will be exempt from the fee. Individuals claiming the poverty guideline exception must certify their eligibility using Form 656-A, Offer in Compromise Application Fee Instructions and certification. To submit an OIC, taxpayers are to use the May 2001 version of Form 656, Offer in Compromise. The application fee for OICs that do not qualify for an exception must be submitted using a check or money order payable to the United States Treasury.

IRS News Release, IR-2003-124, October 23, 2003.

Chief Counsel concluded that a Code Sec. 7122 compromise would not legally bind a minor in a compromise agreement with the IRS. A minor child may repudiate, avoid or disaffirm a contract under state laws; thus, Chief Counsel advised against the IRS entering into compromise agreements with minors. Moreover, status as the legal guardian of a minor's property does not include the capacity to compromise the minor's tax liability.

CCA Letter Ruling 200220026, March 28, 2002.

Chief Counsel provided background information regarding Code Sec. 7122 and its legislative history as they relate to Chief Counsel Notice CC-2001-036. The notice set forth procedures to be followed by Associate Chief Counsel (SB/SE) offices when issuing the statutorily required opinion in offer in compromise cases. It also clarified procedures for the review of offers based on doubt as to collectibility and/or liability. Further, the notice added procedures and standards for the review of offers based upon the promotion of effective tax administration.

CCA Letter Ruling 200131029, July 2, 2001.

Chief Counsel concluded that the IRS need not require that individual offers in compromise submitted by married taxpayers specify that the offers were made in conjunction with each other in order to protect the collectability of the couple's joint and separate liabilities. Moreover, the offers did not have to specify that a failure to pay the entire amount of either offers would result in a default of both offers.

CCA Letter Ruling 200051043, October 26, 2000.

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. . Because the individual failed to timely appeal the denial of his offer in compromise to the IRS Office of Appeals, he could not later request a review of that denial in the district court.

D.L. Kadunce, DC Pa., 2008-2 USTC ¶50,669.

With the start of the 2009 tax filing season, the IRS has announced steps to help financially distressed taxpayers receive their refunds faster, as well as provided additional help to individuals who are struggling to meet their tax obligations. Several suggestions are offered to taxpayers who owe back taxes, such as additional review of offers-in-compromise and expedited levy releases.

IRS News Release IR-2009-2.

The Tax Court properly upheld the IRS's determination of an individual's federal income tax liability. The notice of federal tax lien was not prematurely filed because the IRS had considered the individual's offer in compromise, and gave him ample notice before issuing the lien. Furthermore, the individual's charitable contributions were not "necessary expenses" with respect to his proposed offer in compromise.

G.E. Freeman, CA-9, 2009-1 USTC ¶50,320.

Suits by the United States: Complaint

A complaint, as amended, alleged sufficient facts to give the defendants notice of the Government's theory of their liability as officers of an unincorporated association.

Communist Party of the U.S., DC, 63-1 USTC ¶9158.

The District Court permitted an amendment of the Government's complaint in a suit to collect taxes where the amendment did not state an additional cause of action nor did it prejudice the taxpayer's right to raise any available defenses.

S. Saladoff, DC, 64-1 USTC ¶9149.

The government's complaint to reduce assessments of federal tax liabilities to judgment was sufficient although it failed to allege either (1) that the taxpayers were sent deficiency notices prior to assessment and prior to expiration of the statute of limitations or (2) that they had waived such notice and consented to an extension of the limitation period. Proof of one of these points would, however, be required before judgment could be rendered for the government.

J. Forma, DC N.Y., 90-1 USTC ¶50,326.

The government's motion to vacate a default judgment and to dismiss the counterclaim on which it was based for lack of subject matter jurisdiction, following the decision in J. Forma ( 90-1 USTC ¶50,326), above, was denied. However, the default judgment was vacated for the limited purpose of holding a hearing to determine whether the taxpayers were entitled to the damages sought.

J. Forma, DC N.Y., 92-1 USTC ¶50,156, 784 FSupp 1132.

The IRS failed to establish that the notice of deficiency was sent for two of the tax years at issue; therefore, the taxpayer was not liable for the amounts assessed. However, the district court lacked subject matter jurisdiction over a claim of damages resulting from the sale of the taxpayer's house since he did not bring the required suit within the limitation period.

J. Forma, DC N.Y., 93-1 USTC ¶50,076. Vac'd and rem'd on another issue, CA-2, 95-1 USTC ¶50,012, 42 F3d 759.

The government stated a proper claim for relief in a suit to recover an individual's unpaid income taxes from the transferee who received the transferor's assets. The complaint stated with particularity the amount that the government sought to recover and the source of the liability.

H.B. Matzner, DC Fla., 97-1 USTC ¶50,413.

Answers by trustees to a government complaint that the trustees neglected, failed or refused to fully pay taxes assessed against the trusts were struck because the trusts were not represented by an attorney. The trustees' argument that certain treaties to which the United States was a signatory protected their right to defend the trusts in propria persona was without merit. Procedural rules governed the requirement that the trusts be represented by counsel.

M. Carey, DC Calif., 2006-1 USTC ¶50,338.

Documents filed by an individual that purported to be a response to a government complaint alleging unpaid federal taxes were struck. The response failed to comply with the Federal Rules of Civil Procedure and the local rules because they did not bear a caption setting forth the proper title of the action. Instead, the response contained only insufficient defenses and immaterial matters.

H.A. Wesselman, DC Ill., 2006-2 USTC ¶50,375.

The government was entitled to reduce to judgment federal income, employment and unemployment taxes assessed against an individual. The individual's claim that the IRS had selectively prosecuted the action against him was rejected because he did not provide evidence that the government had singled him out for prosecution. The individual also did not show that the decision to prosecute was made on the basis of an unjustifiable standard or that the prosecution was intended to prevent his exericse of a fundamental right.

D.L. Kadunce, DC Pa., 2008-2 USTC ¶50,669.

A federal district court had subject matter jurisdiction over the government's complaint seeking to reduce outstanding tax liabilities to judgment and to foreclose tax liens on a couple's real property. The government complied with the applicable procedural and pleading requirements, the government's claims were not time barred, the complaint provided sufficient information regarding the underlying tax assessments and the government sufficiently pled the existence of property rights based on the federal tax liens at issue.

D.R. Black, DC Wash., 2009-1 USTC ¶50,154.

A corporation's motion to strike certain allegations in the government's complaint regarding an individual's involvement in an abusive tax shelter scheme was denied. There was a reasonable chance that the allegations were relevant and pertinent to the government's action seeking a determination that the corporation was the individual's nominee and that the tax liability allegedly owed by the individual should be satisfied by foreclosing a federal tax lien upon real properly held by the corporation. The allegations were not immaterial, impertinent or scandalous, but addressed matters that had a bearing upon the government's claims that the individual owed federal taxes and that he used the corporation as a nominee to conceal his assets.

I. Cohen, DC Ill., 2009-1 USTC ¶50,287.

tax return preparer was permanently enjoined from promoting an abusive mining development scheme and preparing returns fraudulently claiming mining development deductions for customers who had not incurred mining development expenses. He was aware that the deductions reported on his customers' tax returns were improper and would result in an understatement of tax. He knowingly made materially false and misleading statements to his customers regarding the deductions and advised them not to cooperate with the IRS. Injunctive relief was necessary since he did not admit that the returns he prepared were false and would likely, unless enjoined, continue to promote his tax scheme and prepare false returns. . In order to obtain an injunction under § 7407, the United States must prove that the return preparer engaged in conduct subject to penalty under I.R.C. §§ 6694 or 6695. This is quite interesting because the defenses to the 6694 penalty, like “reasonable cause” can prevent an injunction. The transactions in the Camp case below were clearly tax motivated, but there are 6694 defenses that could be available even in tax motivated situations if you apply the rationale of this case to its logical conclusion.


United States of America, Plaintiff v. William H. Camp, Jr., d/b/a Universal Business Systems, Defendant.

U.S. District Court, West. Dist. Wash., Seattle Div.; Civ. 2:08-cv-00292-RSM, April 29, 2009.


ORDER GRANTING PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT



FINAL JUDGMENT OF PERMANENT INJUNCTION


MARTINEZ, United States District Judge: Plaintiff, United States of America, moves for summary judgment of permanent injunction, pursuant to Federal Rule of Civil Procedure 56 and Internal Revenue Code (I.R.C., 26 U.S.C.) §§ 7402, 7407, and 7408, against Defendant William H. Camp, Jr., individually and doing business as Universal Business Systems. The United States seeks to prevent Camp from further promoting an unlawful tax scheme in violation of I.R.C. §§ 6700 and 6701, and from preparing federal tax returns for others. Defendant Camp did not respond to the United States' motion. The Court construes Defendant Camp's silence as an admission that the motion has merit. See Local Rule CR 7(b)(2). Accordingly, the Court makes the following findings of fact and conclusions of law and enters this permanent injunction.


Findings of Fact


The Court finds that because Camp has failed to answer the Requests for Admissions properly served on him by the United States, the matters therein are deemed admitted pursuant to FRCP 36(a)(3). Based on a full review of all of the evidence, the Court finds as follows:
1. Defendant William Camp resides in and operates his business, Universal Business Systems, in the District of Columbia. Camp prepared tax returns on behalf of many state of Washington residents. (Pl.'s St. of Undisputed Facts ¶ 2.)

2. Camp is not a certified public accountant, and has never held an accounting license, but is a non-CPA accountant and an income tax return preparer who prepares federal income tax returns. Camp has described, or allowed himself to be described, as an accountant. He continues to advertise his accounting services. (Pl.'s St. of Undisputed Facts ¶ 3, 4, 31.)

3. Camp assisted in the organization and planning of the Mining Interest Development Action Strategy ("MIDAS") program, a scheme promoted through Merendon Mining (Colorado), Inc. ("Merendon"), a Colorado corporation that indicated that it owned two formerly active gold mines in Colorado and Arizona. Merendon affiliates told investors that, with new technology, the mines might be able to produce gold and other minerals. Camp provided Merendon prospectuses to clients. (Pl.'s St. of Undisputed Facts ¶ 5.)

4. The prospectus provides that Merendon has developed a mineral program that allows participants to obtain an interest in minerals produced at a mine in Jamestown, Colorado. It provides that the investors must collectively invest $100 million annually and investors will receive 50% of the minerals extracted as a result of their respective ownership share of the total investment. (Pl.'s St. of Undisputed Facts ¶ 6.)

5. Between and including 2003 and 2005, Camp was contacted by, or he otherwise communicated with, persons who had received his name from a Structurist (Merendon marketing representatives) or other persons affiliated with the Institute for Financial Learning, Capital Alternatives, Merendon, Merendon Mining (Nevada), Inc. or any of their affiliates. (Pl.'s St. of Undisputed Facts ¶ 7.)

6. Between and including 2003 and 2005, Camp participated in communications with customers, prospective customers, investors or prospective investors, or members or prospective members of the Institute for Financial Learning, Capital Alternatives, Merendon Mining (Colorado), Inc., Merendon Mining (Nevada), Inc. or any of their affiliates, concerning the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 8.)

7. During one or more of the communications described in Paragraph 6, Camp stated that one was eligible for a deduction pursuant to Internal Revenue Code (26 U.S.C., I.R.C.) § 616 because of one's participation in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 9.)

8. Persons who participated in MIDAS were required to sign Mining Agreements obligating them to contribute a certain amount of funds toward the development of mines owned by Merendon. The investments in Merendon were treated as "development expenditure payments." (Pl.'s St. of Undisputed Facts ¶ 10.)

9. Camp told Merendon investors about the tax consequences of mining development deductions pursuant to § 616 of the Internal Revenue Code. Specifically, Camp stated that it was legal or otherwise consistent with the internal revenue laws to claim a federal income tax deduction for mining development expenses pursuant to I.R.C. § 616, upon participation in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 11.)

10. After he prepared their tax returns, Camp stated to one or more customers that the returns he had prepared were legal or otherwise in compliance with the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 12.)

11. Camp told participants in the MIDAS program that they did not have to pay the amounts provided in their Mining Agreements prior to submitting the tax returns he prepared. (Pl.'s St. of Undisputed Facts ¶ 13.)

12. Between and including 2003 and 2005, Camp contacted, or was contacted by, potential or actual participants in the MIDAS program concerning his preparation of federal income tax returns for such persons. Camp requested and obtained the federal income tax returns of individuals for one or several of the tax years including 1997, 1998, 1999, 2000, 2001, and 2002. (Pl.'s St. of Undisputed Facts ¶ 14.)

13. Between and including 2003 and 2005, Camp prepared amended federal income tax returns for all of the persons listed in his letter to the Internal Revenue Service (IRS) of November 14, 2006. (Pl.'s St. of Undisputed Facts ¶ 15.)

14. Camp prepared amended income tax returns for at least 22 MIDAS customers, claiming a deduction pursuant to I.R.C. § 616. Camp prepared tax returns claiming Merendonrelated deductions for clients from Washington, Florida, California, Texas, Georgia, and New York. (Pl.'s St. of Undisputed Facts ¶ 16.)

15. On each of those amended federal income tax returns, Camp determined the amount of the claimed § 616 deduction based on the amount of taxes reported on the taxpayers' original federal income tax returns. When he prepared each of the amended returns, Camp knew that the taxpayers had not paid toward the development or production of any mine the amounts Camp listed on the amended tax returns. (Pl.'s St. of Undisputed Facts ¶ 17.)

16. Instead of reporting deductions based on amounts customers had actually invested in the mining scheme - which would have been zero in many cases - Camp reported deductions based on the entire amount of customers' purported ten-year contractual investment. Camp prepared the amended income tax returns for Merendon investors for the year 2002 including the contractual expenditures as ordinary deductions. (Pl.'s St. of Undisputed Facts ¶ 18.)

17. Camp, either independently or in collaboration with other persons involved in Merendon, prepared amended federal income tax returns indicating that customers made a mining investment in the year 2002, in part because in the year 2002, internal revenue laws allowed losses to be carried back five years, rather than the otherwise applicable three-year period. (Pl.'s St. of Undisputed Facts ¶ 19.)

18. None of the persons for whom Camp prepared federal income tax returns had paid any amounts toward the development of any mines to Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, Capital Alternatives, or any predecessors, successors or affiliates thereto prior to and including December 31, 2002. None of the Mining Agreements signed by MIDAS participants for whom Camp prepared federal income tax returns were completed and signed prior to December 31, 2002. (Pl.'s St. of Undisputed Facts ¶ 20.)

19. Camp similarly knew or had reason to know that Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other person or entity on their behalf, had not paid, on behalf of MIDAS participants, the amounts he reported on the tax returns, toward the development of any mining facility. (Pl.'s St. of Undisputed Facts ¶ 21.)

20. Camp knew that any mining expenses actually spent between and including 2002 and 2005 by Merendon, Inc., Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other person or entity on their behalf, were for the production of ores or minerals, rather than the development of a mine. (Pl.'s St. of Undisputed Facts ¶ 22.)

21. Camp, either independently or in collaboration with other persons involved in Merendon, prepared the tax returns for MIDAS customers in part to increase the total amount of reported deductions. Camp reported that one or more persons had paid, as mining development expenses, amounts in excess of their income for the applicable tax year, in order that those persons could obtain a refund of taxes previously paid to the United States. (Pl.'s St. of Undisputed Facts ¶ 23.)

22. Neither Camp nor his customers knew, or had a reasonable basis to believe, that ore or minerals had been disclosed to investors (with respect to the mines described in the MIDAS prospectus and accompanying documents), in commercially marketable quantities sufficient to reasonably justify commercial exploitation. (Pl.'s St. of Undisputed Facts ¶ 24.)

23. Camp knew that the persons for whom he prepared returns had not paid or incurred the expenditures he reported as deductions under § 616 on the returns. (Pl.'s St. of Undisputed Facts ¶ 25.)

24. Camp knew that his Merendon customers did not materially participate in any activity concerning the mines identified in the MIDAS prospectus or the operation of Merendon, Merendon Mining (Nevada), Inc., the Institute for Financial Learning, or any other affiliated entity. (Pl.'s St. of Undisputed Facts ¶ 26.)

25. At all times prior to and after the preparation of the income tax returns for MIDAS customers, Camp knew that the investments for which he reported a deduction pursuant to I.R.C. § 616 were not "at risk," as provided by the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 27.)

26. In preparing each of the federal income tax returns described above, Camp knew that the taxpayers were likely to submit the documents and returns he prepared to the IRS in affiliation with the determination of their federal tax liabilities, or otherwise in connection with a material matter arising under the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 28.)

27. Camp knew that the tax returns or documents would result in an understatement of the tax liability for the persons for whom Camp prepared the returns. Camp knew that the reported deductions under I.R.C. § 616 were matters material to the determination of the taxpayers' federal tax liabilities. (Pl.'s St. of Undisputed Facts ¶ 29.)

28. Camp prepared an additional opinion letter dated November 1, 2003 in which he represented that he was an accountant and purported to advise Merendon about how customers could report their Merendon "investments" on their tax returns. (Pl.'s St. of Undisputed Facts ¶ 30.)

29. At the time he prepared the opinion letter, Camp had not read or otherwise consulted any legal authority concerning the applicability of the deduction under I.R.C. § 616. In addition, he knew that MIDAS participants had not paid any money directly toward any mining development or production activity. (Pl.'s St. of Undisputed Facts ¶ 32.)

30. At the time he prepared the opinion letter, Camp knew that MIDAS participants were not engaged in the business activity of mining, and did not intend to become so engaged. (Pl.'s St. of Undisputed Facts ¶ 33.)

31. Camp knew that the opinion letter was likely to be distributed or would potentially be distributed to prospective and actual participants in the MIDAS program. (Pl.'s St. of Undisputed Facts ¶ 34.)

32. Some investors in Merendon received tax opinion letters, which stated that the development expenses paid by customers were deductible. (Pl.'s St. of Undisputed Facts ¶ 35.)

33. Camp charged his customers fees based on the complexity of the returns prepared, and charged one Seattle customer $4,000 to prepare one original tax return and five amended tax returns. Camp charged each of his MIDAS customers amounts up to $4,000 to prepare the amended tax returns. (Pl.'s St. of Undisputed Facts ¶ 36.)

34. One Camp customer paid over $3 million in federal income tax for the years 1997 through 2002 based on total income of approximately $8 million reported on his federal income tax returns. Camp prepared amended returns eliminating the vast majority of the customer's income tax liability for 1997 through 2002, and claiming large tax refunds for those years. (Pl.'s St. of Undisputed Facts ¶ 37.)

35. The majority of Camp's customers in the MIDAS program had Net Operating Loss ("NOL") carrybacks, as a result of Camp's claimed deductions under § 616. Camp did not treat the losses generated by the MIDAS deductions as passive activity losses, pursuant to § 469 of the Internal Revenue Code. (Pl.'s St. of Undisputed Facts ¶ 38.)

36. Camp prepared and submitted to the IRS one or more Forms 2848 granting him authorization to act as a Power of Attorney on behalf of the MIDAS participants for whom he prepared amended federal income tax returns. (Pl.'s St. of Undisputed Facts ¶ 39.)

37. Camp represented participants for whom he and Eric Peterson had prepared tax returns containing Merendon-related deductions. Peterson was enjoined by the United States District Court for the Southern District of Texas in January 2009. Camp maintained contact with his customers who were participants in Merendon during 2006 when he represented some of them during IRS examinations. (Pl.'s St. of Undisputed Facts ¶ 40.)

38. In a December 7, 2004 meeting with the IRS in connection with its audit of three MIDAS participants, Camp admitted that he had prepared a number of federal income tax returns claiming mining deductions, but he refused to name other customers for whom he prepared similar returns. In the meeting, Camp claimed that Merendon had asked him to appear at the interview in order to explain the transaction and facilitate acceptance of the refund claims. After Camp received a formal request from an IRS Area Director, he supplied to the IRS a list of some customers for whom he had prepared tax returns. (Pl.'s St. of Undisputed Facts ¶ 41.)

39. In the same meeting, Camp claimed that he had researched I.R.C. § 616 extensively and was knowledgeable about preparing amended income tax returns. Camp also stated that the federal tax returns he prepared were correct and complied with the internal revenue laws regarding mining development investment deductions, though he knew or had reason to know that the tax returns were not correct or in compliance with the internal revenue laws. (Pl.'s St. of Undisputed Facts ¶ 42.)

40. With respect to IRS audits, Camp requested that customers have the IRS direct inquiries regarding their tax returns directed to him. Camp told his MIDAS customers not to agree to the IRS's proposed treatment of their tax returns or other matters concerning the returns. (Pl.'s St. of Undisputed Facts ¶ 43.)

41. The IRS issued refunds to some Merendon investors. (Pl.'s St. of Undisputed Facts ¶ 44.)

42. Camp did not tell any persons for whom he prepared federal income tax returns pursuant to the MIDAS program that they could be subject to penalties or criminal prosecution for failing to accurately report their income, deductions, or other information on their federal income tax returns. (Pl.'s St. of Undisputed Facts ¶ 45.)


Conclusions of Law


This Court has jurisdiction of this matter pursuant to 28 U.S.C. §§ 1340 and 1345, and 26 U.S.C. §§ 7202(a), 7407, and 7408 because Camp has prepared tax returns and promoted the MIDAS program to persons within the state of Washington. In order to obtain an injunction under § 7407, the United States must prove that Camp, an income tax return preparer, engaged in conduct subject to penalty under I.R.C. §§ 6694 or 6695. For an injunction under § 7408, the United States must prove that Camp engaged in conduct subject to penalty under I.R.C. §§ 6700 or 6701. Finally, for an injunction under § 7402, the United States must show that an injunction is necessary or appropriate for the enforcement of the internal revenue laws.

The United States has met the requirements for an injunction under the statutes cited above. Camp violated I.R.C. § 6700 by promoting and selling the MIDAS mining development scheme, and knowingly making materially false or fraudulent statements to customers regarding the allowability of deductions under I.R.C. § 616. Camp made materially false statements to customers regarding the amounts they had to pay in order to be eligible to claim mining development deductions, Merendon Mining's use of customer contributions, and the legality of the claimed mining development expenses. Camp also prepared an opinion letter for distribution to customers falsely claiming that the mining deductions were legal. Camp knew that his statements were false. Camp knew that customers were not actually eligible for deductions under I.R.C. § 616 because none of the customers, or Merendon Mining, had paid any amounts toward the development of any mines in the year 2002. Furthermore, neither Camp nor his customers knew, or had a reasonable basis to believe, that ore or minerals had been disclosed in commercially marketable quantities sufficient to reasonably justify commercial exploitation.

Camp violated I.R.C. §§ 6701 and 6694 by preparing tax returns for customers claiming fraudulent mining deductions for customers who had not incurred the expenses reported, had not made any payments in the year 2002 (the year that Camp reported the deductible payments occurred), and whose payments, even if made, would not have been deductible under I.R.C. § 616. The deductions Camp reported for customers' purported development expenditures did not meet the required factors for § 616 because neither Camp nor the customers knew that ore or minerals existed in commercially marketable quantities. Any amounts paid by Merendon or Camp's customers were toward production, rather than development expenses, and were not actually at risk pursuant to the terms of the Mining Agreement. Finally, Camp offset the claimed mining development expenses against non-passive income in violation of the internal revenue laws. Camp knew that the mining deductions he reported on customers' tax returns were not proper, would more likely than not be not sustained on the merits, and would result in understatements of customers' true income tax liabilities.

Injunctive relief fulfills the legislative purposes of I.R.C. §§ 7402, 7407, and 7408 because Camp has demonstrated a pattern of promoting abusive tax schemes. Camp failed to consult with any tax professional prior to drafting his 2003 opinion letter, and admits he is not a licensed CPA, though he claims to be. There is a significant likelihood Camp will continue promoting the MIDAS tax schemes and preparing false and fraudulent tax returns absent an injunction. He prepared amended returns for at least 22 MIDAS customers, and his conduct is likely to continue absent an injunction because, even when the IRS confronted him with the incorrect returns, Camp continued to insist the deductions were proper, though he had not consulted any tax professional on the matter. Further, Camp advised customers not to cooperate with the IRS, and failed to notify them that they could be subject to civil and criminal penalties as a result of the tax returns he prepared. Finally, Camp's occupation as an accountant, without the necessary license to practice, and tax return preparer place him in a position where further violations are likely.

The United States has met the factors for injunctive relief under I.R.C. §§ 7402, 7407, and 7408. Further, a limited injunction prohibiting Camp only from participating in the prohibited conduct is not sufficient because of his failure to admit the falsity of the returns he prepared, and continued pattern of violations. Camp admits that he continues to hold himself out as an accountant though he has no CPA license, and has willfully prepared returns in blatant disregard for the internal revenue laws claiming millions in fraudulent deductions. Camp continued to advise customers that his positions on the tax laws are correct despite numerous IRS audits indicating otherwise. An injunction is necessary and promotes the goals of the statute because, absent an injunction, Camp will continue to promote this or other fraudulent tax schemes. Camp has made no acknowledgment that the MIDAS scheme he promoted was fraudulent, that the tax returns he prepared were false, and he has made no defense in this action and therefore offers the Court no reason to believe he will not continue to violate the internal revenue laws absent an injunction.

The United States has made the requisite showing that an injunction is warranted under I.R.C. §§ 7402, 7407, and 7408. The government's Motion for Summary Judgment is hereby GRANTED. The Court enters the following permanent injunction against William Camp, individually and doing business as Universal Business Systems.


Permanent Injunction


IT IS HEREBY ORDERED that Defendant Camp, and all those in active concert or participation with him, are permanently ENJOINED pursuant to I.R.C. §§ 7402, 7407, and 7408 from directly or indirectly:
(a) Organizing, promoting, or selling the Mining Interest Development Action Strategy ("MIDAS") program associated with Merendon Mining, Inc. and its subsidiary corporations;

(b) Making false or fraudulent statements, in connection with the organization or sale of a partnership, plan, or other arrangement, about the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of participating in the partnership, plan, or other arrangement;

(c) Organizing, promoting, selling, or advising participation in any other partnership, plan, investment, business venture, or arrangement that makes false or fraudulent representations about federal tax benefits or treatment because of participation in such tax shelter, plan, investment, business venture, or arrangement;

(d) Causing or assisting other persons and entities to understate their federal tax liabilities and avoid paying federal taxes;

(e) Preparing or assisting others in the preparation of any tax forms or documents on behalf of any other person or entity including a claimed deduction under I.R.C. § 616 for which the taxpayer has not made any mining development investment;

(f) Engaging in any other conduct subject to penalty under I.R.C. § 6700, including making or furnishing, in connection with the organization or sale of a partnership, plan, or arrangement, a statement that he knows or has reason to know to be false or fraudulent as to any material federal tax matter, or by making a gross valuation overstatement;

(g) Engaging in conduct subject to penalty under I.R.C. § 6701, including preparing or assisting others in the preparation of any tax forms or other documents to be used in connection with any material matter arising under the internal revenue laws and which he knows will (if so used) result in the understatement of another person's tax liability;

(h) Engaging in any conduct subject to penalty under I.R.C. § 6694, including preparing tax returns for customers reporting an understatement of liability due to an unreasonable position without substantial authority or more likely than not to not be sustained on its merits;

(i) Engaging in any conduct subject to any penalty under the I.R.C.; and

(j) Preparing or filing, or helping others to prepare or file, federal tax returns, amended returns, or any other tax-related documents or forms for any other person or entity other than himself.

(k) Falsely representing himself to be a certified public accountant, a non-certified accountant, or other tax professional;

(l) Falsely representing his experience or education as a tax return preparer; and

(m) Misrepresenting the terms of this injunction to customers or prospective customers, or anyone else.

IT IS FURTHER ORDERED that Camp mail a copy of this Order and a cover letter informing all persons for whom he prepared one or more tax return(s) including a deduction under I.R.C. § 616 or who otherwise participated in the M.I.D.A.S. program of the entry of the Court's findings and injunction, that their tax returns are likely false, that they may be subject to penalties because of the fraudulent tax returns. Camp must mail the Order and cover letter to these identified persons within 20 days of the date of this Order, and must file a sworn certificate stating that he has complied with this requirement and listing the names and addresses of all persons he has notified, within 22 days of the date of this Order.

IT IS FURTHER ORDERED that the Court retains jurisdiction for purposes of implementing and enforcing the final judgment and any additional orders necessary and appropriate to the public interest. The United States may engage in post-judgment discovery to monitor Camp's compliance with this injunction

IT IS FURTHER ORDERED that this Order of Permanent Injunction shall serve as a final judgment in this matter, with each party to bear its own costs.

Dated this 29 day of April, 2009.

Injunction issued. --Injunctions Against Tax Return Preparers: Injunction issued

The defendant was permanently enjoined from acting as a tax return preparer. This was to preclude him from preparing for compensation any federal income tax return (or any portion thereof), including any work papers or summaries from which the return might be prepared, or from employing any persons to prepare such returns or portions of returns at his direction or control.

C. Owens, Jr., DC, 79-2 USTC ¶9742.

Similarly.

C.E. Bullard, DC Tex., 89-2 USTC ¶9620.

An injunction may be issued against a tax adviser under Code Sec. 7402 without showing that a particular provision of the Internal Revenue Code has been violated. On remand, if the district court determines that an accounting firm, accused by the IRS of enticing clients to claim invalid tax credits, acted as a tax adviser, an injunction may be issued to prevent such conduct without tying it to a specific statute prohibiting the activity. If the district court views the firm as a tax preparer, only a partial injunction may be issued under Code Sec. 7407. Since the firm posted bond, an injunction cannot be issued against activities subject to the penalty under Code Sec. 6694: namely, advising clients to claim unjustified credits and using misleading documentation to show clients how bogus credits may be claimed. But the firm may be enjoined from promoting and marketing its services despite posting of the bond, since this activity is not encompassed by the penalty provision.

Ernst & Whinney, CA-11, 84-2 USTC ¶9618, 735 F2d 1296. Cert. denied, 105 SCt 2018.

An individual was permanently enjoined from the promotion and sale of an abusive tax shelter in the form of an estate guardian educational trust. Such individual was also enjoined from engaging in conduct as a tax return preparer that hinders or interferes with an IRS investigation and audit of persons who utilized such educational trusts in the computation of their tax liability.

B. Hutchinson, DC, 83-1 USTC ¶9322.

An injunction could be issued against an income tax preparer compelling production of a list of the names of taxpayers whose returns were prepared by him, despite the fact that the IRS could have uncovered the same information through a summons procedure. Moreover, the court concluded that willfulness was an essential element to justify the issuance of an injunction under Code Sec. 7407(b). However, the appellate court reversed and remanded the action to the trial court since the lower court judge erred by not considering whether the return preparer's refusal to turn over such information was in reliance upon the advice of his attorney, which could be a defense to willfulness under certain circumstances.

N.T. Nordbrock, CA-9, 87-2 USTC ¶9538, 828 F2d 1401.

A lower court decision, which enjoined a tax return preparer from preparing returns and imposed a penalty on him for refusing to provide a list of clients to the IRS, was reversed and remanded. The District Court erred in denying the preparer's demand for a jury trial. By proceeding with a bench trial on the issue of willfulness in refusing to provide the list, his Seventh Amendment right to a jury trial was violated. The preparer did not waive his right to a jury trial by signing a pretrial order which set his case for a bench trial.

N.T. Nordbrock, CA-9, 91-2 USTC ¶50,391.

A federal district court's imposition of a lifetime injunction prohibiting an individual from preparing tax returns for others was not in error because he continually engaged in prohibited conduct by refusing to comply with IRS requests for taxpayer information. In addition, a post-trial motion for a new trial was properly denied because subsequently obtained evidence was substantially the same as that in the return preparer's possession at the time of trial.

N.T. Nordbrock, CA-9, 94-2 USTC ¶50,532, 38 F3d 440.

An individual who referred to himself as a "personal income tax specialist" and who signed taxpayers' returns on the paid preparer's signature line was considered to be an income tax preparer within the meaning of Code Sec. 7701(a)(36). The court determined that he had consistently engaged in the type of conduct for which an injunction can be entered under Code Sec. 7407.

A.G. Venie, DC Pa., 88-1 USTC ¶9326, 691 FSupp 834.

An individual who described himself as a tax accountant, financial consultant and notary public was considered an income tax preparer. Further, the evidence established that he had continually and repeatedly prepared fraudulent and deceptive income tax returns. A preliminary injunction was appropriate. However, since permanently enjoining him from his livelihood would be too harsh, the court set a hearing on the merits in six months.

T.C. Franchi, DC Pa., 91-1 USTC ¶50,086, 756 FSupp 889. Aff'd, CA-3 (unpublished opinion 1/20/92).

A husband and wife were permanently enjoined from acting as income tax return preparers because they repeatedly and willfully understated their clients' tax liabilities and consistently took frivolous or unrealistic positions without adequately disclosing those positions on the returns. The wife's two daughters, who had actively participated in the couple's income tax preparation business, were also enjoined from acting as income tax return preparers unless they became enrolled agents and accepted no tax preparation advice from their mother and stepfather.

C. Bailey, DC Tex., 92-1 USTC ¶50,246. Aff'd, CA-5 (unpublished opinion 6/18/93).

An individual was permanently enjoined from acting as an income tax preparer because he regularly misapprehended, misconstrued and misapplied the tax code and regulations in the information he gave his customers and in the preparation of their returns. Although he did not act with fraudulent intent, he was negligent in his efforts to understand the law, and the positions he advised his clients to take were unrealistic and frivolous.

S.H. Olsen, DC Colo., 97-2 USTC ¶50,730. Aff'd, CA-10 (unpublished opinion), 98-1 USTC ¶50,152.

A tax preparer and his financial services organization were enjoined from organizing, promoting and selling "pure" or "common-law" trusts, and from acting as federal income tax return preparers pending a final determination on the merits. The evidence established that the trusts were created to aid in the illegal avoidance of taxation. Moreover, based upon its fining that the tax preparer continually engaged in such conduct, the court was entitled to enjoin the individual and his organization from acting as tax return preparers until complete compliance with the statutory disclosure requirements had been established.

L.W. Ratfield, DC Fla., 2002-2 USTC ¶50,765.

The government was entitled to a permanent injunction to prohibit a tax return preparer from misrepresenting his education and experience and for guaranteeing tax refunds. Evidence established that the individual continually and repeatedly represented to customers and to the IRS that has was an attorney, when he was not licensed to practice in any state and was not a graduate of an accredited law school. He also frequently guaranteed that his customers would receive tax refunds, although no such guarantees are permitted under the internal revenue laws.

D.J. Gleason, DC Tenn., 2004-1 USTC ¶50,183.

A federal district court did not abuse its discretion when it granted a preliminary injunction enjoining several individuals and businesses from promoting "zero-income" tax theories. Because one of the individuals had an extensive history of tax avoidance and because the individuals operated a bookstore devoted to introducing others to his tax-avoidance schemes, there was a strong likelihood that the promoters would violate Code Sec. 6700 in the future, which was sufficient grounds for a preliminary injunction. Furthermore, the injunction was not an impermissible restraint on First Amendment rights of free speech. The book at the heart of this controversy was determined to consist of commercial speech, which is not entitled to the same protections as political or expressive speech. Ordering that a copy of the injunction be placed on the promoters' websites also did not violate the First Amendment, since requiring disclosure of factual commercial information warning customers of the hazards of a product is regularly allowed.

I.A. Schiff, CA-9, 2004-2 USTC ¶50,328, 379 F3d 621.

Two individuals were enjoined from organizing, promoting and selling abusive tax shelters and acting as tax return preparers. The individuals promoted and participated in an abusive trust scheme known as the "Common Law Business Organization" and asserted under Code Sec. 861 that U.S. residents' domestic income is not taxable. These activities resulted in tax liabilities that were substantially understated, generated over $18 million estimated revenue loss for the government and were subject to penalties under Code Secs. 6694, 6700 and 6701. Further, they engaged in fraudulent, deceptive conduct that interfered with the administration of the tax laws and, absent an injunction, were likely to continue engaging in such activities.

J.L. Binge, DC Ohio, 2005-1 USTC ¶50,121.

A tax preparer and his financial services organization were permanently enjoined from organizing, promoting and selling "common-law" trust arrangements and from acting as tax return preparers.

L.W. Ratfield, DC Fla., 2005-1 USTC ¶50,187.

A permanent injunction that enjoined individuals from continuing to act as income tax return preparers was warranted because an injunction prohibiting them from engaging in fraudulent conduct was insufficient. The individuals had actively solicited customers with promises of large refunds, manipulated or disregarded customers' taxable income, reported fictitious expenses and deductions, filed fraudulent returns and asserted fallacious justifications when questioned by their customers. The permanent injunction reduced the risk that they would cause additional harm to customers, the government and the public.

E. Ferrand, DC La., 2006-1 USTC ¶50,287.

Permanent injunctions were granted against return preparers. The government showed that the preparers had engaged in conduct described in Code Sec. 7407(b) and that injunctive relief was appropriate to prevent the recurrence of such conduct.

E. May, DC, 83-1 USTC ¶9220.

M.D. Rotzinger, DC Ill., 88-1 USTC ¶9303.

A. Abdo, Jr., DC N.C., 2001-2 USTC ¶50,591.

D.P. Rosile, Sr. DC Fla., 2002-2 USTC ¶50,566.

R.L. Foster, DC Va., 2002-2 USTC ¶50,785.

A. Abdo, Jr., DC N.C., 2003-1 USTC ¶50,107. Aff'd, per curiam, CA-4 (unpublished opinion), 2003-1 USTC ¶50,483.

J.D. Hubacek, DC Nev., 2004-2 USTC ¶50,346.

J.E. Wolf, DC Okla., 2005-1 USTC ¶50,319.

C.B. Eden, DC Mo., 2005-1 USTC ¶50,366.

L.A. Baxter, DC Ala., 2005-1 USTC ¶50,423.

J.A. Fernandez, DC Fla., 2005-2 USTC ¶50,611.

J.E. Rosamond, DC La., 2005-2 USTC ¶50,639.

B.J. Hill, DC Ariz., 2006-1 USTC ¶50,252.

L.A.P. Moser, DC Hawaii, 2007-1 USTC ¶50,104.

E. Sonibare, DC Minn., 2007-1 USTC ¶50,353.

A.J. Pugh, Jr., DC N.Y., 2007-2 USTC ¶50,814.

P.M. Ballard, DC Texas, 2008-1 USTC ¶50,267.

D.L. Prewett, DC Fla., 2008-1 USTC ¶50,325.

R. Kyle, DC Calif., 2008-2 USTC ¶50,559.

A first-instance permanent injunction from tax preparation business was issued against two return preparers; however, the preparers were allowed to continue their tax return preparation business. The preparers knowingly misrepresented their eligibility to practice before the IRS and prepared or aided in the preparation of their customers' returns that understated their customers' tax liabilities based on positions which they knew or had reason to know were without a reasonable basis. Because the government had suffered irreparable harm and had no adequate remedy at law, injunctive relief was warranted to prevent a recurrence of such conduct. However, a balance of the hardships and consideration of the public interest favored allowing the preparers to continue their tax return preparation business, while enjoining the offending conduct. The delay in enforcement by the IRS, coupled with the preparers' good faith effort towards eradicating past unlawful behavior and implementing procedures and practices designed to minimize or eliminate errors or mistakes in their tax preparation practice weighed against a permanent bar.

A.E. Cruz, DC Fla., 2009-1 USTC ¶50,145.