Tax Attorney: Tile worker held to be an independent contractor
An individual hired to do tiling work in a condominium renovation was an independent contractor, not an employee, and was, therefore, liable for the self-employment tax. The taxpayer was hired to perform tile work on the condominium for a fixed price. The party paying for the renovation supplied only the tile itself, while the taxpayer supplied his own tools and the materials necessary for the work (glue, grout, etc.) and, if the cost of materials exceeded the payment the taxpayer received, he would lose money. After the party renovating the condominium and the taxpayer had a dispute about his work hours, a set work schedule was established. The party performing the renovation indicated that he would not hire the taxpayer for any additional projects, and did not withhold FICA taxes from his payments to the taxpayer and the taxpayer never filled out a Form W-4. The taxpayer's degree of control over his own work, the fact that he provided his own tools and materials, his risk of loss on the project, the fact that he could not be discharged from the job, the lack of permanency in the relationship and the lack of intent to form an employer-employee relationship were consistent with independent contractor status. Only the fact that the taxpayer's work was integral to the renovation of the condominium indicated an employer-employee relationship. -
Uriah Vincent Jones v. Commissioner.
Dkt. No. 18719-05 , TC Memo. 2007-249, August 27, 2007.
[Code Sec. 3401]
Withholding: FICA: Independent contractor. --
H.
Uriah Vincent Jones, pro se; Ladd C. Brown, Jr., for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined a deficiency of $2,274 in petitioner's Federal income tax for 2003. After concessions by petitioner, the issue for decision is whether petitioner is liable for self-employment tax. This turns on whether petitioner was an employee or independent contractor of DBMA Corporation (DBMA) during 2003.
FINDINGS OF FACT
Some facts are stipulated and are so found. The stipulated facts and the exhibits submitted therewith are incorporated herein by this reference. At the time he filed the petition, petitioner resided in Palm Beach Gardens, Florida.
From August through December 2003, petitioner, a marble and tile installer, worked on a condominium renovation for DBMA. Barry Shapiro (Mr. Shapiro), president of DBMA, hired petitioner to work on the condominium renovation.
Petitioner submitted a series of proposals to Mr. Shapiro describing the work petitioner was to perform on the condominium renovation. Mr. Shapiro contracted petitioner to perform the tile work on the condominium renovation. In August 2003, petitioner began work by honing the floors and showers of the condominium and taking other preparatory steps in order to complete his work. From August through December 2003, petitioner worked a total of approximately 16 days on the condominium renovation.
DBMA paid petitioner a fixed sum for his work on the condominium renovation. If petitioner needed any additional assistants, petitioner was responsible for hiring, paying, and supervising them.
While working on the condominium renovation, petitioner provided his own work tools. In addition to work tools, petitioner also supplied grout, cork, cork glue, and soundproofing materials. Mr. Shapiro supplied the tile. DBMA did not reimburse petitioner for the supplies he purchased because these amounts were incorporated into petitioner's proposal.
Initially, petitioner set his own hours of work on the condominium renovation. A dispute arose between petitioner and Mr. Shapiro regarding the hours petitioner worked. After this dispute, petitioner agreed to maintain a fixed work schedule of 10:30 a.m. to 4:30 p.m. when working on the condominium renovation.
DBMA paid petitioner $8,360 for his work on the condominium renovation. At no point did petitioner ever sign or submit a Form W-4, Employee's Withholding Allowance Certificate (Form W-4). After petitioner completed work on the condominium renovation, Mr. Shapiro did not engage the services of petitioner on other jobs. In 2003, petitioner worked for three other companies that treated him as an employee, and all three companies issued him Forms W-2, Wage and Tax Statement (Forms W-2), as opposed to Forms 1099-MISC, Miscellaneous Income (Forms 1099-MISC).
Petitioner timely filed a Form 1040EZ, Income Tax Return for Single and Joint Filers With No Dependents, for 2003. Petitioner conceded that he did not report the income he received from DBMA on his 2003 tax return. After filing his 2003 income tax return, petitioner received a Form 1099-MISC, from DBMA. Petitioner did not amend his 2003 tax return after receiving the Form 1099-MISC.
Respondent timely mailed a notice of deficiency to petitioner with respect to taxable year 2003, and petitioner timely petitioned the Court.
OPINION
The burden of proof is on petitioner to show that respondent's determination set forth in the notice of deficiency is incorrect. Rule 142(a)(1);1 Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner has neither claimed nor shown that he satisfied the requirements of section 7491(a) to shift the burden of proof to respondent with regard to any factual issue. Accordingly, petitioner bears the burden of proof. Rule 142(a).
The Federal Insurance Contributions Act (FICA), secs. 3101-3125, 68A Stat. 415 (1954), taxes a portion of the wages paid to an employee (FICA tax). The portion of the wages taxed is defined in section 3121(a). Under FICA, the employer and the employee each pay a like amount of tax. See secs. 3101, 3111. The employer withholds the employee's half of the FICA tax and remits it, along with the employer's half, to the Department of the Treasury. See sec. 3102. The FICA tax has two components, the old age, survivors, and disability insurance portion (OASDI) and the hospital insurance portion. For the year in issue, the OASDI rate was 6.2 percent for both the employer and employee, a total of 12.4 percent. The hospital insurance portion was 1.45 percent for both the employer and the employee, a total of 2.9 percent. The combined rate of the FICA tax was 15.3 percent for 2003. DBMA did not withhold any FICA tax because it treated petitioner as an independent contractor.
Independent contractors are not subject to the FICA tax; however, they are subject to a tax under chapter 2 of the Code, the Self-Employment Contributions Act of 1954 (SECA), secs. 1401-1403. See secs. 1401 and 1402. The SECA tax is a different tax from the FICA tax, though the SECA tax contains the same two components as the FICA tax. The SECA rate is equal to the sum of the employer and employee tax rates under FICA.
For the purposes of FICA, an employee is defined as: (1) any officer of a corporation; (2) any common law employee; (3) any individual in a specified occupation group who is not a common law employee; and (4) any individual who performs services that are included under an agreement entered into pursuant to the Social Security Act, 42 U.S.C. sec. 218 (2000). Sec. 3121(d).
A common law employee-employer relationship exists when:
the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which services are performed; it is sufficient if he has the right to do so. The right to discharge is also an important factor indicating that the person possessing that right is an employer. Other factors characteristic of an employer, but not necessarily present in every case, are the furnishing of tools and the furnishing of a place to work, to the individual who performs the services. In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor. * * * [Sec. 31.3121(d)-1(c)(2), Employment Tax Regs.]
Petitioner contends that he was a common law employee of DBMA. We consider the following factors to decide whether a worker is a common law employee or an independent contractor: (1) The degree of control exercised by the principal; (2) which party invests in work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; and (7) the relationship the parties believed they were creating. Weber v. Commissioner, 103 T.C. 378, 387 (1994), affd. per curiam 60 F.3d 1104 (4th Cir. 1995). All the facts and circumstances of each case are considered, and no single factor is dispositive. Id.
1. Degree of Control
The degree of control necessary to find employee status varies with the nature of the services provided by the worker. Id. at 388. To retain the requisite control over the details of an individual's work, the principal need not stand over the individual and direct every move made by the individual; it is sufficient if he has the right to do so. Id. ; see sec. 31.3401(c)-1(b), Employment Tax Regs.
Similarly, the employer need not set the employee's hours or supervise every detail of the work environment to control the employee. Gen. Inv. Corp. v. United States , 823 F.2d 337, 342 (9th Cir. 1987). The fact that workers set their own hours does not necessarily make them independent contractors. Id.
As the project manager, Mr. Shapiro did have some control over petitioner. For instance, after a dispute regarding the hours petitioner kept, Mr. Shapiro and petitioner agreed that petitioner would maintain a fixed work schedule. Despite this, petitioner was free to complete by the means and methods of his choice, the work he was contracted to do. Petitioner advised Mr. Shapiro that the floor in the laundry room needed to be resloped. Additionally, petitioner completed work offsite at his home workshop after advising Mr. Shapiro as to the best means and method to complete the project.
Based on the record before us, petitioner's degree of control over his own work on the condominium renovation is consistent with independent contractor status.
2. Investment in Facilities
The fact that a worker provides his or her own tools generally indicates independent contractor status. Breaux & Daigle, Inc. v. United States , 900 F.2d 49, 53 (5th Cir. 1990).
Petitioner provided his own tools. Furthermore, other than the tile, petitioner supplied most of the supplies he used such as grout, soundproofing materials, cork, and cork glue. Additionally, petitioner was not reimbursed for the materials that he provided. These amounts were included in the proposals that petitioner provided.
Based on the record before us, this factor is consistent with independent contractor status.
3. Opportunity for Profit or Loss
As noted supra, petitioner sent proposals to Mr. Shapiro regarding the work to be done on the condominium renovation. DBMA paid petitioner a fixed sum regardless of the time spent on the job. If petitioner underestimated the cost of the supplies needed or the time it took to complete the job, petitioner bore the risk of losing money, not Mr. Shapiro. Furthermore, if assistants were needed, it was petitioner's sole responsibility to hire and pay them. Additionally, petitioner bore the risk of loss on any loss or damage to his work tools.
Based on the record before us, petitioner's opportunity for profit or loss on his work on the condominium renovation is consistent with independent contractor status.
4. Right To Discharge
Petitioner was never fired by Mr. Shapiro, but Mr. Shapiro chose not to engage petitioner on any future projects. It appears that as long as petitioner's work was quality work that met the job specifications, petitioner could not have been dismissed from his duties on the condominium renovation. Petitioner phoned Mr. Shapiro approximately 3 weeks after petitioner completed work on the condominium renovation. At that time, only after petitioner had finished his duties on the condominium renovation, Mr. Shapiro notified petitioner that he did not wish to work with petitioner on any other projects.
Based on the record before us, the fact that petitioner could not be discharged as long as his work met the specifications is consistent with independent contractor status.
5. Integral Part of Business
As the project manager on the condominium renovation, Mr. Shapiro's responsibilities included making sure that the work was completed. The condominium renovation required tile work. Accordingly petitioner's job was an integral part of DBMA's work.
Based on the record before us, the integral nature of petitioner's work could suggest employee status. This, however, is but one factor that must be weighed among the others.
6. Permanency of the Relationship
A transitory work relationship may point toward independent contractor status. Herman v. Express Sixty-Minutes Delivery Serv ., Inc., 161 F.3d 299, 305 (5th Cir. 1998). If, however, the worker works in the course of the employer's trade or business, the fact that he does not work regularly is not necessarily significant. Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 430 (2d Cir. 1974) (transients may be employees); Kelly v. Commissioner, T.C. Memo. 1999-140 (working for a number of employers during a tax year does not necessitate treatment as an independent contractor). In considering the permanency of the relationship, we must also consider the principal's right to discharge the worker and the worker's right to quit at any time.
DBMA contracted petitioner to work on the condominium renovation and paid petitioner for the job he performed, regardless of the amount of time petitioner spent on the work. Petitioner worked for approximately 16 days, from August through December 2003, on the condominium renovation and received 14 checks from DBMA for his work. Although petitioner stated that DBMA promised him more work, whether or not the relationship continued was within the discretion of Mr. Shapiro. Once DBMA completed the condominium renovation, the relationship between petitioner and DBMA ceased.
Before petitioner began the condominium renovation, he was an employee of Koeckritz Enterprises, Inc. (Koeckritz). Prior to working for Koeckritz, in 2003 petitioner also worked for Celtic Marble & Tile, Inc., and Selective HR Solutions V, Inc. During 2003, petitioner received a total of three Forms W-2 from the three employers. This, however, does not require us to conclude that petitioner worked for DBMA as an employee.
Based on the record before us, petitioner's lack of a permanent relationship with DBMA is consistent with independent contractor status.
7. Relationship the Parties Thought They Created
Petitioner has worked on tile and marble installation for dozens of companies and stated that he always has been treated as an employee by those other companies. Mr. Shapiro stated that DBMA never had any employees and always has treated the individuals who worked for DBMA as independent contractors and issued them Forms 1099-MISC. Although the parties thought they were creating different relationships, we note that petitioner did not submit a Form W-4 to DBMA as he submitted to his three employers. The record does not indicate that petitioner requested or inquired about a Form W-4 from DBMA.
Based on the record before us, the facts are consistent with independent contractor status.
8. Conclusion
In the matter before us, although one factor might indicate an employer-employee relationship, the vast majority suggest that petitioner was an independent contractor of DBMA. Having weighed the evidence and considered the totality of the circumstances, we conclude that petitioner was an independent contractor of DBMA. As a result, he is responsible for self-employment tax for 2003.
In reaching our holding herein, we have considered all arguments made by the parties, and to the extent not mentioned above, we find them to be irrelevant or without merit.
To reflect the foregoing,
Decision will be entered for respondent.
1 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the year in issue.
Alvin S. Brown, Esq.
tax attorney
703.425.1400 ex 106
www.irstaxattorney.com
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Tuesday, August 28, 2007
Monday, August 27, 2007
Back Taxes: New controversial return preparer reporting requirements
The new law requires the return preparer to prove that a postion Thas a "realistic possibility" of being successful.
That new standard is rediculous. Most return preparers are untrained, inexperienced and they are not lawyers. In addition there are no standards for "realistic possibility." That standard is very subjective. I agree with the criticism of the new law as discussed below.
My personal advice to all tax return preparers is to always file a disclaimer when they file a tax return. The disclaimer should identify the basis for the information on the tax return. The disclaimer should be a full disclosure of the source of all of the data used in the tax return and what decisions were made in determining any of the data used in the tax return.
Notice 2007-54 , to be published in I.R.B. 2007-27, July 2, 2007.
[ Code Secs. 6662, 6694 and 7701]
Estate, gift, generation-skipping transfer, and income taxes: Returns and procedures: Return preparer penalties: Transitional relief. --
The IRS has provided transitional relief and guidance relating to the return preparer penalty provisions of Code Sec. 6694, as amended by the Small Business and Work Opportunity Act of 2007 (P.L. 110-28) (the Small Business Tax Act). The Small Business Tax Act expanded the income tax return preparer penalties to apply to all tax return preparers, including preparers of estate, gift, and generation-skipping transfer (GST) tax returns. The amendments also altered the standards of conduct that a return preparer must meet to avoid imposition of the penalty.
The "realistic possibility" standard for undisclosed positions was replaced by an "unreasonable position" standard. In addition, the Small Business Tax Act of 2007 increased the amount of the return preparer penalty for the understatement of a tax liability from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim.
The return preparer penalty for an understatement of tax liability due to willful or reckless conduct was increased under the new law from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim. The IRS is considering the type of guidance necessary to address the changes made by the Small Business Tax Act. In the interim, for estate, gift, and GST tax returns, the reasonable basis standard provided in the regulations issued under Code Sec. 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the IRS will impose a penalty under Code Sec. 6694(a). The transitional relief is effective as of May 25, 2007.
.
This notice provides guidance and transitional relief for the return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Act of 2007.
SCOPE
The transitional relief provided by this notice will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.
BACKGROUND
The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat. ___, (the Act) was enacted into law on May 25, 2007. Section 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.
The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of section 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers. In order to address these questions, the Internal Revenue Service and the Treasury Department are considering whether regulations or other published guidance are needed, including but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4. Because the Act extends the types of returns subject to the new provisions, changes are also required to the relevant forms and publications. The Service must also alter existing procedures in order to process disclosures with certain forms and in electronic formats. Because the amendments to section 6694 are effective immediately for returns prepared after May 25, 2007, the Service and the Treasury Department believe that effective tax administration requires transitional relief with respect to the new standards of conduct under section 6694(a).
PENALTY UNDER SECTION 6694
Prior to amendment by the Act, the penalty under section 6694(a) applied if:
(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,
(2) any person who is an the income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and,
(3) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous.
Prior to amendment by the Act, the penalty under section 6694(b) applied if any part of an understatement was due to:
(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or
(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.
Section 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns. The Act amended section 6694(a) to provide that the penalty would apply if:
(A) the tax return preparer knew (or reasonably should have known) of the position,
(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the position.
Although the Act did not alter the standard of conduct under section 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.
Section 8246 of the Act amends the standards of conduct under section 6694(a) in two ways. First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.
The Act also increased the first-tier section 6694(a) penalty for understatements from $250 to the greater of $1000 or 50% of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier section 6694(b) penalty for willful or reckless conduct from $1000 to the greater of $5,000 or 50% of the income derived (or to be derived) by the tax return preparer.
Under both the prior and current law, disclosure under section 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2). In addition, under both the prior and current law, the penalty under section 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.
TRANSITIONAL RELIEF
In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service is providing the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the Service will impose a penalty under section 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).
For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the Service will impose a penalty under section 6694(a).
This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.
No transitional relief is available under section 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.
EFFECTIVE DATE
This Notice is effective as of May 25, 2007.
CONTACT INFORMATION
The principal author of this notice is Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Hara at (202) 622-4910 (not a toll-free call).
Controversial Return Preparer Reporting Standards Must Be Corrected, AICPA Tells Congress
The controversial "more likely than not" reporting standards for return preparers in the Small Business and Work Opportunity Tax Act of 2007 (2007 Act) (P.L. 110-28) should apply to tax-avoidance items and not to routine items, the AICPA told leaders of the House and Senate tax-writing committees in a July 10 letter released on July 13. The AICPA also warned that preparers will become advisors, rather than advocates, because of the new law.
"More Likely than Not"
The 2007 Act increases the tax return reporting standards under Code Sec. 6694 on undisclosed, nontax avoidance items from the "realistic possibility of success" to "more likely than not." The AICPA observed, "A preparer must satisfy a higher standard than the standard the taxpayer must satisfy (substantial authority) to avoid the imposition of an understatement penalty." In addition, "it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared even though the taxpayer would not be subject to a penalty with respect to that same tax return position."
In addition to the penalty in the statute, practitioners could be in violation of Circular 230 with another penalty and automatic referral to the IRS Office of Professional Responsibility," AICPA Vice President - Taxation Thomas Ochsenschlager, stated.
Preparer's Role
The "more likely than not" approach "results in a fundamental change in the role of a preparer," the AICPA warned. Preparers become advisors rather than advocates.
The AICPA also cautioned that determining the probable correctness of the treatment of routine items would be extremely difficult, if not impossible. "There sometimes is little guidance for the tax treatment of an item at the time the item must be reported on a return and the proper treatment of an item frequently depends on an analysis of unique or unusual circumstances that were not contemplated in published guidance."
Corrective Action
Congress should equalize the return preparer standards with the taxpayer standards, the AICPA stated. For nontax-avoidance items, the "substantial authority" standard should apply. The "more-likely-than-not standard" should apply for tax-avoidance items, such as items attributable to any "listed transaction." The AICPA also recommended an expansion of the authorities that can be relied on in determining if the "substantial authority" is met to include field service advice memoranda, treatises and legal scholarly literature.
Ochsenschlager explained that this "major change in tax policy" was made without any congressional hearings. The AICPA, in its letter to House Ways and Means Committee Chairman Charles B. Rangel, D-N.Y., and ranking member Jim McCrery, and Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking member Charles E. Grassley, R-Iowa, said that the IRS was "blindsided" by the new rule. The IRS issued transitional relief in June (IR-2007-115, Notice 2007-54, I.R.B. 2007-27, 12, TAXDAY, 2007/06/12, I.4). At this time, legislation has not yet been introduced in Congress.
SEC. 6694. UNDERSTATEMENT OF TAXPAYER'S LIABILITY BY TAX RETURN PREPARER.
6694(a) UNDERSTATEMENT DUE TO UNREASONABLE POSITIONS. --
6694(a)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a position described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --
6694(a)(1)(A) $1,000, or
6694(a)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.
6694(a)(2) UNREASONABLE POSITION. --A position is described in this paragraph if --
6694(a)(2)(A) the tax return preparer knew (or reasonably should have known) of the position,
6694(a)(2)(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
6694(a)(2)(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
6694(a)(2)(C)(ii) there was no reasonable basis for the position.
6694(a)(3) REASONABLE CAUSE EXCEPTION. --No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.
6694(b) UNDERSTATEMENT DUE TO WILLFUL OR RECKLESS CONDUCT. --
6694(b)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a conduct described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --
6694(b)(1)(A) $5,000, or
6694(b)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.
6694(b)(2) WILLFUL OR RECKLESS CONDUCT. --Conduct described in this paragraph is conduct by the tax return preparer which is --
6694(b)(2)(A) a willful attempt in any manner to understate the liability for tax on the return or claim, or
6694(b)(2)(B) a reckless or intentional disregard of rules or regulations.
6694(b)(3) REDUCTION IN PENALTY. --The amount of any penalty payable by any person by reason of this subsection for any return or claim for refund shall be reduced by the amount of the penalty paid by such person by reason of subsection (a).
6694(c) EXTENSION OF PERIOD OF COLLECTION WHERE PREPARER PAYS 15 PERCENT OF PENALTY. --
6694(c)(1) IN GENERAL. --If, within 30 days after the day on which notice and demand of any penalty under subsection (a) or (b) is made against any person who is a tax return preparer, such person pays an amount which is not less than 15 percent of the amount of such penalty and files a claim for refund of the amount so paid, no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until the final resolution of a proceeding begun as provided in paragraph (2). Notwithstanding the provisions of section 7421(a), the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court. Nothing in this paragraph shall be construed to prohibit any counterclaim for the remainder of such penalty in a proceeding begun as provided in paragraph (2).
6694(c)(2) PREPARER MUST BRING SUIT IN DISTRICT COURT TO DETERMINE HIS LIABILITY FOR PENALTY. --If, within 30 days after the day on which his claim for refund of any partial payment of any penalty under subsection (a) or (b) is denied (or, if earlier, within 30 days after the expiration of 6 months after the day on which he filed the claim for refund), the tax return preparer fails to begin a proceeding in the appropriate United States district court for the determination of his liability for such penalty, paragraph (1) shall cease to apply with respect to such penalty, effective on the day following the close of the applicable 30-day period referred to in this paragraph.
6694(c)(3) SUSPENSION OF RUNNING OF PERIOD OF LIMITATIONS ON COLLECTION. --The running of the period of limitations provided in section 6502 on the collection by levy or by a proceeding in court in respect of any penalty described in paragraph (1) shall be suspended for the period during which the Secretary is prohibited from collecting by levy or a proceeding in court.
6694(d) ABATEMENT OF PENALTY WHERE TAXPAYER LIABILITY NOT UNDERSTATED. --If at any time there is a final administrative determination or a final judicial decision that there was no understatement of liability in the case of any return or claim for refund with respect to which a penalty under subsection (a) or (b) has been assessed, such assessment shall be abated, and if any portion of such penalty has been paid the amount so paid shall be refunded to the person who made such payment as an overpayment of tax without regard to any period of limitations which, but for this subsection, would apply to the making of such refund.
6694(e) UNDERSTATEMENT OF LIABILITY DEFINED. --For purposes of this section, the term "understatement of liability" means any understatement of the net amount payable with respect to any tax imposed by this title or any overstatement of the net amount creditable or refundable with respect to any such tax. Except as otherwise provided in subsection (d), the determination of whether or not there is an understatement of liability shall be made without regard to any administrative or judicial action involving the taxpayer.
6694(f) CROSS REFERENCE. --
For definition of tax return preparer, see section 7701(a)(36).
National Association of Tax Professionals Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007
August 27, 2007
National Association of Tax Professionals: Comments: Tax gap.
NATP
National Association of Tax Professionals
Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007
Tax Return Reporting Standards for Preparers
July 30, 2007
EXECUTIVE SUMMARY -
We understand and support the need and determination on the part of Congress and the Treasury to reduce the "tax gap." Our members are solidly behind reasonable efforts toward this goal. We urge caution, however, as well as support from the public in enacting provisions that impinge upon their rights and relationships in satisfying their compliance with tax law. There was not so much as a hearing on this vital matter nor was there any recommendation from Treasury to create this conflict.
The National Association of Tax Professionals (NATP) was surprised that, on May 25, a tax provision, found in section 8246 of the U.S. Troop Readiness, Veteran's Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 ("the Act"), was enacted without warning and without the characteristic protocol accorded the public to comment. The provision was made under Subtitle B of Title VIII of the Act and is popularly referred to as the "Small Business and Work Opportunity Act of 2007."
Section 6694 of the Internal Revenue Code was thereby amended to revise and raise the standards for tax preparers and those who provide advice, the result of which ends up on a return. The problem arises in that the standards were raised to a point higher or "tougher" than the standards for the taxpayer him or herself. Tax preparers, in order to be protected from a possible imposition of an understatement penalty, must now either hold and be able to demonstrate a reasonable belief that a position taken on a return would "more likely than not" be sustained on its merits, or otherwise insist on a disclosure of the position on the return. Taxpayers, on the other hand, may take a position on a return that has a "substantial authority" for being upheld. Previous to the enactment of this provision, tax return preparers were held to a standard (realistic possibility of success) that was lower than the standard for taxpayers. The Act further extends the penalties for understatement of tax liability to all tax returns including estate and gift tax returns, employment tax returns, and excise tax returns and significantly increases their amounts.
Given the rapid and constant rate at which federal tax law changes, taxpayers increasingly seek the aid of a competent preparer. It is now common to have issues awaiting guidance from Treasury as well as from the IRS in order for professionals, much less taxpayers, to understand the substantively correct position to be taken with regard to an item on a return. It is also now common for technology to challenge guidance previously issued by Treasury and the IRS. One has only to contemplate the continually developing issues affected by the domestic production activities deduction created in the American Jobs Creation Act of 2004 to understand this problem. Preparers and taxpayers are, in these cases, often in the realm of meteorologists in determining the chances of a position being substantively correct. Preparers, however, are subject to penalties for understatement of a tax liability if that reporting standard cannot be satisfied unless they insist on a disclosure of the item. Add to this the fact that the imposition and determination of the appropriateness of the increased penalties are all at the discretion of the IRS and the effect on advocating and representing the taxpayer is indeed chilling.
It appears as though the rights of taxpayers to tax advice and counsel are somewhat less that that of other potential litigants. Imagine standards such as these being imposed in the context of a civil or criminal proceeding. NATP requests a correction to the obvious problems caused by this provision of the Act.
NATP is an eclectic group of tax professionals. Our membership is comprised of attorneys, CPAs, EAs, CFPs, CSAs, BBAs, LLBs, JDs, MBAs, PhDs, as well as Associate degrees, those who have entered the profession as a second career and part-time professionals. Therefore, we have no bias for any one group of tax professionals over another. Our 18,000+ members are employed in offices that assist more than eleven million taxpayers. All of NATP's members are potentially negatively impacted by Section 8246 of the Act, as are all taxpayers. The change in standards resulting from this legislation causes, at a minimum, the following serious problems not only for tax return preparers, but also for taxpayers and the government:
The change made by the Act raises the tax return reporting standard for preparers above the standard for taxpayers, thereby creating the potential for conflicts of interest between preparers and their clients. As a result, it affects the very nature of the representation of taxpayers and a taxpayer's right to representation. Taxpayers pay for and expect competent service that does not put them at a further disadvantage than the duty to which they are personally held in paying a fair and just tax.
Applying the tougher "more likely than not" standard to a tax return preparer results in a fundamental change in the role of the preparer, from that of an advocate to that of an advisor or even an auditor.
It is frequently extremely difficult, if not impossible, to determine the probable correctness of the treatment of some routine items with the degree of certainty required for the higher "more likely than not" standard because: (1) there sometimes is little guidance, if any, for the tax treatment of an item at the time the item must be reported on a return; and (2) the proper treatment of an item frequently depends on an analysis of unique or unusual facts and circumstances that were not contemplated in published guidance.
A disclosure made under a system with a "more likely than not" standard could be viewed as a concession on the merits.
The potential penalties on a preparer for failure to satisfy that high standard are so severe that preparers will feel compelled to protect themselves by urging their clients to include disclosures for virtually every item for which there is even the slightest uncertainty regarding the proper treatment. This problem is compounded by the fact that the preparer could be subject to disciplinary action by the IRS Office of Professional Responsibility. These excessive disclosures for routine tax return positions will overburden tax administration, thereby defeating the purpose of the disclosure system and also undermining the electronic filing initiative, which currently is not capable of processing a large number of disclosures in a return.
To avoid this disruption to our tax system and the resultant unfairness to the taxpayer and tax return preparer, NATP recommends that the section 6694 tax return preparer standards be either restored to their standard before the Act (realistic possibility of success) or, at most, raised to a point equal with the taxpayer standards (substantial authority). We would agree that for tax shelter ("tax avoidance") items the "more likely than not" standard should continue to apply. For non-tax shelter ("non-tax avoidance") items, however, the "substantial authority" standard should apply. The rationale for these recommendations is set forth in more detail below.
About NATP
Whereas we could claim here that the National Association of Tax Professionals (NATP) represents the hundreds of thousands of tax return preparers affected by this proposed bill, we believe in stating facts that are not misleading. NATP's 18,000 members are employed in offices that assist more than 11 million taxpayers. Our members include individual preparers (81% of which have undergraduate or graduate degrees), Enrolled Agents, Certified Public Accountants, accountants, attorneys, and Certified Financial Planners. NATP is a nonprofit professional association that is committed to the integrity of the tax administration system and the application of tax laws and regulations by providing education, research, and information to tax professionals. For almost 30 years, we have existed to serve professionals who work in all areas of tax practice. We provide our members with over 200 tax education offerings in over 100 cities throughout the United States, a service unmatched by any other national tax association. In addition, our 35 Chapters and National headquarters serve the public through regular news releases, client brochures and newsletters, and a designated taxpayer website. Our Chapters provide significant member involvement in local and state communities. Our headquarters are located in Appleton, Wisconsin. Our members are served by a staff of 42 employees, 14 of which are CPAs, attorneys, and EAs.
General Comments
The changes brought about by section 8246 of the Act to section 6694 of the Internal Revenue Code surprised tax professionals in every industry association and industry media publication as well as those in government administration. There is a time-honored protocol usually followed by Congress when pursuing legislation that will have a profound effect on the American public at large. There are usually hearings with attendant publicity and subsequent study over such momentous matters. Commentary is sought from respected authorities, academicians, independent policy institutes and the public. Additional debate quite often emanates from Congressional committees and subcommittees. These changes, however, were contained in an appropriations bill introduced on May 8 to help fund the war in Iraq among other things. It passed on May 25. Somehow, in all the fervor, Congress either side-stepped or forgot about this protocol.
We read, in the June 4 edition of Tax Notes Today, that the IRS Chief Counsel commented about the sudden and unexpected change to section 6694, indicating that the IRS had been "blind-sided" by this provision in the Act. It constitutes a major change in tax policy. Although the Treasury Department did ask for and increase in the dollar amount of the section 6694 penalty, it did not recommend a change in the preparer standards. No one, other than Congressional staff, had the chance to view and comment on this legislation. Little time, if any, was given to its study. . .which could easily lead one to conclude that the full consequences of this particular provision were not studied by Congress. Indeed, there is already a proposal to amend a portion of the Act for this very reason.
NATP joins with many others in the industry on behalf of American taxpayers to voice the need and urge Congress to correct the problems and inequities in Section 8246 of the Act. We have held discussions with the AICPA on these matters. We support the positions put forth in their July 10 paper on these issues. We also agree with the AICPA that this matter requires expeditious treatment for the tax profession, taxpayers and the tax administration system. It is in that spirit that the National Association of Tax Professionals hereby submits the detailed commentary below on the nature and consequences of this provision in the hope that it will be studied and that a correction to the problems therein set forth will be expedited. Whereas we have made some original comment, we believe there is no need or time to "reinvent the wheel" by otherwise restating the eloquent positions already set forth by the AICPA. The detailed commentary submitted is largely that of the AICPA, used with their permission.
SPECIFIC COMMENTS
Having Different Reporting Standards for Taxpayers and Preparers is Bad Policy
Section 6694 as revised by the Act, requires that a preparer must satisfy a higher standard ("more likely than not") than the standard the taxpayer must satisfy ("substantial authority") in order to avoid the imposition of an understatement penalty with respect to an undisclosed, non-tax avoidance item reported on the taxpayer's return. Thus, it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared, even though the taxpayer would not be subject to a penalty with respect to that same tax return position. That is just plain bad tax policy.
Having a higher standard for the preparer may result in a conflict of interest situation between the preparer and the taxpayer. If the higher preparer standard is not satisfied for a tax return position, the preparer can be protected from the imposition of the section 6694 penalty only if that position is disclosed on the taxpayer's return. Thus, in some situations, even though the taxpayer is not required to disclose a position on a return, the preparer might be forced to encourage the taxpayer to do so, to protect the preparer from a penalty. This is also, clearly, bad policy.
Section 10.29 of Circular 230 specifies generally that "a practitioner shall not represent a client ... before the Internal Revenue Service if the representation involves a conflict of interest." It then defines "conflict of interest" to include a situation where there is "a significant risk that the representation of one or more clients will be materially limited by ... a personal interest of the practitioner." The provision in the Act that raises the preparer standard above that of the taxpayer for penalty purposes creates the potential for conflict of interest situations that could put preparers in violation of Circular 230; thus, it is contrary to a fundamental policy underlying practice before the IRS.
Further, the preparer does not control the taxpayer's tax return and cannot force the taxpayer to disclose a position on a return. If the taxpayer does not agree to disclose the position, the preparer could be placed in a professionally difficult situation of not being able to sign the taxpayer's return, which would be particularly problematic in view of the section 6695 penalty for failure to sign returns that an individual prepares. The very nature of tax representation and a taxpayer's right to representation could be adversely affected if the preparer is required to withdraw from an engagement because the taxpayer will not include a disclosure in the taxpayer's return. It also puts the preparer in an economically disadvantaged position in trying to collect for services rendered.
In addition, a preparer's withdrawal from an engagement because of the taxpayer's refusal to disclose may result in the taxpayer seeking out a preparer who is less knowledgeable about the merits of the position or who feels less constrained by ethical standards and is, therefore, willing to prepare and sign returns that do not comply with the section 6694 reporting standards. Alternatively, the difference in standards between taxpayers and paid preparers may result in the taxpayer deciding to prepare returns in house, in which case the section 6694 standard would not apply.
Accordingly, for the sake of equity in the application of understatement penalties, the ethical operation of the tax compliance system, sound tax policy and the preservation of the nature of taxpayer representation and the taxpayer's right to representation, it is critical that the standards applicable to tax return preparers be, at most, equalized with the standards applicable to taxpayers.
The Recognized Right of the Public to Advocacy and Representation and the Right to Practice
Richard Morgante, Commissioner of the Wage and Investment Division of the IRS, spoke at NATP's National Conference in Las Vegas on July 24, 2007. He stated that ". . .the IRS expects the American public to pay only the amount of tax owed, no more. . .but no less." Sixty percent of taxpayers engage the services of a tax professional in order to accurately determine the amount of tax owed. They pay for the knowledge of the complexity of our tax laws so that their tax liability can be fairly determined. A tax return preparer has long been viewed as having dual roles - as an advocate for the taxpayer-client, and as an advisor with a duty not only to the taxpayer-client, but also to the public and the tax system. The advocacy role of the preparer previously had been recognized and accepted by the government, as evidenced by the "realistic possibility of success" reporting standard in section 6694 prior to the recent revision and in the current section 10.34 of Circular 230. The House Committee Report accompanying the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) stated "[t]he committee has adopted this new standard because it generally reflects the professional conduct standards applicable to lawyers and to certified public accountants." The new, "more likely than not," reporting standard substantially and inequitably changes that, turning preparers into supplemental representatives of the IRS through a form of coercion. What's more, in those cases where a return must be filed before adequate guidance is given with respect to a difficult tax issue, the IRS and the Treasury Department have the luxury of playing "Monday morning quarterbacks" in determining the appropriate treatment of a particular tax item or circumstance.
This is a major change in tax policy that should not have been made without hearings and extensive consideration. For this reason, the change to the "more likely than not" reporting standard for non-tax avoidance items should be overridden. As noted above, NATP recommends that the preparer standards should be, at most, equalized with the "realistic possibility of success" standards that apply to taxpayers.
When a "Higher Standard" Ought to Apply to Tax Return Preparers
The United States income tax system has long been recognized as voluntary on the part of taxpayers. They are expected to report their transactions in accordance with the rules prescribed by the income tax laws. Congress has wisely built into the system the flexibility for taxpayers to reasonably interpret the many grey areas of the law without the threat of having penalties imposed. This flexibility is evidenced in the twotiered approach to the standards applicable to taxpayers; one approach for routine, non-tax avoidance items and one for potentially abusive tax avoidance items.
As part of that approach, Congress, Treasury, and the IRS have developed a disclosure regime to provide the IRS with early knowledge of potentially abusive transactions that merit scrutiny. The regime uses various "filters" (i.e., a focus on certain types of transactions) for capturing useful information from taxpayers and "material advisors" while at the same time minimizing the burden imposed on those individuals. This targeted approach to obtaining disclosures also minimizes the number of unnecessary disclosures that must be dealt with by the IRS.
"Substantial Authority" Standard for Non-Tax Avoidance Items
Currently, section 6662 provides that an understatement penalty will not be imposed on a taxpayer with respect a tax return position taken for a non-tax avoidance item if either: (1) the taxpayer has "substantial authority" for the tax treatment of the item on the tax return (i.e., the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions, typically understood to be approximately a 40% likelihood of the treatment prevailing on the merits); or (2) the taxpayer made a specific disclosure of the position on the return and there was a "reasonable basis" for the tax treatment of the item on the tax return (i.e., roughly a 20% likelihood of the treatment prevailing on the merits).
Federal tax law is constantly changing; at any given time, there are many issues awaiting guidance from the Treasury Department and the IRS. For example, Treasury's 2006 - 2007 Priority Guidance Plan lists 264 guidance projects that Treasury planned to address between July 2006 and June 2007. As a result, there is sometimes little or no authority or guidance for the tax treatment of an item at the time the item must be reported on a return. Even if there is some authority, in many instances, the proper treatment of an item may not be clear where there are unique facts and circumstances. Thus, given the exceedingly complex and dynamic nature of the tax law, it may be difficult for taxpayers and preparers to know the probable correctness of many return positions. It is not only unrealistic, but in many cases, impossible, to ensure the proper tax treatment of an item with the high degree of accuracy required by the "more likely than not" standard. In some situations, there simply may be no tax treatment that is "more likely than not" the proper treatment.
When Congress created the current section 6662 taxpayer substantial understatement penalty in 1982, it recognized these problems and, as a result, for non-tax avoidance items, decided against imposing a standard requiring certainty, such as the "more likely than not standard" does. The Joint Committee on Taxation Blue Book for Public Law 97-248, section 323 (a) specifically notes that: "Congress did not adopt an absolute standard that a taxpayer may take a position on a return only if, in fact, the position reflects the correct treatment of the item because, in some circumstances, tax advisors may be unable to reach so definitive a conclusion. Rather, Congress adopted a more flexible standard under which the courts may assure that taxpayers who take non-disclosed highly aggressive filing positions are subject to the penalty while those who endeavor in good faith to fairly self-assess are not penalized."
The IRS task force that studied the penalty regime in 1989 likewise pointed out that:
"...a variety of factors limit the ability of taxpayers to report positions disclosing a liability that is probably correct. Perhaps the most significant limitation is the ambiguity inherent in applying a complex and changing set of tax rules to an infinite variety of factual situations, which may themselves be of ambiguous import. These complexities may result in failure to recognize issues, incorrect conclusions as to the probability that a particular position will prevail, and differences of opinion regarding probability that are not resolvable short of the courthouse. The complexity of modern financial affairs, when coupled with the legal requirement to file a return by a statutory deadline and the costs of making the best possible assessment of each individual issue may also provide practical limits on the pursuit of a theoretically perfect return." Witness the myriad questions and factual diversity in the pursuit of the domestic production activity deduction fostered by the American Jobs Creation Act of 2004.
The current taxpayer standard of "substantial authority" for non-tax avoidance items strikes a balance, taking into account the uncertainties that exist when reporting an item on a return and the IRS' need to focus on information that will enable it to prevent abuses to the tax system. In contrast, a standard of "more likely than not" for non-tax avoidance transactions would pose an unworkable burden on the tax system. Accordingly, NATP strongly recommends that both the taxpayer and preparer standard for reporting non-tax avoidance items be, at most, "substantial authority." NATP also recommends an expansion of the authorities that can be relied on in determining if the "substantial authority" standard is met, to include field service advices, treatises, and legal scholarly literature.
"More Likely Than Not" Standard for Tax Avoidance Items
Section 6664(d) provides that an understatement penalty under section 6662A will not be imposed on a taxpayer for tax deficiencies that are assessed with respect to tax avoidance transactions if there was reasonable cause for the understatement and the taxpayer acted in good faith. Further, these requirements will be satisfied only if: (1) the taxpayer made a specific disclosure of the position on the return; (2) there was "substantial authority" for the tax treatment of the item on the return; and (3) the taxpayer reasonably believed that the tax treatment of the item on the return was "more likely than not" the proper treatment (i.e., a greater than 50% likelihood of the treatment prevailing on the merits).
NATP strongly supports well-targeted efforts to eliminate abusive transactions and close the "tax gap." Such transactions undercut the large majority of honest taxpayers and tax return preparers who strive every day to obey the increasingly complex tax laws. NATP believes that the most effective way to combat abusive transactions without interfering with a taxpayer's right to legally minimize taxes is through disclosure and penalties. But, for a disclosure system to be effective in combating abuse, it must be able to focus on the transactions that are the most likely to be abusive. If the "more likely than not" standard is applied to all items, including routine, non-tax avoidance items, the ability of the disclosure system to focus on abusive transactions will be seriously impaired.
Given the complexity of the tax law, the lack of guidance from the Treasury Department and the IRS on many issues, and the factual nature of many issues, the "more likely than not" standard for taxpayers has heretofore wisely been reserved for tax avoidance transactions rather than imposed as a uniform rule for all transactions. NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance items. This would be consistent with the approach that Congress and Treasury have taken in recent years to utilize directed disclosures that focus on the potentially problematic transactions without either overburdening the IRS with unnecessary disclosures or inhibiting the electronic filing system.
Does Disclosure Unfairly Concede the Issue?
A disclosure made in a tax system that has "more likely than not" as the reporting standard could be viewed as a concession of the issue disclosed, since the disclosure would only be required if an analysis of the applicable authorities and facts by the taxpayer or preparer resulted in the conclusion that the tax treatment "more likely than not" was not the proper treatment. If the preparer has concluded that the standard has not been satisfied, but the taxpayer wishes to pursue the matter and not disclose, the preparer could be forced to withdraw and the taxpayer's right to tax representation would be affected. So would the tax preparer's right to practice and the preparer's ability to collect for services rendered at that point. To avoid these results, with respect to non-tax avoidance items, NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance transactions.
As Ubiquitous as Circular 230 Disclosure Disclaimers
Because of the difficulty of satisfying the "more likely than not" standard, in many routine situations, and the severe penalties for understating tax liabilities, disclosures may be made for numerous tax return positions with respect to which there is any uncertainty regarding the ultimate tax treatment. The resulting increase in the number of disclosures will not create the desired outcome of the disclosure regime, which is the "weeding out" of abuses in the system. This doesn't even take into account the possibilities of multiple professionals covering their bases because they may be deemed "preparers" under this provision of the Act. Consider the recurring circumstance of inherited items and the treatment of their basis on a 1040. Who does the appraisal to determine basis? Will that appraiser be deemed a preparer for these circumstances? Will they want some disclosure of that fact on the taxpayer's return?
Adding to this problem is the fact that, if an understatement penalty is imposed on a preparer who is subject to Circular 230, the preparer may be subject not only to a high section 6694 monetary penalty, but also to an additional fine under Circular 230 and disciplinary action by the IRS Office of Professional Responsibility. Rather than risk such severe penalties, with a "more likely than not" standard, it is likely that preparers will strongly encourage disclosures, even on routine, non-tax avoidance items.
Clearly, this is not a desired outcome. The IRS will be swamped with paper; the ability of the IRS to focus its attention on potentially abusive tax avoidance transactions will be obstructed; the electronic filing system will be undermined, since currently it is not designed to accept a large number of disclosures per return; important disclosures will be overlooked; and a large percent of the voluminous disclosures will be meaningless. If you doubt that the IRS will be swamped with such disclosures, consider the ubiquitous disclaimers under Circular 230 that accompany every and any e-mail or other correspondence from a Circular 230 professional.
The Internal Revenue Service Advisory Council noted in the Briefing Book for its November 15, 2006 public meeting that, even under the current system of targeted disclosures, there is a continuing problem with overdisclosure. The Council gave an example of tens of thousands of unnecessary disclosures received during the year for just one type of transaction. The Council also noted that there is anecdotal evidence that little or nothing was being done with disclosures that had been made. In discussing this problem, the Council cautioned that although it was "fully supportive of the IRS' attack on "abusive tax shelters," it believed that "it is important for the IRS to distinguish between "abusive transactions and transactions that reduce a taxpayer's liability through appropriate tax planning." This situation of excessive disclosures will be drastically worsened if the standard for non-tax avoidance items is "more likely than not."
Given the overwhelming burden that will be imposed on the tax system by excessive disclosures that are made as a result of the high "more likely than not" standard, NATP strongly recommends that the taxpayer and preparer standard for reporting non-tax avoidance items be "substantial authority."
6. Conclusion
NATP recommends that the section 6694 tax return preparer standards be returned to their previous standard of the "realistic possibility of success" or, at most, equalized with the standards currently applicable to taxpayers (substantial authority) for non-tax avoidance items. For tax avoidance items, the "more likely than not" standard should continue to apply. Thank you for the opportunity to share these comments.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
To provide "IRS transparency" you should upload your IRS experiences to www.irsforum.org.
The new law requires the return preparer to prove that a postion Thas a "realistic possibility" of being successful.
That new standard is rediculous. Most return preparers are untrained, inexperienced and they are not lawyers. In addition there are no standards for "realistic possibility." That standard is very subjective. I agree with the criticism of the new law as discussed below.
My personal advice to all tax return preparers is to always file a disclaimer when they file a tax return. The disclaimer should identify the basis for the information on the tax return. The disclaimer should be a full disclosure of the source of all of the data used in the tax return and what decisions were made in determining any of the data used in the tax return.
Notice 2007-54 , to be published in I.R.B. 2007-27, July 2, 2007.
[ Code Secs. 6662, 6694 and 7701]
Estate, gift, generation-skipping transfer, and income taxes: Returns and procedures: Return preparer penalties: Transitional relief. --
The IRS has provided transitional relief and guidance relating to the return preparer penalty provisions of Code Sec. 6694, as amended by the Small Business and Work Opportunity Act of 2007 (P.L. 110-28) (the Small Business Tax Act). The Small Business Tax Act expanded the income tax return preparer penalties to apply to all tax return preparers, including preparers of estate, gift, and generation-skipping transfer (GST) tax returns. The amendments also altered the standards of conduct that a return preparer must meet to avoid imposition of the penalty.
The "realistic possibility" standard for undisclosed positions was replaced by an "unreasonable position" standard. In addition, the Small Business Tax Act of 2007 increased the amount of the return preparer penalty for the understatement of a tax liability from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim.
The return preparer penalty for an understatement of tax liability due to willful or reckless conduct was increased under the new law from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the preparer with respect to the return or refund claim. The IRS is considering the type of guidance necessary to address the changes made by the Small Business Tax Act. In the interim, for estate, gift, and GST tax returns, the reasonable basis standard provided in the regulations issued under Code Sec. 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the IRS will impose a penalty under Code Sec. 6694(a). The transitional relief is effective as of May 25, 2007.
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This notice provides guidance and transitional relief for the return preparer penalty provisions under section 6694 of the Internal Revenue Code, as amended by the Small Business and Work Opportunity Act of 2007.
SCOPE
The transitional relief provided by this notice will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.
BACKGROUND
The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat. ___, (the Act) was enacted into law on May 25, 2007. Section 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return which reflects an understatement of liability, and increase applicable penalties. The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.
The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of section 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers. In order to address these questions, the Internal Revenue Service and the Treasury Department are considering whether regulations or other published guidance are needed, including but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4. Because the Act extends the types of returns subject to the new provisions, changes are also required to the relevant forms and publications. The Service must also alter existing procedures in order to process disclosures with certain forms and in electronic formats. Because the amendments to section 6694 are effective immediately for returns prepared after May 25, 2007, the Service and the Treasury Department believe that effective tax administration requires transitional relief with respect to the new standards of conduct under section 6694(a).
PENALTY UNDER SECTION 6694
Prior to amendment by the Act, the penalty under section 6694(a) applied if:
(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits,
(2) any person who is an the income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position, and,
(3) such position was not disclosed as provided in section 6662(d)(2)(B)(ii) or was frivolous.
Prior to amendment by the Act, the penalty under section 6694(b) applied if any part of an understatement was due to:
(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or
(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.
Section 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns. The Act amended section 6694(a) to provide that the penalty would apply if:
(A) the tax return preparer knew (or reasonably should have known) of the position,
(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the position.
Although the Act did not alter the standard of conduct under section 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.
Section 8246 of the Act amends the standards of conduct under section 6694(a) in two ways. First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.
The Act also increased the first-tier section 6694(a) penalty for understatements from $250 to the greater of $1000 or 50% of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier section 6694(b) penalty for willful or reckless conduct from $1000 to the greater of $5,000 or 50% of the income derived (or to be derived) by the tax return preparer.
Under both the prior and current law, disclosure under section 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2). In addition, under both the prior and current law, the penalty under section 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.
TRANSITIONAL RELIEF
In order to provide sufficient time to address issues pertaining to the implementation of the Act, the Service is providing the following transitional relief: For income tax returns, amended returns, and refund claims, the standards set forth under the previous law and current regulations under section 6694 will be applied in determining whether the Service will impose a penalty under section 6694(a). Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2).
For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under section 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the Service will impose a penalty under section 6694(a).
This transitional relief will apply to all returns, amended returns, and refund claims due on or before December 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before January 15, 2008; and to 2007 employment and excise tax returns due on or before January 31, 2008.
No transitional relief is available under section 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.
EFFECTIVE DATE
This Notice is effective as of May 25, 2007.
CONTACT INFORMATION
The principal author of this notice is Michael E. Hara of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, contact Mr. Hara at (202) 622-4910 (not a toll-free call).
Controversial Return Preparer Reporting Standards Must Be Corrected, AICPA Tells Congress
The controversial "more likely than not" reporting standards for return preparers in the Small Business and Work Opportunity Tax Act of 2007 (2007 Act) (P.L. 110-28) should apply to tax-avoidance items and not to routine items, the AICPA told leaders of the House and Senate tax-writing committees in a July 10 letter released on July 13. The AICPA also warned that preparers will become advisors, rather than advocates, because of the new law.
"More Likely than Not"
The 2007 Act increases the tax return reporting standards under Code Sec. 6694 on undisclosed, nontax avoidance items from the "realistic possibility of success" to "more likely than not." The AICPA observed, "A preparer must satisfy a higher standard than the standard the taxpayer must satisfy (substantial authority) to avoid the imposition of an understatement penalty." In addition, "it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared even though the taxpayer would not be subject to a penalty with respect to that same tax return position."
In addition to the penalty in the statute, practitioners could be in violation of Circular 230 with another penalty and automatic referral to the IRS Office of Professional Responsibility," AICPA Vice President - Taxation Thomas Ochsenschlager, stated.
Preparer's Role
The "more likely than not" approach "results in a fundamental change in the role of a preparer," the AICPA warned. Preparers become advisors rather than advocates.
The AICPA also cautioned that determining the probable correctness of the treatment of routine items would be extremely difficult, if not impossible. "There sometimes is little guidance for the tax treatment of an item at the time the item must be reported on a return and the proper treatment of an item frequently depends on an analysis of unique or unusual circumstances that were not contemplated in published guidance."
Corrective Action
Congress should equalize the return preparer standards with the taxpayer standards, the AICPA stated. For nontax-avoidance items, the "substantial authority" standard should apply. The "more-likely-than-not standard" should apply for tax-avoidance items, such as items attributable to any "listed transaction." The AICPA also recommended an expansion of the authorities that can be relied on in determining if the "substantial authority" is met to include field service advice memoranda, treatises and legal scholarly literature.
Ochsenschlager explained that this "major change in tax policy" was made without any congressional hearings. The AICPA, in its letter to House Ways and Means Committee Chairman Charles B. Rangel, D-N.Y., and ranking member Jim McCrery, and Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking member Charles E. Grassley, R-Iowa, said that the IRS was "blindsided" by the new rule. The IRS issued transitional relief in June (IR-2007-115, Notice 2007-54, I.R.B. 2007-27, 12, TAXDAY, 2007/06/12, I.4). At this time, legislation has not yet been introduced in Congress.
SEC. 6694. UNDERSTATEMENT OF TAXPAYER'S LIABILITY BY TAX RETURN PREPARER.
6694(a) UNDERSTATEMENT DUE TO UNREASONABLE POSITIONS. --
6694(a)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a position described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --
6694(a)(1)(A) $1,000, or
6694(a)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.
6694(a)(2) UNREASONABLE POSITION. --A position is described in this paragraph if --
6694(a)(2)(A) the tax return preparer knew (or reasonably should have known) of the position,
6694(a)(2)(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits, and
6694(a)(2)(C)(i) the position was not disclosed as provided in section 6662(d)(2)(B)(ii), or
6694(a)(2)(C)(ii) there was no reasonable basis for the position.
6694(a)(3) REASONABLE CAUSE EXCEPTION. --No penalty shall be imposed under this subsection if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.
6694(b) UNDERSTATEMENT DUE TO WILLFUL OR RECKLESS CONDUCT. --
6694(b)(1) IN GENERAL. --Any tax return preparer who prepares any return or claim for refund with respect to which any part of an understatement of liability is due to a conduct described in paragraph (2) shall pay a penalty with respect to each such return or claim in an amount equal to the greater of --
6694(b)(1)(A) $5,000, or
6694(b)(1)(B) 50 percent of the income derived (or to be derived) by the tax return preparer with respect to the return or claim.
6694(b)(2) WILLFUL OR RECKLESS CONDUCT. --Conduct described in this paragraph is conduct by the tax return preparer which is --
6694(b)(2)(A) a willful attempt in any manner to understate the liability for tax on the return or claim, or
6694(b)(2)(B) a reckless or intentional disregard of rules or regulations.
6694(b)(3) REDUCTION IN PENALTY. --The amount of any penalty payable by any person by reason of this subsection for any return or claim for refund shall be reduced by the amount of the penalty paid by such person by reason of subsection (a).
6694(c) EXTENSION OF PERIOD OF COLLECTION WHERE PREPARER PAYS 15 PERCENT OF PENALTY. --
6694(c)(1) IN GENERAL. --If, within 30 days after the day on which notice and demand of any penalty under subsection (a) or (b) is made against any person who is a tax return preparer, such person pays an amount which is not less than 15 percent of the amount of such penalty and files a claim for refund of the amount so paid, no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until the final resolution of a proceeding begun as provided in paragraph (2). Notwithstanding the provisions of section 7421(a), the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court. Nothing in this paragraph shall be construed to prohibit any counterclaim for the remainder of such penalty in a proceeding begun as provided in paragraph (2).
6694(c)(2) PREPARER MUST BRING SUIT IN DISTRICT COURT TO DETERMINE HIS LIABILITY FOR PENALTY. --If, within 30 days after the day on which his claim for refund of any partial payment of any penalty under subsection (a) or (b) is denied (or, if earlier, within 30 days after the expiration of 6 months after the day on which he filed the claim for refund), the tax return preparer fails to begin a proceeding in the appropriate United States district court for the determination of his liability for such penalty, paragraph (1) shall cease to apply with respect to such penalty, effective on the day following the close of the applicable 30-day period referred to in this paragraph.
6694(c)(3) SUSPENSION OF RUNNING OF PERIOD OF LIMITATIONS ON COLLECTION. --The running of the period of limitations provided in section 6502 on the collection by levy or by a proceeding in court in respect of any penalty described in paragraph (1) shall be suspended for the period during which the Secretary is prohibited from collecting by levy or a proceeding in court.
6694(d) ABATEMENT OF PENALTY WHERE TAXPAYER LIABILITY NOT UNDERSTATED. --If at any time there is a final administrative determination or a final judicial decision that there was no understatement of liability in the case of any return or claim for refund with respect to which a penalty under subsection (a) or (b) has been assessed, such assessment shall be abated, and if any portion of such penalty has been paid the amount so paid shall be refunded to the person who made such payment as an overpayment of tax without regard to any period of limitations which, but for this subsection, would apply to the making of such refund.
6694(e) UNDERSTATEMENT OF LIABILITY DEFINED. --For purposes of this section, the term "understatement of liability" means any understatement of the net amount payable with respect to any tax imposed by this title or any overstatement of the net amount creditable or refundable with respect to any such tax. Except as otherwise provided in subsection (d), the determination of whether or not there is an understatement of liability shall be made without regard to any administrative or judicial action involving the taxpayer.
6694(f) CROSS REFERENCE. --
For definition of tax return preparer, see section 7701(a)(36).
National Association of Tax Professionals Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007
August 27, 2007
National Association of Tax Professionals: Comments: Tax gap.
NATP
National Association of Tax Professionals
Comments on Revisions to Section 6694 Made by the Small Business and Work Opportunity Act of 2007
Tax Return Reporting Standards for Preparers
July 30, 2007
EXECUTIVE SUMMARY -
We understand and support the need and determination on the part of Congress and the Treasury to reduce the "tax gap." Our members are solidly behind reasonable efforts toward this goal. We urge caution, however, as well as support from the public in enacting provisions that impinge upon their rights and relationships in satisfying their compliance with tax law. There was not so much as a hearing on this vital matter nor was there any recommendation from Treasury to create this conflict.
The National Association of Tax Professionals (NATP) was surprised that, on May 25, a tax provision, found in section 8246 of the U.S. Troop Readiness, Veteran's Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007 ("the Act"), was enacted without warning and without the characteristic protocol accorded the public to comment. The provision was made under Subtitle B of Title VIII of the Act and is popularly referred to as the "Small Business and Work Opportunity Act of 2007."
Section 6694 of the Internal Revenue Code was thereby amended to revise and raise the standards for tax preparers and those who provide advice, the result of which ends up on a return. The problem arises in that the standards were raised to a point higher or "tougher" than the standards for the taxpayer him or herself. Tax preparers, in order to be protected from a possible imposition of an understatement penalty, must now either hold and be able to demonstrate a reasonable belief that a position taken on a return would "more likely than not" be sustained on its merits, or otherwise insist on a disclosure of the position on the return. Taxpayers, on the other hand, may take a position on a return that has a "substantial authority" for being upheld. Previous to the enactment of this provision, tax return preparers were held to a standard (realistic possibility of success) that was lower than the standard for taxpayers. The Act further extends the penalties for understatement of tax liability to all tax returns including estate and gift tax returns, employment tax returns, and excise tax returns and significantly increases their amounts.
Given the rapid and constant rate at which federal tax law changes, taxpayers increasingly seek the aid of a competent preparer. It is now common to have issues awaiting guidance from Treasury as well as from the IRS in order for professionals, much less taxpayers, to understand the substantively correct position to be taken with regard to an item on a return. It is also now common for technology to challenge guidance previously issued by Treasury and the IRS. One has only to contemplate the continually developing issues affected by the domestic production activities deduction created in the American Jobs Creation Act of 2004 to understand this problem. Preparers and taxpayers are, in these cases, often in the realm of meteorologists in determining the chances of a position being substantively correct. Preparers, however, are subject to penalties for understatement of a tax liability if that reporting standard cannot be satisfied unless they insist on a disclosure of the item. Add to this the fact that the imposition and determination of the appropriateness of the increased penalties are all at the discretion of the IRS and the effect on advocating and representing the taxpayer is indeed chilling.
It appears as though the rights of taxpayers to tax advice and counsel are somewhat less that that of other potential litigants. Imagine standards such as these being imposed in the context of a civil or criminal proceeding. NATP requests a correction to the obvious problems caused by this provision of the Act.
NATP is an eclectic group of tax professionals. Our membership is comprised of attorneys, CPAs, EAs, CFPs, CSAs, BBAs, LLBs, JDs, MBAs, PhDs, as well as Associate degrees, those who have entered the profession as a second career and part-time professionals. Therefore, we have no bias for any one group of tax professionals over another. Our 18,000+ members are employed in offices that assist more than eleven million taxpayers. All of NATP's members are potentially negatively impacted by Section 8246 of the Act, as are all taxpayers. The change in standards resulting from this legislation causes, at a minimum, the following serious problems not only for tax return preparers, but also for taxpayers and the government:
The change made by the Act raises the tax return reporting standard for preparers above the standard for taxpayers, thereby creating the potential for conflicts of interest between preparers and their clients. As a result, it affects the very nature of the representation of taxpayers and a taxpayer's right to representation. Taxpayers pay for and expect competent service that does not put them at a further disadvantage than the duty to which they are personally held in paying a fair and just tax.
Applying the tougher "more likely than not" standard to a tax return preparer results in a fundamental change in the role of the preparer, from that of an advocate to that of an advisor or even an auditor.
It is frequently extremely difficult, if not impossible, to determine the probable correctness of the treatment of some routine items with the degree of certainty required for the higher "more likely than not" standard because: (1) there sometimes is little guidance, if any, for the tax treatment of an item at the time the item must be reported on a return; and (2) the proper treatment of an item frequently depends on an analysis of unique or unusual facts and circumstances that were not contemplated in published guidance.
A disclosure made under a system with a "more likely than not" standard could be viewed as a concession on the merits.
The potential penalties on a preparer for failure to satisfy that high standard are so severe that preparers will feel compelled to protect themselves by urging their clients to include disclosures for virtually every item for which there is even the slightest uncertainty regarding the proper treatment. This problem is compounded by the fact that the preparer could be subject to disciplinary action by the IRS Office of Professional Responsibility. These excessive disclosures for routine tax return positions will overburden tax administration, thereby defeating the purpose of the disclosure system and also undermining the electronic filing initiative, which currently is not capable of processing a large number of disclosures in a return.
To avoid this disruption to our tax system and the resultant unfairness to the taxpayer and tax return preparer, NATP recommends that the section 6694 tax return preparer standards be either restored to their standard before the Act (realistic possibility of success) or, at most, raised to a point equal with the taxpayer standards (substantial authority). We would agree that for tax shelter ("tax avoidance") items the "more likely than not" standard should continue to apply. For non-tax shelter ("non-tax avoidance") items, however, the "substantial authority" standard should apply. The rationale for these recommendations is set forth in more detail below.
About NATP
Whereas we could claim here that the National Association of Tax Professionals (NATP) represents the hundreds of thousands of tax return preparers affected by this proposed bill, we believe in stating facts that are not misleading. NATP's 18,000 members are employed in offices that assist more than 11 million taxpayers. Our members include individual preparers (81% of which have undergraduate or graduate degrees), Enrolled Agents, Certified Public Accountants, accountants, attorneys, and Certified Financial Planners. NATP is a nonprofit professional association that is committed to the integrity of the tax administration system and the application of tax laws and regulations by providing education, research, and information to tax professionals. For almost 30 years, we have existed to serve professionals who work in all areas of tax practice. We provide our members with over 200 tax education offerings in over 100 cities throughout the United States, a service unmatched by any other national tax association. In addition, our 35 Chapters and National headquarters serve the public through regular news releases, client brochures and newsletters, and a designated taxpayer website. Our Chapters provide significant member involvement in local and state communities. Our headquarters are located in Appleton, Wisconsin. Our members are served by a staff of 42 employees, 14 of which are CPAs, attorneys, and EAs.
General Comments
The changes brought about by section 8246 of the Act to section 6694 of the Internal Revenue Code surprised tax professionals in every industry association and industry media publication as well as those in government administration. There is a time-honored protocol usually followed by Congress when pursuing legislation that will have a profound effect on the American public at large. There are usually hearings with attendant publicity and subsequent study over such momentous matters. Commentary is sought from respected authorities, academicians, independent policy institutes and the public. Additional debate quite often emanates from Congressional committees and subcommittees. These changes, however, were contained in an appropriations bill introduced on May 8 to help fund the war in Iraq among other things. It passed on May 25. Somehow, in all the fervor, Congress either side-stepped or forgot about this protocol.
We read, in the June 4 edition of Tax Notes Today, that the IRS Chief Counsel commented about the sudden and unexpected change to section 6694, indicating that the IRS had been "blind-sided" by this provision in the Act. It constitutes a major change in tax policy. Although the Treasury Department did ask for and increase in the dollar amount of the section 6694 penalty, it did not recommend a change in the preparer standards. No one, other than Congressional staff, had the chance to view and comment on this legislation. Little time, if any, was given to its study. . .which could easily lead one to conclude that the full consequences of this particular provision were not studied by Congress. Indeed, there is already a proposal to amend a portion of the Act for this very reason.
NATP joins with many others in the industry on behalf of American taxpayers to voice the need and urge Congress to correct the problems and inequities in Section 8246 of the Act. We have held discussions with the AICPA on these matters. We support the positions put forth in their July 10 paper on these issues. We also agree with the AICPA that this matter requires expeditious treatment for the tax profession, taxpayers and the tax administration system. It is in that spirit that the National Association of Tax Professionals hereby submits the detailed commentary below on the nature and consequences of this provision in the hope that it will be studied and that a correction to the problems therein set forth will be expedited. Whereas we have made some original comment, we believe there is no need or time to "reinvent the wheel" by otherwise restating the eloquent positions already set forth by the AICPA. The detailed commentary submitted is largely that of the AICPA, used with their permission.
SPECIFIC COMMENTS
Having Different Reporting Standards for Taxpayers and Preparers is Bad Policy
Section 6694 as revised by the Act, requires that a preparer must satisfy a higher standard ("more likely than not") than the standard the taxpayer must satisfy ("substantial authority") in order to avoid the imposition of an understatement penalty with respect to an undisclosed, non-tax avoidance item reported on the taxpayer's return. Thus, it is possible for a preparer to be subject to a penalty with respect to a position taken on a return he or she prepared, even though the taxpayer would not be subject to a penalty with respect to that same tax return position. That is just plain bad tax policy.
Having a higher standard for the preparer may result in a conflict of interest situation between the preparer and the taxpayer. If the higher preparer standard is not satisfied for a tax return position, the preparer can be protected from the imposition of the section 6694 penalty only if that position is disclosed on the taxpayer's return. Thus, in some situations, even though the taxpayer is not required to disclose a position on a return, the preparer might be forced to encourage the taxpayer to do so, to protect the preparer from a penalty. This is also, clearly, bad policy.
Section 10.29 of Circular 230 specifies generally that "a practitioner shall not represent a client ... before the Internal Revenue Service if the representation involves a conflict of interest." It then defines "conflict of interest" to include a situation where there is "a significant risk that the representation of one or more clients will be materially limited by ... a personal interest of the practitioner." The provision in the Act that raises the preparer standard above that of the taxpayer for penalty purposes creates the potential for conflict of interest situations that could put preparers in violation of Circular 230; thus, it is contrary to a fundamental policy underlying practice before the IRS.
Further, the preparer does not control the taxpayer's tax return and cannot force the taxpayer to disclose a position on a return. If the taxpayer does not agree to disclose the position, the preparer could be placed in a professionally difficult situation of not being able to sign the taxpayer's return, which would be particularly problematic in view of the section 6695 penalty for failure to sign returns that an individual prepares. The very nature of tax representation and a taxpayer's right to representation could be adversely affected if the preparer is required to withdraw from an engagement because the taxpayer will not include a disclosure in the taxpayer's return. It also puts the preparer in an economically disadvantaged position in trying to collect for services rendered.
In addition, a preparer's withdrawal from an engagement because of the taxpayer's refusal to disclose may result in the taxpayer seeking out a preparer who is less knowledgeable about the merits of the position or who feels less constrained by ethical standards and is, therefore, willing to prepare and sign returns that do not comply with the section 6694 reporting standards. Alternatively, the difference in standards between taxpayers and paid preparers may result in the taxpayer deciding to prepare returns in house, in which case the section 6694 standard would not apply.
Accordingly, for the sake of equity in the application of understatement penalties, the ethical operation of the tax compliance system, sound tax policy and the preservation of the nature of taxpayer representation and the taxpayer's right to representation, it is critical that the standards applicable to tax return preparers be, at most, equalized with the standards applicable to taxpayers.
The Recognized Right of the Public to Advocacy and Representation and the Right to Practice
Richard Morgante, Commissioner of the Wage and Investment Division of the IRS, spoke at NATP's National Conference in Las Vegas on July 24, 2007. He stated that ". . .the IRS expects the American public to pay only the amount of tax owed, no more. . .but no less." Sixty percent of taxpayers engage the services of a tax professional in order to accurately determine the amount of tax owed. They pay for the knowledge of the complexity of our tax laws so that their tax liability can be fairly determined. A tax return preparer has long been viewed as having dual roles - as an advocate for the taxpayer-client, and as an advisor with a duty not only to the taxpayer-client, but also to the public and the tax system. The advocacy role of the preparer previously had been recognized and accepted by the government, as evidenced by the "realistic possibility of success" reporting standard in section 6694 prior to the recent revision and in the current section 10.34 of Circular 230. The House Committee Report accompanying the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) stated "[t]he committee has adopted this new standard because it generally reflects the professional conduct standards applicable to lawyers and to certified public accountants." The new, "more likely than not," reporting standard substantially and inequitably changes that, turning preparers into supplemental representatives of the IRS through a form of coercion. What's more, in those cases where a return must be filed before adequate guidance is given with respect to a difficult tax issue, the IRS and the Treasury Department have the luxury of playing "Monday morning quarterbacks" in determining the appropriate treatment of a particular tax item or circumstance.
This is a major change in tax policy that should not have been made without hearings and extensive consideration. For this reason, the change to the "more likely than not" reporting standard for non-tax avoidance items should be overridden. As noted above, NATP recommends that the preparer standards should be, at most, equalized with the "realistic possibility of success" standards that apply to taxpayers.
When a "Higher Standard" Ought to Apply to Tax Return Preparers
The United States income tax system has long been recognized as voluntary on the part of taxpayers. They are expected to report their transactions in accordance with the rules prescribed by the income tax laws. Congress has wisely built into the system the flexibility for taxpayers to reasonably interpret the many grey areas of the law without the threat of having penalties imposed. This flexibility is evidenced in the twotiered approach to the standards applicable to taxpayers; one approach for routine, non-tax avoidance items and one for potentially abusive tax avoidance items.
As part of that approach, Congress, Treasury, and the IRS have developed a disclosure regime to provide the IRS with early knowledge of potentially abusive transactions that merit scrutiny. The regime uses various "filters" (i.e., a focus on certain types of transactions) for capturing useful information from taxpayers and "material advisors" while at the same time minimizing the burden imposed on those individuals. This targeted approach to obtaining disclosures also minimizes the number of unnecessary disclosures that must be dealt with by the IRS.
"Substantial Authority" Standard for Non-Tax Avoidance Items
Currently, section 6662 provides that an understatement penalty will not be imposed on a taxpayer with respect a tax return position taken for a non-tax avoidance item if either: (1) the taxpayer has "substantial authority" for the tax treatment of the item on the tax return (i.e., the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary positions, typically understood to be approximately a 40% likelihood of the treatment prevailing on the merits); or (2) the taxpayer made a specific disclosure of the position on the return and there was a "reasonable basis" for the tax treatment of the item on the tax return (i.e., roughly a 20% likelihood of the treatment prevailing on the merits).
Federal tax law is constantly changing; at any given time, there are many issues awaiting guidance from the Treasury Department and the IRS. For example, Treasury's 2006 - 2007 Priority Guidance Plan lists 264 guidance projects that Treasury planned to address between July 2006 and June 2007. As a result, there is sometimes little or no authority or guidance for the tax treatment of an item at the time the item must be reported on a return. Even if there is some authority, in many instances, the proper treatment of an item may not be clear where there are unique facts and circumstances. Thus, given the exceedingly complex and dynamic nature of the tax law, it may be difficult for taxpayers and preparers to know the probable correctness of many return positions. It is not only unrealistic, but in many cases, impossible, to ensure the proper tax treatment of an item with the high degree of accuracy required by the "more likely than not" standard. In some situations, there simply may be no tax treatment that is "more likely than not" the proper treatment.
When Congress created the current section 6662 taxpayer substantial understatement penalty in 1982, it recognized these problems and, as a result, for non-tax avoidance items, decided against imposing a standard requiring certainty, such as the "more likely than not standard" does. The Joint Committee on Taxation Blue Book for Public Law 97-248, section 323 (a) specifically notes that: "Congress did not adopt an absolute standard that a taxpayer may take a position on a return only if, in fact, the position reflects the correct treatment of the item because, in some circumstances, tax advisors may be unable to reach so definitive a conclusion. Rather, Congress adopted a more flexible standard under which the courts may assure that taxpayers who take non-disclosed highly aggressive filing positions are subject to the penalty while those who endeavor in good faith to fairly self-assess are not penalized."
The IRS task force that studied the penalty regime in 1989 likewise pointed out that:
"...a variety of factors limit the ability of taxpayers to report positions disclosing a liability that is probably correct. Perhaps the most significant limitation is the ambiguity inherent in applying a complex and changing set of tax rules to an infinite variety of factual situations, which may themselves be of ambiguous import. These complexities may result in failure to recognize issues, incorrect conclusions as to the probability that a particular position will prevail, and differences of opinion regarding probability that are not resolvable short of the courthouse. The complexity of modern financial affairs, when coupled with the legal requirement to file a return by a statutory deadline and the costs of making the best possible assessment of each individual issue may also provide practical limits on the pursuit of a theoretically perfect return." Witness the myriad questions and factual diversity in the pursuit of the domestic production activity deduction fostered by the American Jobs Creation Act of 2004.
The current taxpayer standard of "substantial authority" for non-tax avoidance items strikes a balance, taking into account the uncertainties that exist when reporting an item on a return and the IRS' need to focus on information that will enable it to prevent abuses to the tax system. In contrast, a standard of "more likely than not" for non-tax avoidance transactions would pose an unworkable burden on the tax system. Accordingly, NATP strongly recommends that both the taxpayer and preparer standard for reporting non-tax avoidance items be, at most, "substantial authority." NATP also recommends an expansion of the authorities that can be relied on in determining if the "substantial authority" standard is met, to include field service advices, treatises, and legal scholarly literature.
"More Likely Than Not" Standard for Tax Avoidance Items
Section 6664(d) provides that an understatement penalty under section 6662A will not be imposed on a taxpayer for tax deficiencies that are assessed with respect to tax avoidance transactions if there was reasonable cause for the understatement and the taxpayer acted in good faith. Further, these requirements will be satisfied only if: (1) the taxpayer made a specific disclosure of the position on the return; (2) there was "substantial authority" for the tax treatment of the item on the return; and (3) the taxpayer reasonably believed that the tax treatment of the item on the return was "more likely than not" the proper treatment (i.e., a greater than 50% likelihood of the treatment prevailing on the merits).
NATP strongly supports well-targeted efforts to eliminate abusive transactions and close the "tax gap." Such transactions undercut the large majority of honest taxpayers and tax return preparers who strive every day to obey the increasingly complex tax laws. NATP believes that the most effective way to combat abusive transactions without interfering with a taxpayer's right to legally minimize taxes is through disclosure and penalties. But, for a disclosure system to be effective in combating abuse, it must be able to focus on the transactions that are the most likely to be abusive. If the "more likely than not" standard is applied to all items, including routine, non-tax avoidance items, the ability of the disclosure system to focus on abusive transactions will be seriously impaired.
Given the complexity of the tax law, the lack of guidance from the Treasury Department and the IRS on many issues, and the factual nature of many issues, the "more likely than not" standard for taxpayers has heretofore wisely been reserved for tax avoidance transactions rather than imposed as a uniform rule for all transactions. NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance items. This would be consistent with the approach that Congress and Treasury have taken in recent years to utilize directed disclosures that focus on the potentially problematic transactions without either overburdening the IRS with unnecessary disclosures or inhibiting the electronic filing system.
Does Disclosure Unfairly Concede the Issue?
A disclosure made in a tax system that has "more likely than not" as the reporting standard could be viewed as a concession of the issue disclosed, since the disclosure would only be required if an analysis of the applicable authorities and facts by the taxpayer or preparer resulted in the conclusion that the tax treatment "more likely than not" was not the proper treatment. If the preparer has concluded that the standard has not been satisfied, but the taxpayer wishes to pursue the matter and not disclose, the preparer could be forced to withdraw and the taxpayer's right to tax representation would be affected. So would the tax preparer's right to practice and the preparer's ability to collect for services rendered at that point. To avoid these results, with respect to non-tax avoidance items, NATP recommends that the "more likely than not" standard be applied to taxpayers and preparers only with respect to tax avoidance transactions.
As Ubiquitous as Circular 230 Disclosure Disclaimers
Because of the difficulty of satisfying the "more likely than not" standard, in many routine situations, and the severe penalties for understating tax liabilities, disclosures may be made for numerous tax return positions with respect to which there is any uncertainty regarding the ultimate tax treatment. The resulting increase in the number of disclosures will not create the desired outcome of the disclosure regime, which is the "weeding out" of abuses in the system. This doesn't even take into account the possibilities of multiple professionals covering their bases because they may be deemed "preparers" under this provision of the Act. Consider the recurring circumstance of inherited items and the treatment of their basis on a 1040. Who does the appraisal to determine basis? Will that appraiser be deemed a preparer for these circumstances? Will they want some disclosure of that fact on the taxpayer's return?
Adding to this problem is the fact that, if an understatement penalty is imposed on a preparer who is subject to Circular 230, the preparer may be subject not only to a high section 6694 monetary penalty, but also to an additional fine under Circular 230 and disciplinary action by the IRS Office of Professional Responsibility. Rather than risk such severe penalties, with a "more likely than not" standard, it is likely that preparers will strongly encourage disclosures, even on routine, non-tax avoidance items.
Clearly, this is not a desired outcome. The IRS will be swamped with paper; the ability of the IRS to focus its attention on potentially abusive tax avoidance transactions will be obstructed; the electronic filing system will be undermined, since currently it is not designed to accept a large number of disclosures per return; important disclosures will be overlooked; and a large percent of the voluminous disclosures will be meaningless. If you doubt that the IRS will be swamped with such disclosures, consider the ubiquitous disclaimers under Circular 230 that accompany every and any e-mail or other correspondence from a Circular 230 professional.
The Internal Revenue Service Advisory Council noted in the Briefing Book for its November 15, 2006 public meeting that, even under the current system of targeted disclosures, there is a continuing problem with overdisclosure. The Council gave an example of tens of thousands of unnecessary disclosures received during the year for just one type of transaction. The Council also noted that there is anecdotal evidence that little or nothing was being done with disclosures that had been made. In discussing this problem, the Council cautioned that although it was "fully supportive of the IRS' attack on "abusive tax shelters," it believed that "it is important for the IRS to distinguish between "abusive transactions and transactions that reduce a taxpayer's liability through appropriate tax planning." This situation of excessive disclosures will be drastically worsened if the standard for non-tax avoidance items is "more likely than not."
Given the overwhelming burden that will be imposed on the tax system by excessive disclosures that are made as a result of the high "more likely than not" standard, NATP strongly recommends that the taxpayer and preparer standard for reporting non-tax avoidance items be "substantial authority."
6. Conclusion
NATP recommends that the section 6694 tax return preparer standards be returned to their previous standard of the "realistic possibility of success" or, at most, equalized with the standards currently applicable to taxpayers (substantial authority) for non-tax avoidance items. For tax avoidance items, the "more likely than not" standard should continue to apply. Thank you for the opportunity to share these comments.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
To provide "IRS transparency" you should upload your IRS experiences to www.irsforum.org.
Friday, August 24, 2007
Tax Help: IRS levied a personal residence - taxpayer made the wrong argument. He should have argued that the levy of his residence would have created an "economic hardship" under IRC 6343. IRS 6343 prevents an IRS levy if it does create an "economic hardship."
Kevin F. Foley and Shula K. Foley v. Commissioner
Dkt. No. 11602-06L , TC Memo. 2007-242, August 23, 2007.
[Code Sec. 6330]
Collection: Collection alternatives: Delay of collection actions: Appeals officer: Abuse of discretion. --
An Appeals officer did not abuse his discretion by sustaining a proposed levy against a married couple's residence. The IRS had levied on the couple's residence because they had no other assets. At their Collection Due Process (CDP) hearing, the couple did not dispute their underlying tax liability but, instead, requested that their outstanding tax liability be designated as currently not collectible. The Appeals officer did not abuse his discretion by determining that the taxes were indeed currently collectible because the couple represented that they planned to sell or refinance the residence in the future and would be able to pay the entire tax liability after the sale. Moreover, the taxpayers did not explain why they could not access the equity from their residence immediately, nor give any reason why collection should be delayed to allow them more time to sell or refinance the house.
Mark A Pridgeon, for petitioners. Trent D. Usitalo, for respondent.
MEMORANDUM OPINION
SWIFT, Judge: This matter is before us under Rule 121 on the parties' cross-motions for summary judgment. The underlying issue in this collection case is whether respondent's Appeals Office abused its discretion in sustaining respondent's proposed levy action against petitioners' residence.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Background
At the time of filing the petition, petitioners resided in Afton, Minnesota.
In 1999, petitioners earned $359,378 in short-term capital gains.
On September 7, 2000, petitioners purchased a new residence for $140,000 with a $40,522 cash down payment and a contract for deed for the balance with a balloon payment due on June 1, 2007.
On or about February 21, 2005, petitioners filed late their 1999 joint Federal income tax return showing a tax liability of $99,548. Petitioners included no payment with the return, and in 1999 petitioners paid no withholding taxes and no estimated taxes.
On or about April 4, 2005, respondent assessed the above $99,548 tax liability reported on petitioners' 1999 Federal income tax return, along with interest and penalties and mailed to petitioners a notice and demand for payment.
On or about October 10, 2005, respondent mailed to petitioners a notice of intent to levy relating to petitioners' 1999 Federal income taxes, plus penalties and interest in the total amount of $197,202.22.
On October 28, 2005, respondent filed a Federal tax lien in Washington County, Minnesota, relating to petitioners' 1999 outstanding Federal income taxes.
On or about November 2, 2005, petitioners timely requested an Appeals Office hearing, seeking to avoid or at least to postpone respondent's proposed levy.
In their Appeals Office hearing, petitioners requested that respondent designate their outstanding 1999 Federal income taxes as currently not collectible. Petitioners also represented that because of the balloon payment due on their contract for deed in June of 2007 they intended to sell or refinance their residence and that funds therefrom would be used by petitioners to pay their outstanding 1999 Federal income taxes. Petitioners also represented that they had several business deals that at some point might provide funds to pay their 1999 Federal income taxes.
In the Appeals Office hearing petitioners did not challenge their underlying 1999 Federal income tax liability. Per respondent's request, petitioners filed Form 433-A, indicating that petitioners' monthly living expenses exceeded their monthly earned income and showing their residence as their only significant asset.
On or about April 26, 2006, respondent's Appeals officer advised petitioners' representative that the proposed levy action was sustained and that petitioners should consider either refinancing or selling their residence to pay their 1999 Federal income taxes.
The Appeals officer further determined that it was not appropriate to levy on petitioners' bank accounts because petitioners had no funds in their bank accounts.1
The Appeals officer on his own initiative considered other collection alternatives. In particular, the Appeals officer determined that an installment agreement would not be appropriate because petitioners' monthly necessary living expenses exceeded their monthly income. The Appeals officer further determined that an offer-in-compromise would not be appropriate because of the amount of equity in petitioners' residence.
The Appeals officer determined that it was appropriate to levy on petitioners' residence because there was sufficient equity in the residence to satisfy petitioners' entire outstanding tax liability.
On or about May 11, 2006, respondent's notice of determination was mailed to petitioners, sustaining respondent's proposed levy.
In the notice of determination, the Appeals officer determined, and petitioners do not dispute, that as of May 2006, petitioners had a balance due on the contract for deed relating to their residence of $67,836, and petitioners' residence had a fair market value of approximately $460,000.
On June 19, 2006, petitioners timely filed a petition with this Court.
In their petition, petitioners alleged only the following error:
The Respondent erred in determining that a short-term extension of time to June 2007 for the petitioners to refinance or sell their home pursuant to a balloon payment on their Contract for Deed and thereby raise the funds to pay the liabilities was not an appropriate collection alternative * * *.
Discussion
Summary judgment is appropriate where the pleadings, answers to interrogatories, depositions, admissions, and other material show there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Beery v. Commissioner, 122 T.C. 184, 187 (2004).
Under section 6330(d)(1), where a taxpayer's underlying tax liability is not at issue, we generally review respondent's Appeals Office notice of determination for an abuse of discretion. Sego v. Commissioner, 114 T.C. 604, 609-610 (2000). In an Appeals Office hearing, generally respondent is required to consider issues raised by a taxpayer including collection alternatives and challenges to the appropriateness of the collection action. Sec. 6330(c).
A taxpayer may request that his Federal income tax liability be designated as currently not collectible. Such status may be available where, based on the taxpayer's assets, equity, income, and expenses, the taxpayer has no apparent ability to make payments on the outstanding tax liability. 2 Administration, Internal Revenue Manual (CCH), sec. 5.16.1.2.9, at 17,810. See also Willis v. Commissioner, T.C. Memo. 2003-302.
In a number of situations, courts have held that it will not be regarded as an abuse of discretion where an Appeals officer refuses to delay a proposed collection action to allow a taxpayer to sell an asset. See Castillo v. Commissioner, T.C. Memo. 2004-238; Clawson v. Commissioner, T.C. Memo. 2004-106; Medlock v. United States , 325 F. Supp. 2d 1064, 1077-1079 (C.D. Cal. 2003).
Herein, the record establishes that respondent's Appeals officer did not abuse his discretion in sustaining the proposed levy. The Appeals officer considered petitioners' request to designate their liability as currently not collectible and correctly determined that it was not merited because of the equity in petitioners' residence. Further, the Appeals officer did not abuse his discretion in rejecting petitioners' request to postpone the levy until after June 2007 to allow petitioners to refinance or sell their residence.
We note that petitioners purchased a new residence with $40,522 in cash at a time when they owed a substantial tax liability. See Steinberg v. Commissioner, T.C. Memo. 2006-217 (no abuse of discretion in rejecting an offer-in-compromise where taxpayers spent $100,000 on a residence down payment).
We are not aware of any reason why petitioners did not attempt to refinance or to sell their residence before June 2007 as recommended by respondent's Appeals officer to pay their outstanding 1999 Federal income tax liability. If respondent's tax lien inhibited petitioners from refinancing or selling their residence, petitioners could have requested respondent to subordinate the tax lien under section 6325(d) to facilitate the refinancing or sale. There is no indication that petitioners made such a request.
For the first time in their summary judgment motion, petitioners allege that respondent's Appeals officer abused his discretion by failing to properly balance the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary. Petitioners' argument fails. As stated, petitioners never requested an installment agreement nor did they make an offer-in-compromise, yet the Appeals officer considered these collection alternatives and correctly concluded that a levy on petitioners' residence was the only viable alternative.2
Petitioners contend that the filing of respondent's tax lien alone was sufficient to protect respondent's interest. The lien itself, however, does not collect taxes owed but simply enhances respondent's priority position vis-a-vis other creditors.
Regardless of our opinion, herein, petitioners effectively obtained much of what they wanted --namely --a postponement of respondent's levy until 2007. By requesting an appeal with respondent's Appeals Office and subsequently filing a petition with this Court, respondent was temporarily stayed from levying on petitioners' residence. Sec. 6330(e); Davis v. Commissioner, 115 T.C. 35, 37 (2000).
We hold that respondent's Appeals Office did not abuse its discretion. We will deny petitioners' motion for summary judgment, and we will grant respondent's motion for summary judgment.
To reflect the foregoing,
An appropriate order and decision will be entered for respondent.
1 The record does not explain what disposition petitioners made of the $359,378 in short-term capital gains they realized in 1999.
2 Our opinion here does not necessarily mean that respondent may in fact levy on petitioners' residence. Pursuant to sec. 6334(e), a taxpayer's principal residence is exempt from levy absent the written approval of a Federal district court Judge or Magistrate. We note that, in connection with a proposed levy on a taxpayer's residence, our jurisdiction under sec. 6330(c)(2)(B) to consider whether an Appeals officer properly has balanced the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary would appear to be somewhat duplicative of the Federal district courts' jurisdiction under sec. 6334(e) also to review and approve respondent's levy on a taxpayer's residence.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
To provide IRS "taxparency" upload your IRS experiences to www.irsforum.org
Kevin F. Foley and Shula K. Foley v. Commissioner
Dkt. No. 11602-06L , TC Memo. 2007-242, August 23, 2007.
[Code Sec. 6330]
Collection: Collection alternatives: Delay of collection actions: Appeals officer: Abuse of discretion. --
An Appeals officer did not abuse his discretion by sustaining a proposed levy against a married couple's residence. The IRS had levied on the couple's residence because they had no other assets. At their Collection Due Process (CDP) hearing, the couple did not dispute their underlying tax liability but, instead, requested that their outstanding tax liability be designated as currently not collectible. The Appeals officer did not abuse his discretion by determining that the taxes were indeed currently collectible because the couple represented that they planned to sell or refinance the residence in the future and would be able to pay the entire tax liability after the sale. Moreover, the taxpayers did not explain why they could not access the equity from their residence immediately, nor give any reason why collection should be delayed to allow them more time to sell or refinance the house.
Mark A Pridgeon, for petitioners. Trent D. Usitalo, for respondent.
MEMORANDUM OPINION
SWIFT, Judge: This matter is before us under Rule 121 on the parties' cross-motions for summary judgment. The underlying issue in this collection case is whether respondent's Appeals Office abused its discretion in sustaining respondent's proposed levy action against petitioners' residence.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Background
At the time of filing the petition, petitioners resided in Afton, Minnesota.
In 1999, petitioners earned $359,378 in short-term capital gains.
On September 7, 2000, petitioners purchased a new residence for $140,000 with a $40,522 cash down payment and a contract for deed for the balance with a balloon payment due on June 1, 2007.
On or about February 21, 2005, petitioners filed late their 1999 joint Federal income tax return showing a tax liability of $99,548. Petitioners included no payment with the return, and in 1999 petitioners paid no withholding taxes and no estimated taxes.
On or about April 4, 2005, respondent assessed the above $99,548 tax liability reported on petitioners' 1999 Federal income tax return, along with interest and penalties and mailed to petitioners a notice and demand for payment.
On or about October 10, 2005, respondent mailed to petitioners a notice of intent to levy relating to petitioners' 1999 Federal income taxes, plus penalties and interest in the total amount of $197,202.22.
On October 28, 2005, respondent filed a Federal tax lien in Washington County, Minnesota, relating to petitioners' 1999 outstanding Federal income taxes.
On or about November 2, 2005, petitioners timely requested an Appeals Office hearing, seeking to avoid or at least to postpone respondent's proposed levy.
In their Appeals Office hearing, petitioners requested that respondent designate their outstanding 1999 Federal income taxes as currently not collectible. Petitioners also represented that because of the balloon payment due on their contract for deed in June of 2007 they intended to sell or refinance their residence and that funds therefrom would be used by petitioners to pay their outstanding 1999 Federal income taxes. Petitioners also represented that they had several business deals that at some point might provide funds to pay their 1999 Federal income taxes.
In the Appeals Office hearing petitioners did not challenge their underlying 1999 Federal income tax liability. Per respondent's request, petitioners filed Form 433-A, indicating that petitioners' monthly living expenses exceeded their monthly earned income and showing their residence as their only significant asset.
On or about April 26, 2006, respondent's Appeals officer advised petitioners' representative that the proposed levy action was sustained and that petitioners should consider either refinancing or selling their residence to pay their 1999 Federal income taxes.
The Appeals officer further determined that it was not appropriate to levy on petitioners' bank accounts because petitioners had no funds in their bank accounts.1
The Appeals officer on his own initiative considered other collection alternatives. In particular, the Appeals officer determined that an installment agreement would not be appropriate because petitioners' monthly necessary living expenses exceeded their monthly income. The Appeals officer further determined that an offer-in-compromise would not be appropriate because of the amount of equity in petitioners' residence.
The Appeals officer determined that it was appropriate to levy on petitioners' residence because there was sufficient equity in the residence to satisfy petitioners' entire outstanding tax liability.
On or about May 11, 2006, respondent's notice of determination was mailed to petitioners, sustaining respondent's proposed levy.
In the notice of determination, the Appeals officer determined, and petitioners do not dispute, that as of May 2006, petitioners had a balance due on the contract for deed relating to their residence of $67,836, and petitioners' residence had a fair market value of approximately $460,000.
On June 19, 2006, petitioners timely filed a petition with this Court.
In their petition, petitioners alleged only the following error:
The Respondent erred in determining that a short-term extension of time to June 2007 for the petitioners to refinance or sell their home pursuant to a balloon payment on their Contract for Deed and thereby raise the funds to pay the liabilities was not an appropriate collection alternative * * *.
Discussion
Summary judgment is appropriate where the pleadings, answers to interrogatories, depositions, admissions, and other material show there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Beery v. Commissioner, 122 T.C. 184, 187 (2004).
Under section 6330(d)(1), where a taxpayer's underlying tax liability is not at issue, we generally review respondent's Appeals Office notice of determination for an abuse of discretion. Sego v. Commissioner, 114 T.C. 604, 609-610 (2000). In an Appeals Office hearing, generally respondent is required to consider issues raised by a taxpayer including collection alternatives and challenges to the appropriateness of the collection action. Sec. 6330(c).
A taxpayer may request that his Federal income tax liability be designated as currently not collectible. Such status may be available where, based on the taxpayer's assets, equity, income, and expenses, the taxpayer has no apparent ability to make payments on the outstanding tax liability. 2 Administration, Internal Revenue Manual (CCH), sec. 5.16.1.2.9, at 17,810. See also Willis v. Commissioner, T.C. Memo. 2003-302.
In a number of situations, courts have held that it will not be regarded as an abuse of discretion where an Appeals officer refuses to delay a proposed collection action to allow a taxpayer to sell an asset. See Castillo v. Commissioner, T.C. Memo. 2004-238; Clawson v. Commissioner, T.C. Memo. 2004-106; Medlock v. United States , 325 F. Supp. 2d 1064, 1077-1079 (C.D. Cal. 2003).
Herein, the record establishes that respondent's Appeals officer did not abuse his discretion in sustaining the proposed levy. The Appeals officer considered petitioners' request to designate their liability as currently not collectible and correctly determined that it was not merited because of the equity in petitioners' residence. Further, the Appeals officer did not abuse his discretion in rejecting petitioners' request to postpone the levy until after June 2007 to allow petitioners to refinance or sell their residence.
We note that petitioners purchased a new residence with $40,522 in cash at a time when they owed a substantial tax liability. See Steinberg v. Commissioner, T.C. Memo. 2006-217 (no abuse of discretion in rejecting an offer-in-compromise where taxpayers spent $100,000 on a residence down payment).
We are not aware of any reason why petitioners did not attempt to refinance or to sell their residence before June 2007 as recommended by respondent's Appeals officer to pay their outstanding 1999 Federal income tax liability. If respondent's tax lien inhibited petitioners from refinancing or selling their residence, petitioners could have requested respondent to subordinate the tax lien under section 6325(d) to facilitate the refinancing or sale. There is no indication that petitioners made such a request.
For the first time in their summary judgment motion, petitioners allege that respondent's Appeals officer abused his discretion by failing to properly balance the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary. Petitioners' argument fails. As stated, petitioners never requested an installment agreement nor did they make an offer-in-compromise, yet the Appeals officer considered these collection alternatives and correctly concluded that a levy on petitioners' residence was the only viable alternative.2
Petitioners contend that the filing of respondent's tax lien alone was sufficient to protect respondent's interest. The lien itself, however, does not collect taxes owed but simply enhances respondent's priority position vis-a-vis other creditors.
Regardless of our opinion, herein, petitioners effectively obtained much of what they wanted --namely --a postponement of respondent's levy until 2007. By requesting an appeal with respondent's Appeals Office and subsequently filing a petition with this Court, respondent was temporarily stayed from levying on petitioners' residence. Sec. 6330(e); Davis v. Commissioner, 115 T.C. 35, 37 (2000).
We hold that respondent's Appeals Office did not abuse its discretion. We will deny petitioners' motion for summary judgment, and we will grant respondent's motion for summary judgment.
To reflect the foregoing,
An appropriate order and decision will be entered for respondent.
1 The record does not explain what disposition petitioners made of the $359,378 in short-term capital gains they realized in 1999.
2 Our opinion here does not necessarily mean that respondent may in fact levy on petitioners' residence. Pursuant to sec. 6334(e), a taxpayer's principal residence is exempt from levy absent the written approval of a Federal district court Judge or Magistrate. We note that, in connection with a proposed levy on a taxpayer's residence, our jurisdiction under sec. 6330(c)(2)(B) to consider whether an Appeals officer properly has balanced the need for efficient collection of taxes with the concern that a collection action be no more intrusive than necessary would appear to be somewhat duplicative of the Federal district courts' jurisdiction under sec. 6334(e) also to review and approve respondent's levy on a taxpayer's residence.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
To provide IRS "taxparency" upload your IRS experiences to www.irsforum.org
Thursday, August 23, 2007
Tax Attorney: Tax fraud mens rea
The taxpayer's was taped by an IRS agent in a seminar tellilng the audience how to evade taxes.This was an easy win for the DOJ in the circumsances.
United States of America, Plaintiff-Appellee, v. Michael E. Diesel, Defendant-Appellant. U.S. Court of Appeals, 10th Circuit; 06-3325, July 31, 2007.Unpublished opinion affirming an unreported DC Kan. decision.
[ ¶41,333.217 and
In this appeal, Mr. Diesel a rgues that we should overturn his conviction because (1) he "could not possibly have had the requisite mens rea "; (2) the government unconstitutionally required Mr. Diesel to "create his own tax form"; and (3) the district court violated Apprendi v . New Jersey, 5 30 U.S. 466 (2000) , and its progeny when it sentenced him to a mid-Guidelines term of 42 months of incarceration. Because Mr. Diesel's first two arguments are wholly without merit and Mr. Diesel's third argument is precluded by Supreme Court and our case law, we affirm.
* * *Mr. Diesel founded and, through a series of trusts, effectively owned and operated a telecommunications research company which paid him an annual salary of $103,549 in 1998, $106,754 in 1999, and $108,788 in 2000. Mr . Diesel reported, and presumably paid , income tax on these amounts . In addition to his salary, however, Mr. Diesel's trusts also made over $3 million in distributions from 1998 to 2000, through a series of intermediate trusts , to the Pernour International T rust, an off-shore , Belize-based trust. Mr. Diesel controlled all of the trusts in the chain and ultimately received all of the proceeds from Pernour for his personal use. Mr. Diesel failed to pay income taxes on any of these proceeds.
Mr. Diesel apparently learned how to devise this scheme from the Aegis Company in Chicago, which, following a nationwide investigation, the government successfully prosecuted for tax fraud. In January 1998, an undercover IRS agent at an Aegis seminar in Belize tape recorded Mr . Diesel stating that (1) any income tax above ten percent is "confiscation" and "everybody is trying to cheat" the IRS; (2) the "whole point" of the trusts he employed was that the IRS did not understand them; (3) the trusts are like a "Double K-1 disappearing tax liability trick"; and (4) the trusts were "too good to be true."
Unfortunately for Mr. Diesel, they were not. In January 2005, a federal grand jury returned a three-count indictment against Mr. Diesel, charging him, inter a lia, with three felony violations under 26 U .S.C. 1 , who served as Mr. Diesel's sole witness. Mr. Gross testified that, while he is not a tax attorney 2 , he had advised Mr. Diesel in 2001 that the Aegis trust plan was "appropriate and correct," so long as properly followed. But Mr. Gross also admitted that he knew that the United States Tax Court, as early as 1998, had ruled the Aegis trust plan illegal - and that he communicated this via letter to his clients, including Mr. Diesel.The jury found Mr. Diesel guilty on all three counts, and the district court denied Mr. Diesel's motion for judgment of acquittal. At sentencing, the probation office recommended a Guidelines-based sentence of 37 to 46 months based, in part, on a two-level enhancement under U.S.S.G. §2T1.1(b)(2) for Mr. Diesel's use of "sophisticated means" to conceal his tax evasion offense .
Mr. Diesel objected to this enhancement on factual grounds, arguing that he had concealed nothing. Mr. Diesel also objected that a proper consideration of the factors enumerated under 18 U .S.C. §3553(a) suggested that he deserved a below-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.
At the sentencing hearing, the district court indicated that it had considered Mr. Diesel's written sentencing submission in addition to his oral presentation; that it understood the Guidelines to be merely advisory; and that the Guidelines suggested a sentencing range of 37 to 46 months. The district court then announced its judgment that a 42-month sentence would be appropriate in this case , taking into account Section 3553(a) factors. Specifically, the judge noted, among other things, the seriousness and magnitude of Mr. Diesel's tax evasion scheme; the sophistication of Mr. Diesel's efforts to hide his illegal conduct; as well as the possibility that , if not punished sufficiently, Mr . Diesel's conduct might tempt others to follow his example .
* * *On appeal, Mr. Diesel raises three arguments. We address each in turn.1. Mr. Diesel contends that he "could not possibly have had the requisite mens rea " when he signed his tax returns because it was only after signing each of those returns that he took and spent his annual distributions from the Pernour trust. Aplt. Op. Br. at 8; see also id. a t 10 , 12 . Because Mr. Diesel, despite his assertion to the contrary, failed to raise th is issue in the district court, we review for plain error. We hold, however , that Mr. Diesel's argument fails under any standard of review.
The government's case had nothing whatsoever to do with when or how Mr. Diesel caused Pernour to distribute monies to him. Instead, the case focused on whether Mr. Diesel's tax returns failed to account as income to him the money siphoned into the Pernour trust. Thus, the mens rea question for the jury was whether Mr. Diesel, when he signed his tax returns, willfully failed to disclose as income the monies directed to the Pernour trust. See 26 U .S.C. 3 ,
we again review only for plain error. And we again find no error 3 under any standard of review.With respect to Mr. Diesel's Booker argument, the record simply does not support him.
The district court expressly indicated that it treated the Guidelines as "advisory." See Sent. Tr. at 822 (emphasis added) ("I have given particular emphasis, of course, to the presentence investigation report and the United States Sentencing Guidelines, though treating those guidelines as advisory only and not mandatory, in arriving at what I think is a reasonable sentence in this case."). From this starting point, the district court then expanded the scope of its analysis outside of the Guidelines by weighing the Section 3553(a) factors and Mr. Diesel's arguments before ultimately holding that 42 months of incarceration would be "reasonable" in this case. See id. at 822-35. With respect to Mr. Diesel's Cunningham argument, it is foreclosed by Supreme Court and our precedent. District courts may make factual findings and enhance sentences within the statutory range prescribed for the conduct found by the jury. See, e .g., United States v . Holyfield, 4 8 1 F .3d 1260, 1262-6 3 (10th Cir. 2007) (citing Harris v . United States, 536 U.S. 545 (2002)). Quite unlike Cunningham, Mr. Diesel does not allege that his 42 -month sentence fell outside this range. Nor could he , a s 26 U .S.C. * This order and judgment is not binding precedent except under the doctrines of law of the case, resjudicata and collateral estoppel. It may be cited, however, for its persuasive value consistent with Fed. R . App. P . 32.1 and 10th Cir. R. 3 2 .1.1 Mr. Gross is also one of Mr. Diesel's appellate attorneys on this case . The government has not objected to the propriety of this unusual arrangement, and accordingly we do not address it here .2 See, e .g., IV Tr. T ran. at 599 ( "Well, I really didn't have a tax background at the time I went to the seminar. The only tax background I had was one class in law school."); id. at 613 (stating the one course was "just basic federal income tax").3 While Mr. Diesel objected to this two-level enhancement on factual grounds ( e .g., facts demonstrated that Mr. Diesel reported his income in either his personal or trust returns and thus he did not conceal it), he did not object to the two-level enhancement on constitutional or other legal grounds. See Def. Mot. Obj. to PSR a t 1-5; see also Sent . Tr. at 805-09. Mr . Diesel, however, did make a Booker and Section 3553(a) argument that his overall case presented unique circumstances and asked the district court for a sub-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.
The taxpayer's was taped by an IRS agent in a seminar tellilng the audience how to evade taxes.This was an easy win for the DOJ in the circumsances.
United States of America, Plaintiff-Appellee, v. Michael E. Diesel, Defendant-Appellant. U.S. Court of Appeals, 10th Circuit; 06-3325, July 31, 2007.Unpublished opinion affirming an unreported DC Kan. decision.
[ ¶41,333.217 and
In this appeal, Mr. Diesel a rgues that we should overturn his conviction because (1) he "could not possibly have had the requisite mens rea "; (2) the government unconstitutionally required Mr. Diesel to "create his own tax form"; and (3) the district court violated Apprendi v . New Jersey, 5 30 U.S. 466 (2000) , and its progeny when it sentenced him to a mid-Guidelines term of 42 months of incarceration. Because Mr. Diesel's first two arguments are wholly without merit and Mr. Diesel's third argument is precluded by Supreme Court and our case law, we affirm.
* * *Mr. Diesel founded and, through a series of trusts, effectively owned and operated a telecommunications research company which paid him an annual salary of $103,549 in 1998, $106,754 in 1999, and $108,788 in 2000. Mr . Diesel reported, and presumably paid , income tax on these amounts . In addition to his salary, however, Mr. Diesel's trusts also made over $3 million in distributions from 1998 to 2000, through a series of intermediate trusts , to the Pernour International T rust, an off-shore , Belize-based trust. Mr. Diesel controlled all of the trusts in the chain and ultimately received all of the proceeds from Pernour for his personal use. Mr. Diesel failed to pay income taxes on any of these proceeds.
Mr. Diesel apparently learned how to devise this scheme from the Aegis Company in Chicago, which, following a nationwide investigation, the government successfully prosecuted for tax fraud. In January 1998, an undercover IRS agent at an Aegis seminar in Belize tape recorded Mr . Diesel stating that (1) any income tax above ten percent is "confiscation" and "everybody is trying to cheat" the IRS; (2) the "whole point" of the trusts he employed was that the IRS did not understand them; (3) the trusts are like a "Double K-1 disappearing tax liability trick"; and (4) the trusts were "too good to be true."
Unfortunately for Mr. Diesel, they were not. In January 2005, a federal grand jury returned a three-count indictment against Mr. Diesel, charging him, inter a lia, with three felony violations under 26 U .S.C. 1 , who served as Mr. Diesel's sole witness. Mr. Gross testified that, while he is not a tax attorney 2 , he had advised Mr. Diesel in 2001 that the Aegis trust plan was "appropriate and correct," so long as properly followed. But Mr. Gross also admitted that he knew that the United States Tax Court, as early as 1998, had ruled the Aegis trust plan illegal - and that he communicated this via letter to his clients, including Mr. Diesel.The jury found Mr. Diesel guilty on all three counts, and the district court denied Mr. Diesel's motion for judgment of acquittal. At sentencing, the probation office recommended a Guidelines-based sentence of 37 to 46 months based, in part, on a two-level enhancement under U.S.S.G. §2T1.1(b)(2) for Mr. Diesel's use of "sophisticated means" to conceal his tax evasion offense .
Mr. Diesel objected to this enhancement on factual grounds, arguing that he had concealed nothing. Mr. Diesel also objected that a proper consideration of the factors enumerated under 18 U .S.C. §3553(a) suggested that he deserved a below-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.
At the sentencing hearing, the district court indicated that it had considered Mr. Diesel's written sentencing submission in addition to his oral presentation; that it understood the Guidelines to be merely advisory; and that the Guidelines suggested a sentencing range of 37 to 46 months. The district court then announced its judgment that a 42-month sentence would be appropriate in this case , taking into account Section 3553(a) factors. Specifically, the judge noted, among other things, the seriousness and magnitude of Mr. Diesel's tax evasion scheme; the sophistication of Mr. Diesel's efforts to hide his illegal conduct; as well as the possibility that , if not punished sufficiently, Mr . Diesel's conduct might tempt others to follow his example .
* * *On appeal, Mr. Diesel raises three arguments. We address each in turn.1. Mr. Diesel contends that he "could not possibly have had the requisite mens rea " when he signed his tax returns because it was only after signing each of those returns that he took and spent his annual distributions from the Pernour trust. Aplt. Op. Br. at 8; see also id. a t 10 , 12 . Because Mr. Diesel, despite his assertion to the contrary, failed to raise th is issue in the district court, we review for plain error. We hold, however , that Mr. Diesel's argument fails under any standard of review.
The government's case had nothing whatsoever to do with when or how Mr. Diesel caused Pernour to distribute monies to him. Instead, the case focused on whether Mr. Diesel's tax returns failed to account as income to him the money siphoned into the Pernour trust. Thus, the mens rea question for the jury was whether Mr. Diesel, when he signed his tax returns, willfully failed to disclose as income the monies directed to the Pernour trust. See 26 U .S.C. 3 ,
we again review only for plain error. And we again find no error 3 under any standard of review.With respect to Mr. Diesel's Booker argument, the record simply does not support him.
The district court expressly indicated that it treated the Guidelines as "advisory." See Sent. Tr. at 822 (emphasis added) ("I have given particular emphasis, of course, to the presentence investigation report and the United States Sentencing Guidelines, though treating those guidelines as advisory only and not mandatory, in arriving at what I think is a reasonable sentence in this case."). From this starting point, the district court then expanded the scope of its analysis outside of the Guidelines by weighing the Section 3553(a) factors and Mr. Diesel's arguments before ultimately holding that 42 months of incarceration would be "reasonable" in this case. See id. at 822-35. With respect to Mr. Diesel's Cunningham argument, it is foreclosed by Supreme Court and our precedent. District courts may make factual findings and enhance sentences within the statutory range prescribed for the conduct found by the jury. See, e .g., United States v . Holyfield, 4 8 1 F .3d 1260, 1262-6 3 (10th Cir. 2007) (citing Harris v . United States, 536 U.S. 545 (2002)). Quite unlike Cunningham, Mr. Diesel does not allege that his 42 -month sentence fell outside this range. Nor could he , a s 26 U .S.C. * This order and judgment is not binding precedent except under the doctrines of law of the case, resjudicata and collateral estoppel. It may be cited, however, for its persuasive value consistent with Fed. R . App. P . 32.1 and 10th Cir. R. 3 2 .1.1 Mr. Gross is also one of Mr. Diesel's appellate attorneys on this case . The government has not objected to the propriety of this unusual arrangement, and accordingly we do not address it here .2 See, e .g., IV Tr. T ran. at 599 ( "Well, I really didn't have a tax background at the time I went to the seminar. The only tax background I had was one class in law school."); id. at 613 (stating the one course was "just basic federal income tax").3 While Mr. Diesel objected to this two-level enhancement on factual grounds ( e .g., facts demonstrated that Mr. Diesel reported his income in either his personal or trust returns and thus he did not conceal it), he did not object to the two-level enhancement on constitutional or other legal grounds. See Def. Mot. Obj. to PSR a t 1-5; see also Sent . Tr. at 805-09. Mr . Diesel, however, did make a Booker and Section 3553(a) argument that his overall case presented unique circumstances and asked the district court for a sub-Guidelines sentence. See Def. Sent. Mem. at 1-9; see also Sent. Tr. at 809-20.
Wednesday, August 22, 2007
Back Taxes: New Charity Reporting Requirements - potential of tax abuse
The Treasury Department and IRS have designated the first two "transactions of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. The Treasury and IRS believe these transactions of interest have the potential for abuse, but lack sufficient information to determine whether they should be identified as tax avoidance transactions. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
IRS News Release IR-2007-143 , August 14, 2007.
[ Code Secs. 6111 and 6112 ]
Remainder interests: Charitable contribution deduction: Reportable transactions: --
The Treasury Department and the Internal Revenue Service issued two notices that identify as transactions of interest certain transactions involving "toggling" grantor trusts and certain transactions involving contributions of a successor member interest in a limited liability company.
Recently released final regulations about the disclosure of reportable transactions include the new transaction of interest category as one of the reportable transactions subject to disclosure.
"These are the first two transactions of interest we have published under the new regulatory scheme," said IRS Chief Counsel Don Korb. "Hopefully, the notices released today will give taxpayers and practitioners a better idea of the types of transactions that we will be identifying as transactions of interest in the future."
"Toggling" grantor trust transactions are utilized by grantors of these trusts in an attempt to avoid recognizing gain or to claim a tax loss greater than any actual economic loss by purportedly terminating and then reestablishing the grantor status of the trust. These grantor trust transactions usually occur within a short period of time (typically within 30 days).
Transactions involving contributions of a successor member interest are utilized by persons to claim charitable contributions that may be excessive. These transactions arise when a taxpayer acquires a successor member interest, directly or indirectly, in real property, transfers the interest to a tax-exempt organization, and claims a charitable contribution deduction that is significantly higher than the amount that the taxpayer paid for the interest.
In designating both transactions as transactions of interest, Treasury and the IRS believe both transactions have the potential for abuse, but lack sufficient information to determine whether the transactions should be identified specifically as tax avoidance transactions. Treasury and the IRS may take one or more future actions, including designating the transactions as listed transactions, or providing a new category of reportable transaction.
The notices also alert persons involved with these transactions of interest to certain responsibilities that may arise from their involvement.
Notice 2007-72 , I.R.B. 2007-36, August 14, 2007.
[ Code Secs. 6111 and 6112]
Remainder interests: Charitable contribution deduction: Reportable transactions: Transactions of interest. --
The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction involves taxpayers who purchase a remainder interest or similar successor member interest directly or indirectly in real property and then transfer such interest to a tax-exempt organization, claiming a charitable contribution deduction significantly higher than the amount paid for the interest. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, in which a taxpayer directly or indirectly acquires certain rights in real property or in an entity that directly or indirectly holds real property, transfers the rights more than one year after the acquisition to an organization described in §170(c) of the Internal Revenue Code, and claims a charitable contribution deduction under §170 that is significantly higher than the amount that the taxpayer paid to acquire the rights. The IRS and the Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 and 6112. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.
FACTS
In a typical transaction, Advisor owns all of the membership interests in a limited liability company (LLC) that directly or indirectly owns real property (other than a personal residence as defined in §1.170A-7(b)(3)) that may be subject to a long-term lease. Advisor and Taxpayer enter into an agreement under the terms of which Advisor continues to own the membership interests in LLC for a term of years (the Initial Member Interest), and Taxpayer purchases the successor member interest in LLC (the Successor Member Interest), which entitles Taxpayer to own all of the membership interests in LLC upon the expiration of the term of years. In some variations of this transaction, Taxpayer may hold the Successor Member Interest through another entity, such as a single member limited liability company. Further, the agreement may refer to the Successor Member Interest as a remainder interest.
After holding the Successor Member Interest for more than one year (in order to treat the interest as long-term capital gain property), Taxpayer transfers the Successor Member Interest to an organization described in §170(c) (Charity).
Taxpayer claims the value of the Successor Member Interest to be an amount that is significantly higher than Taxpayer's purchase price (for example, an amount that is a multiple of Taxpayer's purchase price and exceeds normal appreciation). Taxpayer claims a charitable contribution deduction under §170 based on this higher amount. Taxpayer reaches this value by taking into account an appraisal obtained by or on behalf of Advisor or Taxpayer of the fee interest in the underlying real property and the §7520 valuation tables.
The Internal Revenue Service and the Treasury Department are concerned about apparent irregularities in this transaction. Specifically, the IRS and the Treasury Department are concerned with the large discrepancy between (1) the amount Taxpayer paid for the Successor Member Interest, and (2) the amount claimed by Taxpayer as a charitable contribution. The IRS and the Treasury Department also have the following additional concerns, which may be present in some variations of this transaction: (1) any mischaracterization of the ownership interests in LLC; (2) a Charity's agreement not to transfer the Successor Member Interest for a period of time (which may coincide with the expiration of the applicable period in §6050L(a)(1)); and (3) any sale by Charity of the Successor Member Interest to a party selected by or related to Advisor or Taxpayer.
TRANSACTION OF INTEREST
Effective Date
Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.
Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice already may be subject to the requirements of §6011, 6111, or 6112, or the regulations thereunder. When the IRS and the Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and the Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.
Participation
Under §1.6011-4(c)(3)(i)(E), Advisor, LLC or any entity used in place of LLC, Taxpayer, and any members of Taxpayer if Taxpayer is a flow-through entity, are participants in this transaction for each year in which their respective tax returns reflect tax consequences or the tax strategy described in this notice.
Charity is not a participant if it received the Successor Member Interest described in this notice on or prior to August 14, 2007. For Successor Member Interests received after August 14, 2007, under §1.6011-4(c)(3)(i)(E) Charity is a participant in this transaction for the first year for which Charity's tax return reflects the Successor Member Interest described in this notice. In general, Charity is required to report the receipt of the Successor Member Interest described in this notice on its return for the year in which it is received. See §6033. Therefore, in general, Charity will be a participant for the year in which Charity received the Successor Member Interest.
Time for Disclosure
See §1.6011-4(e) and §301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).
Penalties
Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees under §6112 who fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under §6708(a). In addition, the Service may impose other penalties on persons involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or 6662A.
DRAFTING INFORMATION
The principal authors of this notice are Patricia M. Zweibel of the Office of Associate Chief Counsel (Income Tax and Accounting) and Leslie H. Finlow of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information concerning this notice generally, contact Ms. Zweibel at (202) 622-7900 (not a toll-free call). For further information concerning the sections of this notice under the heading TRANSACTIONS OF INTEREST, contact Ms. Finlow at (202) 622-3070 (not a toll-free call).
Notice 2007-73 , I.R.B. 2007-36, August 14, 2007.
[ Code Secs. 6111 and 6112 ]
Grantor trusts: Reportable transactions: Transactions of interest. --
The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction of interest involves a grantor of a trust attempting to avoid recognizing gain, or claiming a tax loss greater than the actual economic loss, by purportedly terminating ( "toggling off") and then reestablishing ( "toggling on") the grantor status of the trust, usually within a brief period of time. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, that uses a grantor trust, and the purported termination and subsequent re-creation of the trust's grantor trust status, for the purpose of allowing the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain. The IRS and Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 and 6112 of the Internal Revenue Code. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.
FACTS
In one variation of the transaction, Grantor purchases four options. The value of each one of the options is expected to move inversely in relation to at least one of the other options over a relevant range of values so that, before expiration of any one of the options, there will be a gain in two options (gain options) and a substantially offsetting loss in the other two options (loss options). Grantor creates Trust and funds Trust with the options and a small amount of cash. Grantor gives a short-term unitrust interest in Trust to Beneficiary and retains a noncontingent remainder interest in Trust. The remainder interest is structured to have a value as determined under §7520 that equals the fair market value of the options. Grantor takes the position that Grantor's remainder interest is a qualified interest under §2702. Because of the retained remainder interest, Grantor treats Trust as a trust owned by Grantor under subpart E ( §671 and following), part I, subchapter J, chapter 1 of the Code (a grantor trust). The trust agreement also provides that Grantor will have the power, exercisable in a nonfiduciary capacity, to reacquire Trust corpus by substituting other property of an equivalent value (the substitution power) and that this substitution power will become effective on a specified date in the future. See §675(4).
After establishing and funding Trust, Grantor sells the remainder interest in Trust to an unrelated person (Buyer) for an amount equal to the fair market value of the remainder interest (which is equal to the fair market value of the options). Grantor claims that the basis in the remainder interest is determined by allocating to the remainder interest a portion of the basis in all of the Trust assets (based on the respective fair market values of the remainder and unitrust interests at the time of the sale). Therefore, Grantor claims there is no gain recognized on the sale of the remainder interest because Grantor's basis in the remainder interest is the same as the amount realized (prearranged to be equivalent to the fair market value of the options). Buyer gives Grantor an installment obligation (Note), cash, or other consideration for the remainder interest. Grantor claims that the sale of the remainder interest has terminated (toggled off) the grantor trust status of Trust so that, during the period after the sale and before the effective date of the substitution power, Trust is no longer a grantor trust under §671.
Grantor claims that, once the substitution power becomes effective, Trust's grantor trust status is restarted (toggled on). The loss options are then closed out. The amount Grantor paid for those options (the original basis of those options) is greater than the amount Trust receives when the loss options are closed out. Grantor claims that Trust's status as a grantor trust causes Grantor to recognize the loss on the two loss options. Grantor calculates the loss based on the difference between the amount realized and the original basis in the loss options, even though Grantor previously used a portion of the basis in the Trust assets (equivalent to the basis in all of the options) to eliminate Grantor's gain on the sale of the remainder interest. Trust's remaining assets then consist of the two gain options, the contributed cash, and amounts received, if any, upon the termination of the loss options.
Buyer then purchases the unitrust interest in Trust from Beneficiary for an amount equal to the actuarial value of that interest (which equals or approximates the amount of cash Grantor contributed to Trust), making Buyer the owner of both the remainder interest and the unitrust interest. Trust then terminates (by operation of law or Buyer's action), and Trust's assets are distributed to Buyer. Buyer claims a basis in the assets (the gain options and the cash) from Trust equal to the amount paid by Buyer for the two separate interests in Trust. Grantor does not treat the termination of Trust as a taxable disposition by Grantor of the assets of Trust.
The gain options are exercised or sold, or otherwise terminate, and Buyer claims to recognize gain on the gain options only to the extent that the amount realized exceeds the basis Buyer allocates to the gain options. The transaction has been structured so that any gain recognized would be minimal. If Buyer purchased the remainder interest from Grantor with a Note, Buyer uses the proceeds from the options to pay the Note. If Grantor borrowed to purchase the options, Grantor repays the loan from the Note proceeds.
In another variation of the transaction, the facts are the same as described above except for the following. Grantor contributes to Trust liquid assets such as cash or marketable securities, rather than options. Grantor's basis in the contributed assets equals or is approximately equal to the fair market value of the assets at the time of contribution. Before the specified date on which Grantor's substitution power becomes effective, Grantor sells the remainder interest in Trust to Buyer for an amount equal to the fair market value of the remainder interest and claims to recognize no gain or a minimal gain or loss for the same reason as described above. As in the prior variation, Grantor claims that the sale terminates (toggles off) Trust's grantor trust status. After the substitution power becomes effective, Grantor substitutes appreciated property for Trust's liquid assets. The fair market value of the substituted property is equivalent to the fair market value of the liquid assets. Grantor claims that, once the substitution power becomes effective (prior to the exchange), Trust's grantor trust status is restarted (toggled on), and, therefore, the substitution will not cause Grantor to recognize gain.
As described above, Buyer purchases the unitrust interest in Trust from Beneficiary, terminates Trust, and receives Trust's assets on distribution. For tax purposes, Grantor does not treat the termination of Trust as a disposition by Grantor of the appreciated assets in Trust. Buyer claims a basis in the assets of Trust (the appreciated property and cash) equal to the amount paid by Buyer for the interests in Trust.
One of the purported tax consequences of the first variation of the transaction is that Grantor sells the remainder interest and receives an amount substantially equal to the fair market value of the (non-cash) assets contributed to Trust but nevertheless claims a tax loss attributable to those assets even though Grantor has not suffered an equivalent economic loss. One of the purported tax consequences of the second variation of the transaction is that Grantor avoids the recognition of gain on the disposition of the appreciated assets substituted for the original assets contributed to Trust.
These transactions usually occur within a short period of time during the taxable year (typically within 30 days), and, in each case, Grantor claims that the termination and subsequent reestablishment of grantor trust status, combined with the series of events regarding Trust's assets, result in tax consequences that could not be achieved without both the toggling off and on of grantor trust status. The transactions in this notice, as described above, do not include the situation where a trust's grantor trust status is terminated, unless there is also a subsequent toggling back to the trust's original status for income tax purposes.
TRANSACTION OF INTEREST
Effective Date
Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.
Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice may already be subject to the requirements of §§6011, 6111, or 6112, or the regulations thereunder. When the IRS and Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.
Participation
Under §1.6011-4(c)(3)(i)(E), Grantor, Buyer, and Beneficiary are participants in this transaction for each year in which their respective tax returns reflect tax consequences or a tax strategy described in this notice.
Time for Disclosure
See §1.6011-4(e) and §301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).
Penalties
Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees under §6112 who fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under §6708(a). In addition, the Service may impose other penalties on parties involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or §6662A.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
To provide IRS "transparency" upload your IRS experiences to www.irsforum.org
The Treasury Department and IRS have designated the first two "transactions of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. The Treasury and IRS believe these transactions of interest have the potential for abuse, but lack sufficient information to determine whether they should be identified as tax avoidance transactions. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
IRS News Release IR-2007-143 , August 14, 2007.
[ Code Secs. 6111 and 6112 ]
Remainder interests: Charitable contribution deduction: Reportable transactions: --
The Treasury Department and the Internal Revenue Service issued two notices that identify as transactions of interest certain transactions involving "toggling" grantor trusts and certain transactions involving contributions of a successor member interest in a limited liability company.
Recently released final regulations about the disclosure of reportable transactions include the new transaction of interest category as one of the reportable transactions subject to disclosure.
"These are the first two transactions of interest we have published under the new regulatory scheme," said IRS Chief Counsel Don Korb. "Hopefully, the notices released today will give taxpayers and practitioners a better idea of the types of transactions that we will be identifying as transactions of interest in the future."
"Toggling" grantor trust transactions are utilized by grantors of these trusts in an attempt to avoid recognizing gain or to claim a tax loss greater than any actual economic loss by purportedly terminating and then reestablishing the grantor status of the trust. These grantor trust transactions usually occur within a short period of time (typically within 30 days).
Transactions involving contributions of a successor member interest are utilized by persons to claim charitable contributions that may be excessive. These transactions arise when a taxpayer acquires a successor member interest, directly or indirectly, in real property, transfers the interest to a tax-exempt organization, and claims a charitable contribution deduction that is significantly higher than the amount that the taxpayer paid for the interest.
In designating both transactions as transactions of interest, Treasury and the IRS believe both transactions have the potential for abuse, but lack sufficient information to determine whether the transactions should be identified specifically as tax avoidance transactions. Treasury and the IRS may take one or more future actions, including designating the transactions as listed transactions, or providing a new category of reportable transaction.
The notices also alert persons involved with these transactions of interest to certain responsibilities that may arise from their involvement.
Notice 2007-72 , I.R.B. 2007-36, August 14, 2007.
[ Code Secs. 6111 and 6112]
Remainder interests: Charitable contribution deduction: Reportable transactions: Transactions of interest. --
The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction involves taxpayers who purchase a remainder interest or similar successor member interest directly or indirectly in real property and then transfer such interest to a tax-exempt organization, claiming a charitable contribution deduction significantly higher than the amount paid for the interest. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, in which a taxpayer directly or indirectly acquires certain rights in real property or in an entity that directly or indirectly holds real property, transfers the rights more than one year after the acquisition to an organization described in §170(c) of the Internal Revenue Code, and claims a charitable contribution deduction under §170 that is significantly higher than the amount that the taxpayer paid to acquire the rights. The IRS and the Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 and 6112. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.
FACTS
In a typical transaction, Advisor owns all of the membership interests in a limited liability company (LLC) that directly or indirectly owns real property (other than a personal residence as defined in §1.170A-7(b)(3)) that may be subject to a long-term lease. Advisor and Taxpayer enter into an agreement under the terms of which Advisor continues to own the membership interests in LLC for a term of years (the Initial Member Interest), and Taxpayer purchases the successor member interest in LLC (the Successor Member Interest), which entitles Taxpayer to own all of the membership interests in LLC upon the expiration of the term of years. In some variations of this transaction, Taxpayer may hold the Successor Member Interest through another entity, such as a single member limited liability company. Further, the agreement may refer to the Successor Member Interest as a remainder interest.
After holding the Successor Member Interest for more than one year (in order to treat the interest as long-term capital gain property), Taxpayer transfers the Successor Member Interest to an organization described in §170(c) (Charity).
Taxpayer claims the value of the Successor Member Interest to be an amount that is significantly higher than Taxpayer's purchase price (for example, an amount that is a multiple of Taxpayer's purchase price and exceeds normal appreciation). Taxpayer claims a charitable contribution deduction under §170 based on this higher amount. Taxpayer reaches this value by taking into account an appraisal obtained by or on behalf of Advisor or Taxpayer of the fee interest in the underlying real property and the §7520 valuation tables.
The Internal Revenue Service and the Treasury Department are concerned about apparent irregularities in this transaction. Specifically, the IRS and the Treasury Department are concerned with the large discrepancy between (1) the amount Taxpayer paid for the Successor Member Interest, and (2) the amount claimed by Taxpayer as a charitable contribution. The IRS and the Treasury Department also have the following additional concerns, which may be present in some variations of this transaction: (1) any mischaracterization of the ownership interests in LLC; (2) a Charity's agreement not to transfer the Successor Member Interest for a period of time (which may coincide with the expiration of the applicable period in §6050L(a)(1)); and (3) any sale by Charity of the Successor Member Interest to a party selected by or related to Advisor or Taxpayer.
TRANSACTION OF INTEREST
Effective Date
Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.
Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice already may be subject to the requirements of §6011, 6111, or 6112, or the regulations thereunder. When the IRS and the Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and the Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.
Participation
Under §1.6011-4(c)(3)(i)(E), Advisor, LLC or any entity used in place of LLC, Taxpayer, and any members of Taxpayer if Taxpayer is a flow-through entity, are participants in this transaction for each year in which their respective tax returns reflect tax consequences or the tax strategy described in this notice.
Charity is not a participant if it received the Successor Member Interest described in this notice on or prior to August 14, 2007. For Successor Member Interests received after August 14, 2007, under §1.6011-4(c)(3)(i)(E) Charity is a participant in this transaction for the first year for which Charity's tax return reflects the Successor Member Interest described in this notice. In general, Charity is required to report the receipt of the Successor Member Interest described in this notice on its return for the year in which it is received. See §6033. Therefore, in general, Charity will be a participant for the year in which Charity received the Successor Member Interest.
Time for Disclosure
See §1.6011-4(e) and §301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).
Penalties
Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees under §6112 who fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under §6708(a). In addition, the Service may impose other penalties on persons involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or 6662A.
DRAFTING INFORMATION
The principal authors of this notice are Patricia M. Zweibel of the Office of Associate Chief Counsel (Income Tax and Accounting) and Leslie H. Finlow of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information concerning this notice generally, contact Ms. Zweibel at (202) 622-7900 (not a toll-free call). For further information concerning the sections of this notice under the heading TRANSACTIONS OF INTEREST, contact Ms. Finlow at (202) 622-3070 (not a toll-free call).
Notice 2007-73 , I.R.B. 2007-36, August 14, 2007.
[ Code Secs. 6111 and 6112 ]
Grantor trusts: Reportable transactions: Transactions of interest. --
The Treasury Department and the IRS have designated a "transaction of interest," published under recently released Reg. §1.6011-4(b)(6), concerning reportable transactions. This transaction of interest involves a grantor of a trust attempting to avoid recognizing gain, or claiming a tax loss greater than the actual economic loss, by purportedly terminating ( "toggling off") and then reestablishing ( "toggling on") the grantor status of the trust, usually within a brief period of time. Persons involved with such transactions of interest have certain disclosure and other responsibilities, and may be subject to penalties for failing to comply with such obligations. In addition, participants in such transactions may be subject to other penalties, including the accuracy-related penalty under Code Secs. 6662 or 6662A.
The Internal Revenue Service and the Treasury Department are aware of a type of transaction, described below, that uses a grantor trust, and the purported termination and subsequent re-creation of the trust's grantor trust status, for the purpose of allowing the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain. The IRS and Treasury Department believe this transaction has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. This notice identifies this transaction, and substantially similar transactions, as transactions of interest for purposes of §1.6011-4(b)(6) of the Income Tax Regulations and §§6111 and 6112 of the Internal Revenue Code. This notice also alerts persons involved with these transactions to certain responsibilities that may arise from their involvement with these transactions.
FACTS
In one variation of the transaction, Grantor purchases four options. The value of each one of the options is expected to move inversely in relation to at least one of the other options over a relevant range of values so that, before expiration of any one of the options, there will be a gain in two options (gain options) and a substantially offsetting loss in the other two options (loss options). Grantor creates Trust and funds Trust with the options and a small amount of cash. Grantor gives a short-term unitrust interest in Trust to Beneficiary and retains a noncontingent remainder interest in Trust. The remainder interest is structured to have a value as determined under §7520 that equals the fair market value of the options. Grantor takes the position that Grantor's remainder interest is a qualified interest under §2702. Because of the retained remainder interest, Grantor treats Trust as a trust owned by Grantor under subpart E ( §671 and following), part I, subchapter J, chapter 1 of the Code (a grantor trust). The trust agreement also provides that Grantor will have the power, exercisable in a nonfiduciary capacity, to reacquire Trust corpus by substituting other property of an equivalent value (the substitution power) and that this substitution power will become effective on a specified date in the future. See §675(4).
After establishing and funding Trust, Grantor sells the remainder interest in Trust to an unrelated person (Buyer) for an amount equal to the fair market value of the remainder interest (which is equal to the fair market value of the options). Grantor claims that the basis in the remainder interest is determined by allocating to the remainder interest a portion of the basis in all of the Trust assets (based on the respective fair market values of the remainder and unitrust interests at the time of the sale). Therefore, Grantor claims there is no gain recognized on the sale of the remainder interest because Grantor's basis in the remainder interest is the same as the amount realized (prearranged to be equivalent to the fair market value of the options). Buyer gives Grantor an installment obligation (Note), cash, or other consideration for the remainder interest. Grantor claims that the sale of the remainder interest has terminated (toggled off) the grantor trust status of Trust so that, during the period after the sale and before the effective date of the substitution power, Trust is no longer a grantor trust under §671.
Grantor claims that, once the substitution power becomes effective, Trust's grantor trust status is restarted (toggled on). The loss options are then closed out. The amount Grantor paid for those options (the original basis of those options) is greater than the amount Trust receives when the loss options are closed out. Grantor claims that Trust's status as a grantor trust causes Grantor to recognize the loss on the two loss options. Grantor calculates the loss based on the difference between the amount realized and the original basis in the loss options, even though Grantor previously used a portion of the basis in the Trust assets (equivalent to the basis in all of the options) to eliminate Grantor's gain on the sale of the remainder interest. Trust's remaining assets then consist of the two gain options, the contributed cash, and amounts received, if any, upon the termination of the loss options.
Buyer then purchases the unitrust interest in Trust from Beneficiary for an amount equal to the actuarial value of that interest (which equals or approximates the amount of cash Grantor contributed to Trust), making Buyer the owner of both the remainder interest and the unitrust interest. Trust then terminates (by operation of law or Buyer's action), and Trust's assets are distributed to Buyer. Buyer claims a basis in the assets (the gain options and the cash) from Trust equal to the amount paid by Buyer for the two separate interests in Trust. Grantor does not treat the termination of Trust as a taxable disposition by Grantor of the assets of Trust.
The gain options are exercised or sold, or otherwise terminate, and Buyer claims to recognize gain on the gain options only to the extent that the amount realized exceeds the basis Buyer allocates to the gain options. The transaction has been structured so that any gain recognized would be minimal. If Buyer purchased the remainder interest from Grantor with a Note, Buyer uses the proceeds from the options to pay the Note. If Grantor borrowed to purchase the options, Grantor repays the loan from the Note proceeds.
In another variation of the transaction, the facts are the same as described above except for the following. Grantor contributes to Trust liquid assets such as cash or marketable securities, rather than options. Grantor's basis in the contributed assets equals or is approximately equal to the fair market value of the assets at the time of contribution. Before the specified date on which Grantor's substitution power becomes effective, Grantor sells the remainder interest in Trust to Buyer for an amount equal to the fair market value of the remainder interest and claims to recognize no gain or a minimal gain or loss for the same reason as described above. As in the prior variation, Grantor claims that the sale terminates (toggles off) Trust's grantor trust status. After the substitution power becomes effective, Grantor substitutes appreciated property for Trust's liquid assets. The fair market value of the substituted property is equivalent to the fair market value of the liquid assets. Grantor claims that, once the substitution power becomes effective (prior to the exchange), Trust's grantor trust status is restarted (toggled on), and, therefore, the substitution will not cause Grantor to recognize gain.
As described above, Buyer purchases the unitrust interest in Trust from Beneficiary, terminates Trust, and receives Trust's assets on distribution. For tax purposes, Grantor does not treat the termination of Trust as a disposition by Grantor of the appreciated assets in Trust. Buyer claims a basis in the assets of Trust (the appreciated property and cash) equal to the amount paid by Buyer for the interests in Trust.
One of the purported tax consequences of the first variation of the transaction is that Grantor sells the remainder interest and receives an amount substantially equal to the fair market value of the (non-cash) assets contributed to Trust but nevertheless claims a tax loss attributable to those assets even though Grantor has not suffered an equivalent economic loss. One of the purported tax consequences of the second variation of the transaction is that Grantor avoids the recognition of gain on the disposition of the appreciated assets substituted for the original assets contributed to Trust.
These transactions usually occur within a short period of time during the taxable year (typically within 30 days), and, in each case, Grantor claims that the termination and subsequent reestablishment of grantor trust status, combined with the series of events regarding Trust's assets, result in tax consequences that could not be achieved without both the toggling off and on of grantor trust status. The transactions in this notice, as described above, do not include the situation where a trust's grantor trust status is terminated, unless there is also a subsequent toggling back to the trust's original status for income tax purposes.
TRANSACTION OF INTEREST
Effective Date
Transactions that are the same as, or substantially similar to, the transactions described in this notice are identified as transactions of interest for purposes of §1.6011-4(b)(6) and §§6111 and 6112 effective August 14, 2007, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in §1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§6111 and 6112. See §1.6011-4(h) and §§301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.
Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice may already be subject to the requirements of §§6011, 6111, or 6112, or the regulations thereunder. When the IRS and Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.
Participation
Under §1.6011-4(c)(3)(i)(E), Grantor, Buyer, and Beneficiary are participants in this transaction for each year in which their respective tax returns reflect tax consequences or a tax strategy described in this notice.
Time for Disclosure
See §1.6011-4(e) and §301.6111-3(e).
Material Advisor Threshold Amount
The threshold amounts are the same as those for listed transactions. See §301.6111-3(b)(3)(i)(B).
Penalties
Persons required to disclose these transactions under §1.6011-4 who fail to do so may be subject to the penalty under §6707A. Persons required to disclose these transactions under §6111 who fail to do so may be subject to the penalty under §6707(a). Persons required to maintain lists of advisees under §6112 who fail to do so (or who fail to provide such lists when requested by the Service) may be subject to the penalty under §6708(a). In addition, the Service may impose other penalties on parties involved in these transactions or substantially similar transactions, including the accuracy-related penalty under §6662 or §6662A.
Alvin S. Brown, Esq.
Tax attorney
703.425.1400
www.irstaxattorney.com
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