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Coordinated Issues Paper - Insurance

Margins and Other Unsubstantiated Additions to Insurance Company Reserves for Unpaid Losses and Claims – 11-18-2009.

LMSB4-1109-041
EFFECTIVE DATE: November 18, 2009

Coordinated Issue Paper
Non-life Insurance Industry
• Health Insurance Companies
• Property-Casualty Companies
• Blue Cross Blue Shield Entities

Margins and Other Unsubstantiated Additions to Insurance Company Reserves for Unpaid Losses and Claims

UILs: 832.06-00 Losses Incurred
832.06-02 Unpaid Losses

Note: This issue paper is not an official pronouncement of the law or the position of the Service and cannot be used, cited or relied upon as such.

ISSUE:
May margins or other additions to reserves for unpaid losses shown on an insurance company's Annual Statement be included in the computation of "losses incurred" for federal income tax purposes where the taxpayer fails to establish that the additional amounts are based upon the company's actual loss experience and the total reserve is in excess of a fair and reasonable estimate within the meaning of Treas. Reg. § 1.832-4(b)?

CONCLUSION:
For federal income tax purposes, estimates of insurance company unpaid losses must be fair and reasonable in amount and must represent actual unpaid losses. Margins or other additions to unpaid losses that are not based upon the company's actual loss experience cannot be included in the deduction for losses incurred. If a taxpayer cannot establish that a margin or other addition to unpaid losses represents actual unpaid losses, the deduction will be disallowed to the extent it exceeds a fair and reasonable estimate.

BACKGROUND
1. The Internal Revenue Code and the NAIC Annual Statement. Beginning with the Revenue Act of 1921, the structure for the taxation of property and casualty insurance companies has been based upon the Annual Statement that insurers file with state regulators in accordance with the forms and procedures approved by the National Association of Insurance Commissioners ("NAIC"). See I.R.C. § 831(b) ("In the case of an insurance company subject to the tax imposed by section 831. . . [t]he term “gross income” means the sum of . . . the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Association of Insurance Commissioners.")

Among other things, the Annual Statement includes a schedule for computing "losses incurred," which is shown as the sum of losses paid during the year less salvage, increased by reinsurance assumed and reduced by reinsurance recovered, plus net losses unpaid at the end of the current year, minus net losses unpaid at the end of the prior year. Liabilities for unpaid losses are often called "loss reserves." Insurance Accounting & Systems Association, Inc. ["IASA"], Property-Casualty Insurance Accounting page 3-5 (7th ed. 1998). For purposes of computing losses incurred, any increase in the reserve for unpaid losses increases the amount of losses incurred, while any decrease in the reserve decreases losses incurred.

For federal income tax purposes, I.R.C. section 832(b)(5) sets forth a similar formula:

(A) In General -- The term “losses incurred” means losses incurred during the taxable year on insurance contracts computed as follows:

(i) To losses paid during the taxable year, deduct salvage and reinsurance recovered during the taxable year.

(ii) To the result so obtained, add . . . all discounted unpaid losses (as defined in section 846) outstanding at the end of the taxable year and deduct . . . all discounted unpaid losses outstanding at the end of the preceding taxable year.

(iii) To the results so obtained, add estimated salvage and reinsurance recoverable as of the end of the preceding taxable year and deduct estimated salvage and reinsurance recoverable as of the end of the taxable year.

The amount of estimated salvage recoverable shall be determined on a discounted basis in accordance with procedures established by the Secretary.

2. Statutory Accounting. NAIC accounting is described as "Statutory Accounting," as opposed to generally accepted accounting principles (GAAP). IASA, supra at page 1-15. See also Physicians Insurance Company of Wisconsin, Inc. v. Commissioner, T.C. Memo. 2001-304 ("Insurance companies are required to prepare their annual statements using a system of accounting known as the statutory or annual statement method, which does not necessarily conform to generally accepted accounting principles that govern the preparation of an insurance company’s financial statements"). In the past, NAIC accounting practices were not set out in a single document. In many cases the only sources were the forms, exhibits, and schedules of the Annual Statement, and the instructions to the Annual Statement. Recently, the NAIC has “codified” various accounting practices in a series of separate documents under the general title “Statement of Statutory Accounting Principles” ("SSAP"), which are set forth in the NAIC's Accounting Practices and Procedures Manual. SSAP No. 55 establishes statutory accounting principles for “Unpaid Claims, Losses and Loss Adjustment Expenses.”

At some point in the process of estimating loss reserves an actuarial projection is made, either by an in-house actuary or by an outside consultant. However, the NAIC does not require that the amount shown on the Annual Statement must be determined by an actuary. Instead, SSAP No. 55 states that “[M]anagement shall record its best estimate of its liabilities for unpaid claims, unpaid losses, and loss/claim adjustment expenses.” Note that SSAP No. 55 refers to management’s best estimate, not the actuary’s best estimate.

The NAIC's instructions to the Annual Statement require that it include a Statement of Actuarial Opinion. The form of the actuarial opinion varies for different types of companies, but generally includes a declaration that the amounts stated are "in accordance with accepted actuarial standards" and "make a good and sufficient provision" for all unpaid obligations or make a "reasonable provision." See, e.g., Utah Medical Insurance Association v. Commissioner, T.C. Memo. 1998-458 ("computed in accordance with accepted loss reserving standards . . . and provided sufficiently for all of petitioner’s unpaid loss and loss expense obligations"); Minnesota Lawyers Mutual Insurance Company v. Commissioner, T.C. Memo. 2000-203, aff'd, 285 F.3d 1086 (8th Cir. 2002) ("were computed in accordance with the standards of practice issued by the Actuarial Standards Board . . . and made reasonable provision for all unpaid loss and loss expense obligations"). See also, Hospital Corporation of America v. Commissioner, T.C. Memo. 1997-482 (opinion letter to Commissioner of Insurance: "were computed in accordance with accepted loss reserving standards . . . and made good and sufficient provision for all . . . unpaid loss and loss expense obligations"); Physicians Insurance Company of Wisconsin, Inc. v. Commissioner, T.C. Memo. 2001-304, (opinion letter to Commissioner of Insurance: “Make a reasonable provision, in the aggregate, for all unpaid loss and loss adjustment expense obligations").

Again, note that the Statement of Actuarial Opinion does not state that the amount shown on the Annual Statement has been determined by an actuary, but only that such amount has been determined "in accordance with" accepted actuarial standards, and makes a "reasonable provision" for all unpaid obligations. See, e.g., Minnesota Lawyers Mutual Insurance Company v. Commissioner, T.C. Memo. 2000-203 ("Petitioner's actuaries did not assist in establishing petitioner's reserves in the first instance but were asked after the fact to review petitioner's carried reserves, for purposes of satisfying the statutory certification requirement").

3. Annual Statement conservatism. In general, state insurance regulators are concerned with the solvency of insurance companies, and accordingly state insurance regulatory accounting favors conservatism. Sears, Roebuck and Co. v. Commissioner, 96 T.C. 61, 72 (1991) ("State regulators are concerned with financial solvency and market conduct, including matters such as pricing and product content, and with regulation of the claims adjustment process. The primary goal of regulation is to preserve the financial assets and solvency of the company, thereby assuring that the insurer will satisfy loss claims").

The Preamble to the NAIC's Accounting Practices and Procedures Manual includes a "Statement of Concepts." The Preamble states that "The primary responsibility of each state insurance department is to regulate insurance companies in accordance with state laws with an emphasis on solvency for the protection of policyholders." Manual, p. P-5. The first "concept" described in the Preamble is the concept of conservatism: "In order to provide a margin of protection for policyholders, the concept of conservatism should be followed when developing estimates as well as establishing accounting principles for statutory reporting." Manual, p. P-6.

This preference for solvency and conservatism is reflected in the NAIC's Health Reserves Guidance Manual 9 (November 6, 2000):

F. Conservatism
1. General
Conservatism can be explicit or implicit depending on the method used. “Explicit conservatism” means that a preliminary reserve is determined using assumptions that represent expected experience; then, a separate provision for adverse deviations from expected -- the “load” or “margin” -- is added to provide conservatism. “Implicit conservatism” means that the reserve is determined using assumptions that are more conservative than what is actually expected. In some cases, reserves may be determined with some implicit conservatism, and then increased by an explicit load or margin to provide sufficient overall conservatism. [Emphasis added.]

* * *

The level of conservatism needed typically will vary by, among other factors, the size of the block of business and the type of coverage. . . . Note, however, that reserve adequacy ultimately is to be judged in the aggregate for a reporting entity. For example, a high degree of conservatism might be appropriate for small-group hospital claims on a stand-alone basis; when a reporting entity combines its reserves for hospital and physician claims, and small and large groups, the necessary degree of conservatism is likely to be substantially less than the sum of the margins developed on a stand-alone basis.

Several factors in the process of determining liabilities would impact the level of conservatism. As the process more precisely adjusts for large claims and for increases and decreases in inventory, the amount of additional margin needed would be decreased. Other factors that impact the margin level are the potential variance in the trend in claim costs at the valuation date and the rate of growth in the line of business.

The level of conservatism needed will also vary according to the sophistication of the reserving process. Less margin should be needed to the extent that the process explicitly and accurately reflects such items as atypically large claims; changes in the level of claim inventory or “backlog” (claims received but not yet processed); trend in claim costs; seasonality of claim costs; changes in provider reimbursement arrangements (e.g., switches between capitation and fee-for-service payments); and changes in the demographic characteristics of the covered lives (age/sex mix, etc.). This list is not exhaustive, and other techniques may also reduce the need for conservatism in the reserve. However, unless such techniques have been in use for a significant period of time, the acceptable reduction in conservatism will be largely a matter of judgment.

The NAIC has recognized a possible conflict between the discussion of "margins" in the Health Reserves Guidance Manual, and SSAP 55, which directs management to record its "best estimate" of its unpaid claim liability. The matter was referred to the NAIC's Emerging Accounting Issues Working Group, which adopted the following "interpretation" of SSAP 55:

The working group reached a consensus that the concept of conservatism is inherent to the estimation of reserves and as such should not be specifically prohibited in the consideration of management’s best estimate. On the other hand, the working group does not believe there should be a specific requirement to include a provision of adverse deviation in claims as the application of estimates varies greatly from company to company and requires the careful judgment of management.

INT 01-28 (October 16, 2001, Accounting Practices and Procedures Manual B-150 (2008). Note that while the working group endorsed the concept of conservatism, it did not believe there should be a specific requirement to include a provision for adverse deviation in claims. In other words, while the concept of a "best estimate" does not prohibit a consideration of conservatism, statutory accounting does not require the addition of a "margin" or other provision for adverse deviation in claims.

4. "Margins" and other "add-ons." As described in the Health Reserves Guidance Manual, an “explicit" margin is distinct and identifiable and is generally added on after an initial determination of the reserve amount necessary to discharge the company’s liability. The taxpayer or its actuary determines a preliminary reserve for unpaid losses based upon expected experience, and then a margin or other amount is added to the preliminary reserve above and beyond the amount needed to meet the expected experience. In contrast, the phrase "implicit conservatism" describes a situation where the taxpayer or its actuary determines the overall reserve using assumptions that are more conservative than what is actually expected, resulting in an overstatement of the overall reserve. In that case, there is only one figure, the final reserve number, rather than a preliminary figure with a separate figure for the explicit margin. In both cases the effect is the same: the overall reserve is overstated, but in the case of an explicit margin, the overstatement is a direct result of the explicit margin, while in the case of implicit conservatism the cause of the overstatement may not be immediately apparent.

The NAIC's Health Reserves Guidance Manual refers to "explicit margins" and "implicit conservatism." The NAIC's Emerging Accounting Issues Working Group, in INT 01-28, refers to a "provision for adverse deviation." Insurers may make additions to Annual Statement loss reserves under other labels or descriptions, such as "reserve for adverse development," or "add-ons." See, e.g., Minnesota Lawyers Mutual Insurance Company v. Commissioner, T.C. Memo. 2000-203, ("bulk reserve for 'adverse loss development'"); Physicians Insurance Company of Wisconsin v. Commissioner, T.C. Memo. 2001-304 ("add-ons to [the actuary's] point estimates").

TAXPAYER'S POSITION
In preparing the Annual Statement that is filed with state insurance regulators, some taxpayers have increased the reserve for unpaid losses by adding explicit margins or other distinct and identifiable amounts that are not based upon the company's actual experience. Other taxpayers have determined the overall reserve using assumptions that are more conservative than what is actually expected. In both situations the taxpayer's Annual Statement includes a Statement of Actuarial Opinion. In both situations the taxpayer uses the Annual Statement reserve amount in preparing its federal income tax returns. In general, taxpayers argue that the Annual Statement numbers must be accepted for federal income tax purposes. Various specific arguments typically raised by taxpayers are addressed below.

DISCUSSION

While section 832 refers to the Annual Statement that insurance companies file with state regulators, for federal income tax purposes the Annual Statement is only a general guide. The Code contains numerous modifications to Annual Statement accounting. While the Annual Statement includes a provision for unpaid losses, for federal income tax purposes the requirements for the deduction are set forth in Treas. Reg. §§ 1.832-4(a)(14) [formerly § 1.832-4(a)(5)] and 1.832-4(b):

§ 1.832-4 Gross income

(a)(14) In computing “losses incurred” the determination of unpaid losses at the close of each year must represent actual unpaid losses as nearly as it is possible to ascertain them.

(b) Losses incurred. -- Every insurance company to which this section applies must be prepared to establish to the satisfaction of the district director that the part of the deduction for “losses incurred” which represents unpaid losses at the close of the taxable year comprises only actual unpaid losses. See section 846 for rules relating to the determination of discounted unpaid losses. These losses must be stated in amounts which, based upon the facts in each case and the company's experience with similar cases, represent a fair and reasonable estimate of the amount the company will be required to pay. Amounts included in, or added to, the estimates of unpaid losses which, in the opinion of the district director, are in excess of a fair and reasonable estimate will be disallowed as a deduction. The district director may require any insurance company to submit such detailed information with respect to its actual experience as is deemed necessary to establish the reasonableness of the deduction for “losses incurred.” [Emphasis added.]

In summary, for federal income tax purposes, the deduction for unpaid losses is limited to actual unpaid losses, and the deduction must be stated in amounts that represent a fair and reasonable estimate of the amount the company will be required to pay.

Several conclusions follow from these general principles:

1. Not all "reserves" shown on the Annual Statement or allowed by state insurance regulators are allowable as deductions for federal income tax purposes. The Internal Revenue Code specifies the items that are deductible for federal income tax purposes. To the extent that a state statute requires a reserve in addition to or in excess of those reserves necessary for the protection of policyholders, the reserve is merely a solvency reserve. Additions to solvency reserves have no bearing on what part of an insurance company’s gross income is treated as net income for tax purposes. United States v. Boston Insurance Co., 269 U.S. 197 (1925); McCoach v. Insurance Company of North America, 244 U.S. 585 (1909); Colonial Surety Co. v. United States, 178 F.Supp. 600, 602 (Ct. Cl. 1959) ("reserves to take care of the other contingencies, although they are proper to insure solvency, are not deductible for tax purposes"). See also, Rev. Rul. 83-174, 1983-2 C.B. 108; Rev. Rul. 76-56, 1976-1 C.B. 185.

2. The Service is not bound by the numbers shown on the Annual Statement. It has long been the position of the Internal Revenue Service that the NAIC Annual Statement is merely a "general guide" in computing insurance company taxable income. Rev. Rul. 61-167, 1961 C.B. 130; Rev. Rul. 60-306, 1960-2 C.B. 211. See Commissioner v. U.S. Guarantee Company, 190 F.2d 152 (2d Cir. 1951), rev’g and rem’g, 8 CCH Tax Ct. Mem. 510 (1949); Commissioner v. General Reinsurance Corp., 190 F.2d 148 (2d Cir. 1951), rev’g and rem’g, 9 CCH Tax Ct. Mem. 141 (1950); Pacific Insurance Co., Ltd. v. United States, 90 F. Supp. 328 (Hawaii D.C. 1950), aff’d, 188 F.2d 571 (9th Cir. 1951); and Pacific Employers Insurance Company v. Commissioner, 89 F.2d 186 (9th Cir. 1937), aff’g 33 B.T.A. 501 (1935). Contra New Hampshire Fire Insurance Co. v. Commissioner, 146 F.2d 697 (1st Cir. 1945), aff’g, 2 T.C. 708 (1943); and Columbia Casualty Co. v. Commissioner, 7 CCH Tax Ct. Mem. 282 (1948).

Annual Statement numbers for loss reserves are not determinative for federal income tax purposes. Hanover Insurance Company v. Commissioner, 598 F.2d 1211, 1217 (1st Cir. 1979), aff'g 65 T.C. 715 (1976). Physicians Insurance Company of Wisconsin v. Commissioner, T.C. Memo. 2001-304. The taxpayer must satisfy the Treasury Regulation's requirement that the part of the deduction for “losses incurred” which represents unpaid losses must comprise only actual unpaid losses, stated in amounts that represent a "fair and reasonable" estimate of the amount the company will be required to pay.

3. The Service is not bound by the Statement of Actuarial Opinion included in the Annual Statement, and the actuary's opinion is not entitled to any presumption or deference. First, under the procedures of SSAP No. 55, the unpaid loss reserve numbers reflected on the Annual Statement are selected by management. The Statement of Actuarial Opinion included in the Annual Statement merely confirms that the numbers selected by management are "in accordance with accepted actuarial standards" and "make a good and sufficient provision" for all unpaid obligations or make a "reasonable provision." In other words, the Statement of Actuarial Opinion does not determine the numbers that are shown on the Annual Statement.

Second, the Statement of Actuarial Opinion included in the Annual Statement -- or any related actuarial study -- is prepared for purposes of the Annual Statement, not for federal income tax purposes. Accordingly, it reflects the standards of Annual Statement accounting, such as conservatism, and not the standards of the Treasury Regulations. The fact that the Statement of Actuarial Opinion concludes that the numbers shown on the Annual Statement make a "reasonable provision" for unpaid losses does not establish that those numbers are "fair and reasonable" for federal income tax purposes. Hanover Insurance Company v. Commissioner, supra, 598 F.2d at 1217.

Third, the Service is not required to accord deference to the opinion of the taxpayer’s actuary. In Vinson & Elkins v. Commissioner, 99 T.C. 9, 16-17 (1992), aff’d, 7 F.3d 1235 (5th Cir. 1993), the Tax Court, explained that in the context of a defined benefit plan under I.R.C. § 412(c)(3) the Service was only permitted to retroactively challenge an actuary’s assumptions if the assumptions were “substantially unreasonable.” In the context of I.R.C. § 832, deference to the taxpayer's actuary is not applicable with respect to estimates of unpaid loss reserves for property and casualty insurers, where a different statutory scheme applies and where Treas. Reg. § 1.832-4 specifically authorizes the Service to adjust a taxpayer’s reserves if they are not fair and reasonable in amount. Treas. Reg. § 1.832-4 does not require that the Service must establish that a reserve is “substantially unreasonable” prior to making any adjustment.

4. For federal income tax purposes, the deduction for unpaid losses must be based on actual loss events. "Formula" reserves are not allowable. Treasury Reg. § 1.832-4(a)(14) (formerly Treas. Reg. § 1.832-4(a)(5)) requires that a taxpayers’ estimate of unpaid losses at the close of each year “represent actual unpaid losses as nearly as it is possible to ascertain them." The predecessor to Treas. Reg. § 1.832-4(a)(14) was promulgated in 1943. See T.D. 5236, 1943 C.B. 519. At that time, the NAIC required insurers to establish unpaid loss reserves equal to the greater of two separately-calculated reserves: (1) a case-based reserve representing the aggregate reserves for specific claims estimated by the insurer’s claims adjusters or; (2) a formula reserve representing a specified percentage of the insurer’s premium volume. See Charles W. Tye, The Convention Form and Insurance Company Tax Problems, 6 Tax Law Rev. 245, 245-246 (1951). Prior to the promulgation of T.D. 5236, the Service had successfully litigated its position that insurers were only entitled to deduct unpaid losses that were calculated on the case method, thereby preventing insurers from using the formula method for tax purposes. See, e.g., Pacific Employers Ins. Co. v. Commissioner, 33 B.T.A. 501 (1935), aff’d, 89 F.2d 186 (9th Cir. 1937); American Title Co. v. Commissioner, 29 B.T.A. 479 (1933), aff’d, 76 F.2d 332 (3d Cir. 1935). Accordingly, the language presently contained in Treas. Reg. § 1.832-4(a)(14) was initially included in the regulations in an attempt to emphasize the Service’s longstanding position that insurers were not entitled to use the formula method for tax purposes. See also Rev. Rul. 61-167, supra (percentage reserve for fidelity and surety business: "The reserve maintained by the taxpayer in this case does not comprise actual losses which, based on the facts of each case and the company's experience in similar cases, can be said to represent a fair and reasonable estimate of the amount the company will be required to pay but, in fact, constitutes a contingency reserve, computed on the basis of a percentage rate established by the Treasury Department, which the taxpayer is required to maintain as a condition of writing surety bonds on United States Government contracts.").

On the Annual Statement, unpaid losses include losses that are "incurred but not reported" ("IBNR"), and the Service allows IBNR losses to be included in the estimate of unpaid losses for federal income tax purposes. Rev. Rul. 70-643, 1970-2 C.B. 141. Although IBNR losses are, by definition, "unreported," the deduction for unpaid losses is limited to losses that have actually been incurred and cannot include estimates of potential future losses or mere contingency reserves. The Tax Court described this distinction in State of Maryland Deposit Insurance Fund Corp. v. Commissioner, 88 T.C. 1050, 1060 (1987):

Clearly, estimates are permissible in calculating IBNR insurance losses. By definition, an insurance company will not yet know the specific amount of such losses at the end of the taxable year (because they have not yet been reported). The authorities are clear, however, that the calculation of IBNR losses must be based on estimates of actually incurred losses as of the end of the year. This is to be distinguished from an impermissible calculation based on estimates of potential losses that might be incurred in future years. Maryland Savings-Share Ins. Corp. v. United States, 226 Ct. Cl. at 499-500, 507, 644 F.2d at 24, 28; Home Mutual Ins. Co. v. Commissioner], 70 T.C. 944, 951 (1978), affd. in part, revd. in part and remanded in part 639 F.2d 333 (7th Cir. 1980); Modern Home Life Ins. Co. v. Commissioner, 54 T.C. 935, 939 (1970).

5. For federal income tax purposes, the deduction for unpaid losses must represent a fair and reasonable estimate of the amount the company expects to pay. No administrative "margin" or "tolerance" is required or allowable. Treasury Reg. § 1.832-4(b) requires that the part of a taxpayer’s deduction for “losses incurred” which represents unpaid losses at the close of the taxable year "must be stated in amounts which, based upon the facts in each case and the company's experience with similar cases, represent a fair and reasonable estimate of the amount the company will be required to pay." (Emphasis added.) The predecessor to Treas. Reg. § 1.832-4(b) was promulgated in 1944, in part to address concerns raised by the 1943 promulgation of T.D. 5236, which required that unpaid losses must represent "actual" unpaid losses, "as nearly as it is possible to ascertain them.” That language appeared to set forth an exact standard with respect to an estimated item that was inherently uncertain. Practitioners raised questions concerning the manner in which the Service would determine whether case-based reserves were overstated. See Charles W. Tye, Federal Taxation of Insurance Companies and Their Problems, 21 Taxes 594, 616 (November 1943) (“The [Service], if it is to try and treat the computation of ’unpaid losses’ as an exact science on a case basis should give the companies more of a guide to their intention in the matter than to merely state that ‘unpaid losses must represent actual unpaid losses as nearly as it is possible to ascertain them’”). The Service addressed these concerns by promulgating T.D. 5387, which authorized the Service to make adjustments to reserves that it deemed impermissibly excessive, i.e., not “fair and reasonable."

Along with T.D. 5387 the Service issued Comm. Mim. R.A. No. 1366, which set forth a rule of thumb for auditing agents to use in determining whether estimates of unpaid losses were reasonable. Specifically, it directed agents to make adjustments to loss reserves for certain lines of insurance only if the average of the preceding five years’ estimated losses exceeded 115 percent of the average one year development of those estimates.

While Comm. Mim. R.A. No. 1366 was not published by the Service its contents were widely circulated among practitioners and the insurance industry. Comm. Mim. R.A. No. 1366 did not represent a legal interpretation but merely provided administrative guidance for examining estimates of unpaid losses.

In 1975, the Service issued Rev. Proc. 75-56, 1975-2 C.B. 596, which effectively revoked Comm. Mim. R.A. No. 1366. Rev. Proc. 75-56 stated that "The long term administrative practice enunciated in Com. Mim. R.A. 1366 can no longer be justified in view of the technological advances made by the insurance industry in the area of statistical collection and analysis. Instead the standard of reasonableness in computing unpaid losses will be that set forth in sections 1.832-4(a)(5) [now section 1.832-4(a)(14)] and 1.832-4(b) of the regulations." Emphasis added.

Comm. Mim. R.A. No. 1366 is sometimes described as providing a 15% "tolerance" for estimates of unpaid loss reserves: that no adjustment should be made if the taxpayer's estimate is not more than 15% greater than the Service's estimate. That procedure no longer applies. Rev. Proc. 75-56 specifically supersedes Comm. Mim. R.A. No. 1366. No tolerance may be allowed.

6. For federal income tax purposes, the determination of a fair and reasonable estimate of unpaid losses is a factual determination to be made based on the standards set forth in Treas. Reg. §§ 1.832-4(a)(14) and 1.832-4(b), and not on the standards of the Annual Statement. The taxpayer must establish that the deduction for unpaid losses is comprised of only actual unpaid losses, and the taxpayer may be required to submit detailed information with respect to its actual experience as is deemed necessary to establish the reasonableness of the deduction. As a preliminary matter, it should first be emphasized that any adjustment to an insurance company's deduction for losses incurred for federal income tax purposes has no effect on the company's loss reserves for Annual Statement or state regulatory purposes. As the Court of Appeals stated in Hanover Insurance Company v. Commissioner, supra, 598 F.2d at 1218:

[The taxpayer] was free to maintain reserves in any amount for unpaid losses. I.R.C. § 832 and accompanying regulations do not limit an insurance company’s freedom to keep records in whatever manner it chooses for financial or state regulatory use. Any increased burden on the insurance company is no greater than that borne by other taxpayers who use different data for tax purposes as opposed to other purposes.

Second, it should also be emphasized that valuation standards for Annual Statement purposes are different from valuation standards for federal income tax purposes, and in any particular case the different standards may produce different results. For federal income tax purposes the question is not whether the amount shown on the Annual Statement makes a "reasonable provision" for unpaid losses. That is an issue for the state insurance regulators, applying their standards of conservatism. Nor is the question whether a "reasonable provision" for Annual Statement purposes should be considered a "fair and reasonable estimate" for federal income tax purposes. Annual Statement valuation standards do not apply for federal income tax purposes.

As indicated above, a taxpayer may overstate its Annual Statement reserve for unpaid losses either by adding an "explicit" margin or by applying "implicit conservatism" in determining the overall reserve. Two cases have dealt with what may be considered "explicit" margins: Minnesota Lawyers Mutual Insurance Company v. Commissioner, T.C. Memo. 2000-203, aff'd, 285 F.3d 1086 (8th Cir. 2002) ("bulk reserve for 'adverse loss development'") and Physicians Insurance Company of Wisconsin v. Commissioner, T.C. Memo. 2001-304 ("add-ons to [the actuary's] point estimates"). The taxpayer in the Minnesota Mutual case made arguments similar to those discussed above, which the Court of Appeals summarized as follows:

MLM contends the deductions claimed on its 1994 and 1995 tax returns should be presumed fair and reasonable because the estimates were selected by professional management and not tax-motivated; certified as reasonable by a qualified actuary; within a range of reasonable actuarial estimates; and reported in MLM's annual statement and accepted by the Minnesota Department of Commerce (MDC) without change. MLM invites us to adopt a test which conclusively establishes the fairness and reasonableness of unpaid loss estimates for tax purposes when the estimates meet these four criteria.

We decline MLM's invitation and affirm the tax court. The fairness and reasonableness of unpaid loss estimates is a factual issue determined by the tax court on a case-by-case basis. The four criteria outlined by MLM should be considered by the tax court in reaching its factual determination, but they are not conclusive. The tax court need not defer to estimates set forth in an annual statement and accepted by a state insurance regulator if the taxpayer cannot otherwise defend its estimates with detailed information related to its own experience. [285 F.3d at 1088.]

The tax court found MLM failed to demonstrate either the necessity or reasonableness of the ALD [adverse loss development] reserves. As a factual matter, the tax court found that MLM did not establish the ALD reserve to hedge against historically inadequate reserves because MLM's recent experience had proven its case reserves to be generous. . . .

The tax court further determined that MLM did not carry its burden of showing the ALD amounts were fair and reasonable -- even assuming MLM could demonstrate the need for an ALD reserve. The tax court noted MLM did not show what specific factors, if any, were taken into account in establishing the extra reserve or how such factors might have been weighed. Indeed, MLM produced no documentation of any kind to show what data it analyzed in determining the amount of the ALD reserve. . . . [285 F.3d at 1090, emphasis added.]

MLM relies principally upon Utah Med. Ins. Ass'n v. Comm'r, 76 T.C.M. (CCH) 1100, 1998 WL 906665 (1998). . . .

The tax court distinguished Utah Med. because, notwithstanding the fact that MLM's unpaid loss estimates fell within an actuary's range of reasonable estimates and were accepted by a state insurance regulator, MLM neglected to present “detailed information with respect to its actual experience,” Treas. Reg. § 1.832-4(b), to establish the reasonableness of its ALD reserve. [285 F.3d at 1091, emphasis added.]

Similarly, in Physicians Insurance Company of Wisconsin v. Commissioner, T.C. Memo. 2001-304 the Tax Court stated:

Petitioner contends that because it reported the same estimates of unpaid losses on its annual statements and tax returns, and because it estimated these unpaid losses in a reasonable manner, using sound business practices, these estimates should be accorded deference for Federal income tax purposes. . . .

Petitioner's contention is at bottom a rehashing of long-rejected arguments that the Code reflects a congressional expectation that the estimates of unpaid losses used for tax purposes should conform to the precise figures shown on the annual statement. [Citing Hanover Ins. Co. v. Commissioner, 598 F.2d 1211, 1217 (1st Cir. 1979).]

Summary and Conclusions:
For federal income tax purposes the standards for the deduction for unpaid losses are set forth in Treas. Reg. §§ 1.832-4(a)(14) and 1.832-4(b). With respect to "margins" or other additions to unpaid losses two elements must be considered:

Estimates of unpaid losses must be fair and reasonable in amount,
and the estimates must represent actual unpaid losses. Margins or other
additions to unpaid losses that are not based on the company's actual experience cannot be included in the deduction for losses incurred.

Estimates of unpaid losses must be fair and reasonable in amount.

For federal income tax purposes the first and principal criterion in the examination of unpaid losses is that amounts included in or added to the estimates of unpaid losses must represent a fair and reasonable estimate of the amount the company will be required to pay. Accordingly, the first step in the examination of unpaid losses is to make an independent evaluation of the amount claimed as a deduction, without regard to the manner in which the taxpayer's Annual Statement reserves were determined or the labels or descriptions which the taxpayer attaches to any additions to its Annual Statement reserves.

If, as a result of this independent evaluation, it appears that the amount claimed by the taxpayer as unpaid losses is in excess of a fair and reasonable estimate, the Service may require the taxpayer to submit detailed information to establish the reasonableness of its deduction for losses incurred as demonstrated by its actual experience. Depending on the specific facts of any particular case, any excess over a fair and reasonable amount may be disallowed on that basis alone.

Estimates of unpaid losses must represent actual unpaid losses.

In addition, depending on the specific facts of the case, where an overstatement of loss reserves is due to distinct and identifiable additions to unpaid losses, including “explicit” margins or other "add-ons," any excess over a fair and reasonable amount may be disallowed on the basis that it does not comprise actual unpaid losses. In those circumstances, the reserve addition fails the “fair and reasonable” standard and also constitutes an unallowable contingency reserve or solvency reserve.

No distinction shall be made or deference given based on who determined or recommended that the margin be added to reserves. While careful consideration should be given to full disallowance of the overstatement for each examination year, the margin or other unsubstantiated addition must, at a minimum, be disallowed. Under Rev. Proc. 75-56, no portion of these additions can be compromised unless the taxpayer provides compelling evidence that the margin or reserve addition meets the documentary requirements of the Regulations, which require that all reserve components be based on the actual historical experience of the taxpayer.





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Provisions of HIRE Act effective 3..18..2010

RIA Special Study: Hiring and Business Stimulus Provisions in the HIRE Act of 2010
The Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147 ) was signed into law by the President on Mar. 18, 2010, one day after it passed Congress. This Special Study explains how the HIRE Act encourages companies to hire (and retain) unemployed workers by creating an employer “payroll tax holiday” of sorts for hiring unemployed workers in 2010 and an employer tax credit if these new hires are retained for at least one year. It also explains how the Act boosts expensing for 2010 and permits certain bond issuers to elect to receive a payment in lieu of providing a tax credit to the bondholders. For a Special Study on the Act's new anti-offshore tax abuse measures, and other revenue raising provisions, see ¶ 2 .
Payroll Tax Holiday in 2010 for Hiring Unemployed Workers
The Federal Insurance Contributions Act (FICA) imposes two taxes, the Old Age, Survivors and Disability Insurance (OASDI) tax and the Medicare Hospital Insurance (HI) tax. These taxes are imposed on employers for wages paid with respect to employment and on employees for wages received with respect to employment. The OASDI tax rate is 6.2% on wages up to an annually-adjusted “wage base” ($106,800 for 2010). The HI tax rate is 1.45% on all wages, regardless of amount. Under pre-Act law, the Social Security payroll tax wasn't forgiven for employers who hired the unemployed.
Employers who hire members of certain targeted groups before Sept. 2011 may claim a work opportunity credit (WOTC) equal to a percentage of up to $6,000 of first-year wages per employee, $12,000 for qualified veterans, and $3,000 for qualified summer youth employees. If the employee is a long-term family assistance recipient, the credit is a percentage of first- and second-year wages, up to $10,000 per employee.
New law. The Act provides relief from the employer share of OASDI taxes for employers that hire unemployed workers. The relief applies to wages paid beginning on Mar. 19, 2010 (the day after the enactment date) and ending on Dec. 31, 2010. ( Code Sec. 3111(d) , as amended by Act Sec. 101(a))
More specifically, the OASDI tax on employers doesn't apply to wages paid by a qualified employer with respect to employment during the period beginning on Mar. 19, 2010 and ending on Dec. 31, 2010, of any qualified individual for services performed:
... in a trade or business of the qualified employer; or
... for a qualified employer that is tax-exempt under Code Sec. 501(a) , in furtherance of the activities related to the purpose or function on which the employer's exemption is based. ( Code Sec. 3111(d)(1) , as amended by Act Sec. 101(a))
RIA observation: The payroll tax holiday applies only to the 6.2% OASDI portion of the employer's tax. It doesn't apply to the 1.45% Medicare (HI) portion of the employer's tax, nor to any part of the employee's tax. It also doesn't affect the self-employment tax paid by self-employed individuals.
RIA observation: The amount of tax forgiven per employee can't exceed $6,621.60, because the OASDI tax applies to only the first $106,800 of wages paid in 2010 ($106,800 × 6.2% = $6,621.60).
RIA observation: An employee need not work for a minimum number of hours in order for the employer to qualify for the payroll tax holiday.
Qualified employer defined. A qualified employer is any employer other than the U.S., a state, or a political subdivision of a state (i.e., a local government, or an instrumentality). ( Code Sec. 3111(d)(2)(A) ) However, a public institution of higher education is a qualified employer even though it is a government instrumentality. ( Code Sec. 3111(d)(2)(B) )
RIA observation: Thus, the payroll tax holiday applies to employers in the private and not-for-profit sectors. It doesn't apply to public-sector employers other than public institutions of higher education.
Qualified individuals defined. A qualified individual is anyone who:
(1) Begins employment with a qualified employer after Feb. 3, 2010, and before Jan. 1, 2011.
RIA observation: Although a qualified employee who begins work after Feb. 3, 2010 can be eligible for the payroll tax holiday, only the employer's portion of OASDI on his wages paid with respect to employment after Mar. 18, 2010 (the enactment date) will be forgiven.
(2) Certifies by signed affidavit, under penalties of perjury, that he hasn't been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer.
(3) Isn't employed to replace another employee of the qualified employer unless that other employee separated from employment voluntarily or for cause.
(4) Isn't related to the qualified employer in a way that would disqualify him for the WOTC under Code Sec. 51(i)(1) . ( Code Sec. 3111(d)(3) )
The Committee Report says an employer may qualify for the payroll tax holiday when it hires an otherwise qualified individual to replace one who was terminated for cause or due to other facts and circumstances, such as where a factory is closed due to lack of demand. When the factory reopens, the payroll tax holiday can be claimed both for rehiring old workers and hiring new workers. However, an employer who terminates an employee without cause in order to claim the payroll tax holiday for hiring the same or another employee doesn't qualify.
RIA observation: Under item (4), above, there's no payroll tax holiday for hiring a relative such as the qualified employer's child or descendant of a child; a stepchild; sibling, stepbrother, or stepsister; parent or stepparent; niece, nephew, uncle or aunt; or in-laws.
If the qualified employer is:
... a corporation, an individual standing in any of the above relationships to anyone who owns, directly or indirectly, more than 50% in value of its outstanding stock, after applying the Code Sec. 267(c) attribution rules, won't qualify.
... a noncorporate entity, an individual standing in any of the above relationships to anyone who owns, directly or indirectly, more than 50% of the capital and profits interests in the entity attribution rules, won't qualify.
... an estate or trust, a grantor, beneficiary, or fiduciary of the estate or trust, or an individual having any of the familial relationships described above to a grantor, beneficiary, or fiduciary of the estate or trust, won't qualify.
An individual unrelated to the qualified employer who is the employer's dependent because he has the same principal place of abode and is a member of the employer's household won't qualify. If the qualified employer is a corporation, an individual who is a dependent of anyone who owns, directly or indirectly, more than 50% in value of the outstanding stock, won't qualify. A dependent of a grantor, beneficiary, or fiduciary of an estate or trust that is a qualified employer won't qualify.
Special rule for first calendar quarter of 2010. The payroll tax holiday doesn't apply for wages paid during the first calendar quarter of 2010. Instead, the amount by which the qualified employer's OASDI tax for wages paid during the first calendar quarter of 2010 would have been reduced if the payroll tax holiday had been in effect for that quarter is treated as a payment against the qualified employer's OASDI tax for the second calendar quarter of 2010. ( Code Sec. 3111(d)(5)(B) ) The payment is treated as made on the date when the employer's second-quarter OASDI tax is due.
RIA observation: Most employers report employment taxes quarterly on Form 941 (Employer's Quarterly Federal Tax Return). The rule providing that the payroll tax holiday doesn't apply for wages paid during the first quarter will give IRS time to issue guidance about the payroll tax holiday and will give employers time to adjust their payroll systems accordingly. Employers won't lose out, because the amount of first-quarter wages that would have been forgiven will be allowed as a credit for the second quarter.
Election out; coordination of payroll holiday with WOTC. A qualified employer may elect, in the manner that IRS requires, not to have the payroll tax holiday apply. ( Code Sec. 3111(d)(4) ) Unless the employer elects out of the payroll holiday, wages paid or incurred to a qualified individual won't qualify for the WOTC during the one-year period beginning on the date that the qualified employer hired the individual. ( Code Sec. 51(c)(5) ) The Committee Report indicates that the election can be made on an employee-by-employee basis.
RIA observation: The WOTC is in many cases more valuable than the payroll tax holiday, especially for low-wage employees, because it is generally 40% of “qualified first-year wages” of up to $6,000, for maximum credit of $2,400 per worker. The payroll tax holiday is equal to 6.2% of wages, and applies only to wages paid through Dec. 31, 2010. However, the WOTC is harder to qualify for, because the employee must be certified by an agency as belonging to a targeted group. The main qualification for payroll tax holiday is that the employee have been unemployed for 60 days, and the employee's affidavit is sufficient for this purpose.
Railroad retirement tax holiday. Effective for compensation paid after Mar. 18, 2010, the Act provides a railroad retirement tax holiday that is similar in many respects to the OASDI tax holiday. ( Code Sec. 3221(c) , as amended by Act Sec. 101(d))
New Up-to-$1,000 Credit for Each “Retained Worker”
For any tax year ending after Mar. 18, 2010, the Act provides an up-to-$1,000 credit for “retained workers.” (Act Sec. 102) A retained worker is defined as any qualified individual, as defined for purposes of the payroll tax holiday (see above):
(1) who was employed by the taxpayer on any date during the tax year,
(2) who was so employed by the taxpayer for a period of not less than 52 consecutive weeks, and
(3) whose wages (as defined in Code Sec. 3401(a) ) for that employment during the last 26 weeks of the period (described in item (2) above) equaled at least 80% of the wages for the first 26 weeks of that period. (Act Sec. 102(b))
RIA observation: The definition of wages for withholding purposes in Code Sec. 3401(a) generally includes all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash. Thus, compensation that isn't subject to withholding, such as certain fringe benefits, wouldn't be included as wages for purposes of the up-to-$1,000 credit for retained workers. Also, wages paid to certain types of employees that are exempt from income tax withholding under Code Sec. 3401(a) wouldn't qualify as wages for purposes of the up-to-$1,000 credit. The exemptions from withholding provided in Code Sec. 3401(a) include wages paid to certain agricultural labor, domestics working in private homes, certain employees working in foreign countries (if the employer is required to withhold on the wages under foreign law), etc.
Amount of the credit. Under Act Sec. 102(a), for any tax year ending after Mar. 18, 2010, the current year business credit determined under Code Sec. 38(b) for the tax year is increased, for each retained worker (as defined above) with respect to which the 52-consecutive-week requirement in (2), above, is first satisfied during the tax year, by the lesser of:
... $1,000; or
... 6.2% of the wages (as defined for income tax withholding in Code Sec. 3401(a) ) paid by the taxpayer to the retained worker during the 52-consecutive-week-period. (Act Sec. 102(a))
RIA observation: If a retained worker's wages during the 52-consecutive-week-period exceed $16,129.03, the increase to the current year business credit for that retained worker will be $1,000.
RIA observation: Since the increase to the current year business credit under the above rules applies in the tax year in which the 52-consecutive-week test is first satisfied, the increase to the current year business credit with respect to each retained employee only occurs in one tax year (i.e., the tax year in which the 52-consecutive-week test is first satisfied by a particular employee).
RIA observation: For an employer using the calendar year as its tax year, the increase to the current year business credit will be claimed on the employer's 2011 tax return.
RIA illustration 1: ABC Corp., a taxpayer using the calendar year as its tax year, hires Earl, a retained worker, on Feb. 15, 2010. The 52-consecutive-week requirement is first satisfied in the 2011 tax year if Earl works for ABC until Feb. 14, 2011. His wages for the 52-consecutive-week period are $30,000. In that case, on its 2011 tax return, ABC's current year business credit will be increased by $1,000 for Earl.
RIA observation: Certain fiscal year taxpayers may have to claim the increase to the current year business credit on tax returns for two tax years on an employee-by-employee basis.
RIA illustration 2: The facts are the same as in illustration (1) except that ABC Corp. uses a fiscal year beginning on Dec. 1 and ending on Nov. 30 as its tax year. ABC Corp. also hires Carol (a retained worker) on Dec. 31, 2010, and she is still working for ABC on Dec. 30, 2011. Carol's wages for the 52-consecutive-week-period are $52,000.
The 52-consecutive-week requirement is first satisfied with respect to Earl on Feb. 14, 2011, and with respect to Carol on Dec. 30, 2011. Thus, ABC can claim the $1,000 increase to the current year business credit for Earl on its tax return for the fiscal year ending on Nov. 30, 2011 and the $1,000 increase for Carol on its tax return for the fiscal year ending on Nov. 30, 2012.
RIA illustration 3: The facts are the same as in illustration (2) except that Earl quits working for ABC on Jan. 30, 2011. Since he only worked for ABC for 50 consecutive weeks, the 52-consecutive-week requirement isn't satisfied for Earl, and ABC can't claim the up-to-$1,000 credit for him.
RIA observation: Presumably, IRS will soon issue a form for claiming the $1,000 increase to the current year business credit for the retention of certain newly hired employees as it has for other employee retention credits such as the Midwestern Disaster Area employee retention credit that is claimed on Form 5884-A and on Form 3800.
RIA caution: An employer will need to keep careful records with respect to each employee hired after Feb. 3, 2010 and before Jan. 1, 2011 so that it can prove that each employee for which it claims the up-to-$1,000 increase to the current year business credit meets the definition of a retained worker.
RIA observation: Presumably, the increase to the current year business credit under Act Sec. 102 occurs before the application of any of the limitations under Code Sec. 38(c) that apply to the general business credit as determined under Code Sec. 38(a)(2) . Thus, the up to $1,000 increase to the current year business credit is subject to the rules that, under Code Sec. 38 , can prevent some taxpayers from enjoying full use of the credit to reduce their tax liabilities in the tax year that the credit is claimed. For example, the increase to the current year business credit under Act Sec. 102 won't be allowed to offset any of a taxpayer's alternative minimum tax (AMT), and will be limited in its offset of a taxpayer's regular income tax.
Carryback limit on the $1,000 increase per retained worker. No portion of the unused business credit under Code Sec. 38 for any tax year that is attributable to the up-to-$1,000 increase in the current year business credit under Act Sec. 102 can be carried to a tax year beginning before Mar. 18, 2010. (Act Sec. 102(c))
RIA observation: A one-year carryback generally applies to unused business credits under Code Sec. 39(a)(1) . However, Act Sec. 102(c) prevents a taxpayer from carrying back any portion of an unused business credit that is attributable to the up-to-$1,000 increase of the current year business credit to a tax year beginning before Mar. 18, 2010. Since a taxpayer using the calendar year as its tax year is only entitled to the up-to-$1,000 increase to the current year business credit in 2011 (see above), the effect of the rule in Act Sec. 102(c) is that a calendar year taxpayer can't carry back any portion of the unused business credit that is attributable to the up-to-$1,000 increase to 2010 (a tax year that began before Mar. 18, 2010). Thus, a calendar year taxpayer isn't allowed the one-year carryback (that would be allowed under Code Sec. 39(a)(1)(A) but for the rule in Act Sec. 102(c)) of any portion of any unused business credit that is attributable to the up-to-$1,000 increase to the current year business credit under Act Sec. 102.
RIA observation: The transitional rule in Act Sec. 102(c) was necessary because the transitional rule in Code Sec. 39(d) (generally providing that no part of any unused current business credit attributable to a component credit can be carried back to any tax year before the first tax year that the component credit was allowable) is limited to the credits listed under Code Sec. 38(b) ), and the increase to the current year business credit under Act Sec. 102 isn't listed in Code Sec. 38(b) .
RIA observation: There are no special carryforward provisions that apply to the up-to-$1,000 increase to the current year business credit for retained workers. Thus, presumably, any portion of the general business credit that is attributable to the increase to the current year business credit will be subject to the 20-year carryforward limitations applicable to current year unused business credits.
U.S. possessions. The Act provides comparable rules relating to the application of the up to $1,000 increase to the current year business credit to employers in U.S. possessions. For this purpose, a U.S. possession includes Puerto Rico and the Northern Mariana Islands. (Act Sec. 102(d)(3)(A))
Expensing Limits Boosted For 2010
Generally, taxpayers can elect to treat the cost of any Code Sec. 179 property placed in service during the tax year as an expense which is not chargeable to capital account, and any cost so treated is allowed as a deduction for the tax year in which the section 179 property is placed in service.
For tax years beginning in 2008 and 2009, the maximum amount that could be expensed under Code Sec. 179 was $250,000, and the maximum deductible expense was reduced (i.e., phased out, but not below zero) by the amount by which the cost of Code Sec. 179 property placed in service during tax year 2008 or 2009 exceeded $800,000. The $250,000 and $800,000 amounts were not adjusted for inflation.
Under pre-Act law, for tax years beginning in 2010, the maximum amount that could be expensed under Code Sec. 179 , was $134,000, and the maximum deductible expense had to be reduced (i.e., phased out, but not below zero) by the amount by which the cost of Code Sec. 179 property placed in service during the 2010 tax year exceeded $530,000 (i.e., the beginning-of-phaseout amount). The 2010 amounts reflected statutory inflation adjustments.
For tax years beginning after 2010, the maximum expensing amount under Code Sec. 179 is $25,000, the beginning-of-phaseout amount is $200,000, and neither amount is adjusted for inflation.
Qualifying property for purposes of the Code Sec. 179 expensing election is depreciable tangible personal property purchased for use in the active conduct of a trade or business, including “off-the-shelf” computer software placed in service in tax years beginning before 2011.
New law. For tax years beginning after 2007 and before 2011, the Act provides that:
... the dollar limitation on the Code Sec. 179 expensing deduction is $250,000,
... the reduction in the dollar limitation (beginning-of-phaseout amount) starts to take effect when property placed in service in a tax year exceeds $800,000, and
... neither the dollar limitation nor the beginning-of-phaseout amount is adjusted for inflation. ( Code Sec. 179(b) , as amended by Act Sec. 201(a)).
Additionally, the increase in dollar limitation amounts and no-inflation-adjustment rule for 2008 and 2009 are removed. (Act Sec. 201(a)(3))
Thus, the Act increases for one year (2010) the amount a taxpayer can expense under Code Sec. 179 . The maximum amount a taxpayer can expense for a tax year beginning in 2010 is $250,000 of the cost of qualifying property placed in service for that tax year. The $250,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during 2010 exceeds $800,000.
RIA observation: Since the $250,000 and $800,000 limitation amounts and no-inflation-adjustment rule applied under pre-Act law for tax years beginning in 2008 and 2009, the Act both extends those limitation and phaseout amounts to tax years beginning in 2010 and eliminates the inflation-adjustment rule which applied for tax years beginning in 2010 under pre-Act law.
RIA illustration : In 2010, Midcorp, a calendar-year taxpayer, places into service Code Sec. 179 property with a cost of $660,000. It can elect to expense $250,000 of the cost (there's no phaseout because the cost of Code Sec. 179 property placed in service during the year does not exceed $800,000, the beginning-of-phaseout amount for 2010).
RIA observation: For property placed in service in tax years beginning in 2010, the Code Sec. 179 expensing deduction phases out completely only when the cost of the property exceeds $1,050,000 ($800,000 (beginning-of-phaseout amount) + $250,000 (dollar limitation)). This is the same limit that applied under pre-Act law for property placed in service in 2008 or 2009.
Issuers of Certain Tax Credit Bonds Can Elect to Receive Direct Payment In Lieu of a Tax Credit to the Bondholder
As an alternative to traditional tax-exempt bonds, state and local governments may issue qualified tax credit bonds. Qualified tax credit bonds allow the bondholder (i.e., investor) to claim a nonrefundable tax credit in lieu of receiving interest. Qualified tax credit bonds include:
... new clean renewable energy bonds (New CREBs)—i.e., certain bonds issued to finance capital expenditures for qualified renewable energy facilities;
... qualified energy conservation bonds (QECBs)—i.e., certain bonds issued for a “qualified energy conservation purpose” such as initiatives for reducing greenhouse emissions;
... qualified zone academy bonds (QZABs)—i.e., certain bonds issued to finance certain academic programs operated by public schools in cooperation with businesses in economically disadvantaged areas; and
... qualified school construction bonds (QSCBs)—i.e., certain bonds issued to finance the construction, rehabilitation, or repair of, or the acquisition of land for, public school facilities.
Build America Bonds (BABs), which are otherwise tax-exempt bonds issued to finance capital projects for which the issuer (i.e., a state or local government) irrevocably elects to treat as taxable bonds, entitle the holder to a nonrefundable tax credit. For BABs that are “qualified bonds”—certain BABs issued before 2011 for which the issuer irrevocably elects, on or before the issue date of the bonds, to have the refundable tax credit rules of Code Sec. 6431 apply—the issuer may elect to claim a refundable tax credit (the so-called “direct payment” option) in lieu of the tax credit to the bondholder.
New law. For bonds originally issued after Mar. 18, 2010, the Act allows an issuer of New CREBS, QECs, QZABs, or QSCBs to make an irrevocable election on or before the issue date of the bonds to receive a payment in lieu of providing a tax credit to the holder of the bonds. Thus, these “specified tax credit bonds” are treated as “qualified bonds” under Code Sec. 6431 , and the issuer is entitled to receive a direct payment from IRS. ( Code Sec. 6431(f) , as amended by Act Sec. 301(a))
RIA observation: Qualified forestry conservation bonds (another type of tax credit bond) aren't “specified tax credit bonds,” qualifying for the direct payment option.
Interest paid to the holder of the bond is includible in the holder's gross income. ( Code Sec. 6431(f)(1)(D) ) The issuer's direct payment option for qualified tax credit bonds is in lieu of the credit for the holder, and the bondholder can't claim the tax credit that otherwise would be available under the qualified tax credit bond rules. ( Code Sec. 6431(f)(1)(E) )
For specified tax credit bonds, the amount that IRS will pay to the issuer (or to any person making interest payments on the issuer's behalf) for any interest payment due under the bond is equal to the lesser of:
(1) the amount of interest payable under the bond on that date ( Code Sec. 6431(f)(1)(C)(i) ), or
(2) the amount of interest that would have been payable under the bond on that date if the interest were determined at the applicable credit rate determined under Code Sec. 54A(b)(3) . ( Code Sec. 6431(f)(1)(C)(ii) )
Thus, the amount of the payment to the issuer of a specified tax credit bond that is a New CREB, QECB, QZAB, or QSCB is a function of the market-determined interest rate on the bond and not a rate set by IRS. (Committee Report)
Under a special rule, for any New CREB or QECB, the amount of the credit determined under Code Sec. 6431(f)(1)(C)(ii) is 70% of the amount otherwise determined, without regard to this rule, Code Sec. 54C(b) (new CREB annual credit is 70% of the amount otherwise allowed), and Code Sec. 54D(b) (QECB annual credit is 70% of the amount otherwise allowed). ( Code Sec. 6431(f)(2) )
The income tax deduction otherwise allowed to the issuer of a qualified bond that is a New CREB, QECB, QZAB, or QSCB for interest paid on the bond is reduced by the amount of the payment made under Code Sec. 6431 for the interest. ( Code Sec. 6431(f)(1)(G) )
RIA observation: The issuer of a New CREB, QECB, QZAB, or QSCB that elects the direct payment option for the bond must make regular interest payments to the bond holders. The deduction otherwise allowed to the issuer for these interest payments must be reduced by the amounts the issuer receives from IRS.
New CREBs, QECBs, QZABs, and QSCBs for which the election is made count against the national limitation for such bonds in the same way that they would if no election were made. (Committee Report)
An issuer can elect the direct payment option for qualified bonds that are New CREBs, QECBs, QZABs, or QSCBs even if the bonds aren't issued before 2011. ( Code Sec. 6431(f)(1)(B) )
RIA observation: However, due to a “zero” national bond volume limitation that is prescribed for both QZABs and QSCBs for years after 2010, they can be issued after 2010 only if unused national bond volume limitations for pre-2011 years can be carried forward. For carryforward for QSCBs, see below.
In a technical correction, the Act also provides that for bonds issued after Feb. 17, 2009—i.e., as if it were originally included in American Recovery and Reinvestment Act §1521—the Code Sec. 54F(e) rule allowing the carryover of unused QSCB limitation by a State or Indian tribal government applies to the 40% of QSCB limitation that is allocated among the largest school districts. It also provides that the limitation amount allocated to a State is to be allocated to QSCBs issuers within the State by the State education agency (or such other agency as is authorized under State law to make the allocation). ( Code Sec. 54F , as amended by Act Sec. 301(b))

Red Flag audit issues - IRS dirty dozen

IR-2010-32,Internal Revenue Service, (Mar. 17, 2010)
2010FED ¶46,304
Code Sec. 6701, Code Sec. 7206, Code Sec. 7623, Code Sec. 7804

IRS dirty dozen: Tax scams: Tax fraud


Beware of IRS' 2010 “Dirty Dozen” Tax Scams
Videos:

Dirty Dozen : English

Message for Tax Preparers : English

Choosing a Return Preparer : English/Spanish/ASL

For this and other videos: YouTube/IRSVideos

IR-2010-32, March 16, 2010
WASHINGTON—The Internal Revenue Service today issued its 2010 “dirty dozen” list of tax scams, including schemes involving return preparer fraud, hiding income offshore and phishing.

“Taxpayers should be wary of anyone peddling scams that seem too good to be true,” IRS Commissioner Doug Shulman said. “The IRS fights fraud by pursuing taxpayers who hide income abroad and by ensuring taxpayers get competent, ethical service from qualified professionals at home in the U.S.”

Tax schemes are illegal and can lead to imprisonment and fines for both scam artists and taxpayers. Taxpayers pulled into these schemes must repay unpaid taxes plus interest and penalties. The IRS pursues and shuts down promoters of these and numerous other scams.

The IRS urges taxpayers to avoid these common schemes:

Return Preparer Fraud
Dishonest return preparers can cause trouble for taxpayers who fall victim to their ploys. Such preparers derive financial gain by skimming a portion of their clients' refunds, charging inflated fees for return preparation services and attracting new clients by promising refunds that are too good to be true. Taxpayers should choose carefully when hiring a tax preparer. Federal courts have issued injunctions ordering hundreds of individuals to cease preparing returns and promoting fraud, and the Department of Justice has filed complaints against dozens of others, which are pending in court.

To increase confidence in the tax system and improve compliance with the tax law, the IRS is implementing a number of steps for future filing seasons. These include a requirement that all paid tax return preparers register with the IRS and obtain a preparer tax identification number (PTIN), as well as both competency tests and ongoing continuing professional education for all paid tax return preparers except attorneys, certified public accountants (CPAs) and enrolled agents.
Setting higher standards for the tax preparer community will significantly enhance protections and services for taxpayers, increase confidence in the tax system and result in greater compliance with tax laws over the long term. Other measures the IRS anticipates taking are highlighted in the IRS Return Preparer Review issued in December 2009.

Hiding Income Offshore
The IRS aggressively pursues taxpayers involved in abusive offshore transactions as well as the promoters, professionals and others who facilitate or enable these schemes. Taxpayers have tried to avoid or evade U.S. income tax by hiding income in offshore banks, brokerage accounts or through the use of nominee entities. Taxpayers also evade taxes by using offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, private annuities or insurance plans.

IRS agents continue to develop their investigations of these offshore tax avoidance transactions using information gained from over 14,700 voluntary disclosures received last year. While special civil-penalty provisions for those with undisclosed offshore accounts expired in 2009, the IRS continues to urge taxpayers with offshore accounts or entities to voluntarily come forward and resolve their tax matters. By making a voluntary disclosure, taxpayers may mitigate their risk of criminal prosecution.

Phishing
Phishing is a tactic used by scam artists to trick unsuspecting victims into revealing personal or financial information online. IRS impersonation schemes flourish during the filing season and can take the form of e-mails, tweets or phony Web sites. Scammers may also use phones and faxes to reach their victims.

Scam artists will try to mislead consumers by telling them they are entitled to a tax refund from the IRS and that they must reveal personal information to claim it. Criminals use the information they get to steal the victim's identity, access bank accounts, run up credit card charges or apply for loans in the victim's name.

Taxpayers who receive suspicious e-mails claiming to come from the IRS should not open any attachments or click on any of the links in the e-mail. Suspicious e-mails claiming to be from the IRS or Web addresses that do not begin with http://www.irs.gov should be forwarded to the IRS mailbox: phishing@irs.gov.

Filing False or Misleading Forms
The IRS is seeing various instances where scam artists file false or misleading returns to claim refunds that they are not entitled to. Under the scheme, taxpayers fabricate an information return and falsely claim the corresponding amount as withholding as a way to seek a tax refund. Phony information returns, such as a Form 1099-Original Issue Discount (OID), claiming false withholding credits usually are used to legitimize erroneous refund claims. One version of the scheme is based on a false theory that the federal government maintains secret accounts for its citizens, and that taxpayers can gain access to funds in those accounts by issuing 1099-OID forms to their creditors, including the IRS.

Nontaxable Social Security Benefits with Exaggerated Withholding Credit
The IRS has identified returns where taxpayers report nontaxable Social Security Benefits with excessive withholding. This tactic results in no income reported to the IRS on the tax return. Often both the withholding amount and the reported income are incorrect. Taxpayers should avoid making these mistakes. Filings of this type of return may result in a $5,000 penalty.

Abuse of Charitable Organizations and Deductions
The IRS continues to observe the misuse of tax-exempt organizations. Abuse includes arrangements to improperly shield income or assets from taxation and attempts by donors to maintain control over donated assets or income from donated property. The IRS also continues to investigate various schemes involving the donation of non-cash assets including situations where several organizations claim the full value for both the receipt and distribution of the same non-cash contribution. Often these donations are highly overvalued or the organization receiving the donation promises that the donor can repurchase the items later at a price set by the donor. The Pension Protection Act of 2006 imposed increased penalties for inaccurate appraisals and set new definitions of qualified appraisals and qualified appraisers for taxpayers claiming charitable contributions.

Frivolous Arguments
Promoters of frivolous schemes encourage people to make unreasonable and outlandish claims to avoid paying the taxes they owe. If a scheme seems too good to be true, it probably is. The IRS has a list of frivolous legal positions that taxpayers should avoid. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or IRS guidance.

Abusive Retirement Plans
The IRS continues to find abuses in retirement plan arrangements, including Roth Individual Retirement Arrangements (IRAs). The IRS is looking for transactions that taxpayers use to avoid the limits on contributions to IRAs, as well as transactions that are not properly reported as early distributions. Taxpayers should be wary of advisers who encourage them to shift appreciated assets at less than fair market value into IRAs or companies owned by their IRAs to circumvent annual contribution limits. Other variations have included the use of limited liability companies to engage in activity that is considered prohibited.

Disguised Corporate Ownership
Corporations and other entities are formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity by means such as improperly using a third party to request an employer identification number.

Such entities can be used to facilitate underreporting of income, fictitious deductions, non-filing of tax returns, participating in listed transactions, money laundering, financial crimes and even terrorist financing. The IRS is working with state authorities to identify these entities and to bring the owners of these entities into compliance with the law.

Zero Wages
Filing a phony wage- or income-related information return to replace a legitimate information return has been used as an illegal method to lower the amount of taxes owed. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer also may submit a statement rebutting wages and taxes reported by a payer to the IRS. Sometimes fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any of the variations of this scheme. Filings of this type of return may result in a $5,000 penalty.

Misuse of Trusts
For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are many legitimate, valid uses of trusts in tax and estate planning, some promoted transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means to avoid income tax liability and to hide assets from creditors, including the IRS.

The IRS has recently seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust arrangement.

Fuel Tax Credit Scams
The IRS receives claims for the fuel tax credit that are excessive. Some taxpayers, such as farmers who use fuel for off-highway business purposes, may be eligible for the fuel tax credit. But other individuals are claiming the tax credit for nontaxable uses of fuel when their occupation or income level makes the claim unreasonable. Fraud involving the fuel tax credit is considered a frivolous tax claim and potentially subjects those who improperly claim the credit to a $5,000 penalty.

How to Report Suspected Tax Fraud Activity
Suspected tax fraud can be reported to the IRS using Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential.

Whistleblowers also may provide allegations of fraud to the IRS and may be eligible for a reward by filing Form 211, Application for Award for Original Information, and following the procedures outlined in Notice 2008-4 , Claims Submitted to the IRS Whistleblower Office under Section 7623 .

new liberal rules on computing future income

IRS Small Business/Self-Employed Interim Guidance for Calculation of Future Income in Offer in Compromise Cases, SBSE 05-0310-012, (Mar. 16, 2010)
2010ARD 052-5
Internal Revenue Service: Compromises: Future income
DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE Washington, DC 20224
March 10, 2010
SMALL BUSINESS / SELF-EMPLOYED DIVISION
SB/SE Control No: SBSE 05-0310-012
Expires: 3/10/2011
Impacted IRM 5.8.5
MEMORANDUM FOR DIRECTORS, COLLECTION AREA OPERATIONS DIRECTORS, CAMPUS COMPLIANCE OPERATIONS AND CHIEF, APPEALS
FROM: Frederick W. Schindler /s/ Frederick W. Schindler Director, Collection Policy
SUBJECT: Interim Guidance for Calculation of Future Income in Offer in Compromise Cases
The purpose of this memorandum is to provide revised guidance in the computation of the taxpayer's future income value during the evaluation of an offer in compromise.
Internal Revenue Manual (IRM) 5.8.5 defines future income as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer. In general, a taxpayer's current income will be used in the analysis of future ability to pay.
Attached to this memorandum is a revision to sections of IRM 5.8.5, Financial Analysis which discuss the calculation of future income and the use of collateral agreements.
The revisions include specific examples of when the use of income averaging and/or a collateral agreement is appropriate.
These procedures are effective upon the date of issuance and should be applied to any offer currently under consideration. Additionally, these procedures may be applied to offers previously rejected which are currently in their appeal period or where the taxpayer has requested appeals consideration. These procedures will be incorporated into the next revision of IRM 5.8 Offers in Compromise.
If you have any questions, you may contact me, or a member of your staff may contact Thomas B. Moore, OIC Senior Program Analyst. Territory or Campus personnel should direct any questions, through their management staff, to the appropriate Area or Campus contact.
Attachment
cc: Commissioner, Small Business/Self-Employed Division
National Chief, Appeals
Chief Counsel
National Taxpayer Advocate
5.8.5.6 Future Income
(1) Future income is defined as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future.
(2) As a general rule, the taxpayer's current income will be used in the analysis of future ability to pay. This includes situations where the taxpayer's income is recently reduced based on a change in occupation or employment status.
(3) Consideration should be given to the taxpayer's overall general situation including such facts as age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.
(4) Situations that may warrant placing a different value on future income than current or past income indicates are discussed in the table below. Additionally, securing a future income collateral agreement based on the taxpayer's earnings potential may be appropriate and are discussed in more detail in IRM 5.8.5.19 and IRM 5.8.6, Collateral Agreements.

If… Then…

Income will increase or decrease or current necessary expenses will increase or decrease Adjust the amount or number of payments to what is expected during the appropriate number of months.

A taxpayer is temporarily or recently unemployed or underemployed Use the level of income expected if the taxpayer were fully employed and if the potential for employment is apparent. Each case should be judged on its own merit, including consideration of special circumstances or ETA issues.
Example: Unemployed - The taxpayer is a construction worker and between jobs. A review of the taxpayer's previous annual income and/or income averaging may be the appropriate method to determine taxpayer's income for calculation purposes.
Example: Underemployed - If a taxpayer is a teacher but recently moved and is currently at a lesser paying job until a teaching position becomes available, or has been hired and does not begin work until the school season begins, the taxpayer is considered to be currently underemployed. Use the anticipated income once the taxpayer is fully employed.

A taxpayer is unemployed and is not expected to return to their previous occupation or previous level of earnings Contact the taxpayer to discuss the expected future level of income. When considering future income, also allow anticipated increases in necessary living expenses and/or applicable taxes.
Each case should be judged on its own merit, including consideration of special circumstances or ETA issues.

A taxpayer is long-term unemployed Use of income averaging is not required; the taxpayer's current income may be used in the future income calculation.
Example: Taxpayer has been unemployed for over one year. There are currently no employment opportunities for the taxpayer and the household is living on one income. Use of the taxpayer's current income with a future income collateral agreement is appropriate.

A taxpayer is long-term underemployed Do not income average; use the taxpayer's current income.
Example: The taxpayer was previously employed in a manufacturing plant making $75,000 per year. There are currently no opportunities for the taxpayer to secure employment making the same rate of pay as their prior job. Their income is now $25,000 per year with no anticipated increase. Use the current income only.

A taxpayer has an irregular employment history or fluctuating income Average earnings over the three prior years. The use of a time period other than three years should be the exception and only when specific circumstances are present.
Example: The taxpayer is a stock broker whose income in 2007 was $150,000 and income in 2008 was $25,000. In this case, you should consider income averaging the prior three years or secure a future income collateral agreement if the offer is accepted.
Note: This practice does not apply to wage earners. Wage earners should be based on current income unless the taxpayer has unique circumstances.

A taxpayer is in poor health and their ability to continue working is questionable Reduce the number of payments to the appropriate number of months it is anticipated the taxpayer will continue working. Consider special circumstance situations when making any adjustments.
Example: Taxpayer has a serious health issue and it is anticipated they will be unable to work after six months. Use the taxpayer's current income for six months then reduce their income to the anticipated amount they will be receiving after they are unable to work.

A taxpayer is close to retirement and has indicated they will be retiring If the taxpayer can substantiate retirement is imminent, adjust the taxpayer's future earnings and expenses accordingly. If it cannot be substantiated, base the calculation on current earnings. At this point, it may be appropriate to discuss other options available to the taxpayer, for example an installment agreement.
Example: The taxpayer is 65 years of age and has indicated they will retire at the age of 66. They provide copies of documents that have been submitted to their employer discussing their retirement date. Use the taxpayer's current income until the taxpayer's anticipated retirement date, then adjust the taxpayer's income to reflect the amount expected in retirement.
Example: The taxpayer is 62 years of age, the taxpayer is in good health, and their income has remained stable for the past three years. The taxpayer states they would like to retire at age 65. Use the taxpayer's current income and if the RCP exceeds the offer amount, discuss the option of securing an installment agreement until the taxpayer actually retires, at which time an offer may be appropriate.

A taxpayer will file a petition for liquidating bankruptcy Consider reducing the value of future income. The total value of future income should not be reduced to an amount less than what could be paid toward non-dischargeable periods, or what would be recoverable through a bankruptcy proceeding. When considering a reduction in future income also consider the intangible value to the taxpayer of avoiding bankruptcy. Refer to IRM 5.8.10.2.

(5) Judgment should be used in determining the appropriate time to apply income averaging on a case by case basis. All circumstances of the taxpayer should be considered when determining the appropriate application of income averaging, including special circumstances and ETA considerations. Below are some examples of when income averaging may or may not be appropriate.
Example: Taxpayer's spouse has not worked for over two and one-half years and has no expectations of returning to work. Do not average income for the spouse's past employment.
Example: Taxpayer has been unemployed for over one year and provided proof that Social Security Disability is the sole source of income. Do not apply income averaging in this case but use current income to determine the taxpayer's future ability to pay.
Example: The taxpayer was incarcerated and unable to work for the past four years and provided proof that a relative is paying for all expenses, including child support payments. The taxpayer has no skills or promise of work in the near future but is planning on attending trade school to improve his chances of getting a job. Do not include income prior to the incarceration. In this case, since the taxpayer has no skills or promise of employment, their future income value may be determined to be zero. Consideration should be given whether it would be in the best interest of the government to accept the offer or reject the offer in favor of other case resolutions.
Example: The taxpayer recently began working after several months of unemployment. Use the most recent three months pay statements to determine future income. Since the taxpayer is a wage earner, the use of income averaging over the prior three years of income is not appropriate.
(6) In situations where the taxpayer's income does not appear to meet their stated living expenses the difference should not be included as additional income to the taxpayer, unless there are clear indications additional income not included on the collection information statement is being received and will continue to be received by the taxpayer. Discussion with the taxpayer/representative and a review of documents submitted by the taxpayer must take place to determine the appropriateness of including an additional amount in the calculation of future income. Verification of the source of unexplained bank deposits or statements from the source of gifts may be required to correctly determine the taxpayer's current income. Telephone contact is recommended to expedite case processing.
Example: The taxpayer has been receiving gifts from their parents to meet current living expenses for the past six months. The taxpayer has no guaranteed right to the funds in the future and the amount does not appear to be based on the transfer of assets to the parents. The gift amount should not be included as income.
Example: The taxpayer has been receiving an amount each month that only began recently, which they state is a gift from a friend. Further research has determined the taxpayer is in business with the friend and the amount is from their business. This amount should be included as income to the taxpayer. Additionally, consideration should be given to referring the taxpayer and the business income tax return to Examination.
Example: The taxpayer had gambling winnings over a period of time, but is not consistent. Do not include those winnings as additional income on the IET. This does not apply to professional gamblers.
Example: The collection information statement (CIS) submitted by the taxpayer included $ 3.000.00 of monthly income, which is verified by paystubs. The CIS submitted by the taxpayer includes $ 4,000.00 of expenses. An additional $ 1,000.00 should not be added to the taxpayer's income based solely on the fact it appears the taxpayer has been meeting the living expenses included on the CIS. Discussion with the taxpayer or representative is necessary to clarify the discrepancy prior to including the amount as additional income.
(7) Employees need to exercise good judgment when determining future income. The history must be clearly documented and support the known facts and circumstances of the case and include analysis of the supporting documents. Each case needs to be evaluated on its own particular set of facts and circumstances. The history must clearly explain the reasoning behind our actions.
Currently 5.8.5.6(7) Future Income Collateral Agreements
(1) In some instances, it may be difficult to calculate the taxpayer's anticipated income. While the use of income averaging is one method available and should be used when averaging the taxpayer's income provides a reasonable calculation of the taxpayer's future earnings potential, it may also be appropriate to use the taxpayer's current income and secure a future income collateral agreement. The use of a future income collateral agreement will protect the government's interest in any substantial increase in the taxpayer's earnings.
(2) A future income collateral agreement is most appropriate in situations where the taxpayer's future income is uncertain, but it is reasonably expected that the taxpayer will be receiving a substantial increase in income.
(3) A future income collateral agreement should not be used to accept an offer for a lesser amount than the calculated RCP. See IRM 5.8.6.3.1, Future Income, for instructions on completing collateral agreements.
Example: A taxpayer is currently in medical school; upon graduation income should increase dramatically. Consider securing a future income collateral agreement.
Example: A taxpayer recently secured a job as an attorney with a starting salary of $80,000 per year, with potential for significant increases in salary. Consider securing a future income collateral agreement.
Example: A taxpayer is a real estate agent who has had two years of high income and the current income is significantly diminished. Based on the current real estate market, it may be appropriate to use the taxpayer's current income and secure a future income collateral agreement in lieu of income averaging.
Example: A taxpayer's RCP is $12,000 but has offered $10,000 plus a future income collateral agreement. A future income collateral agreement is not appropriate in lieu of the taxpayer increasing their offer to the RCP amount. If the taxpayer is not willing to increase their offer to the RCP amount, the offer should be rejected.

The IRS and Treasury Department have provided revised guidance to Small Business/Self-Employed Division directors and the IRS Appeals chief on the computation of a taxpayer's future income value during the evaluation of an offer in compromise. The guidance revises sections of IRM 5.8.5, Financial Analysis, which discuss the calculation of future income and the use of collateral agreements. The revisions include specific examples of when the use of income averaging or a collateral agreement is appropriate.
The procedures apply to future offers and any offer currently under consideration. In addition, the procedures may be applied to offers previously rejected that are currently in their appeal period or where the taxpayer has requested appeals


IRS Small Business/Self-Employed Interim Guidance for Calculation of Future Income in Offer in Compromise Cases, SBSE 05-0310-012, (Mar. 16, 2010)
2010ARD 052-5
Internal Revenue Service: Compromises: Future income
DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE Washington, DC 20224
March 10, 2010
SMALL BUSINESS / SELF-EMPLOYED DIVISION
SB/SE Control No: SBSE 05-0310-012
Expires: 3/10/2011
Impacted IRM 5.8.5
MEMORANDUM FOR DIRECTORS, COLLECTION AREA OPERATIONS DIRECTORS, CAMPUS COMPLIANCE OPERATIONS AND CHIEF, APPEALS
FROM: Frederick W. Schindler /s/ Frederick W. Schindler Director, Collection Policy
SUBJECT: Interim Guidance for Calculation of Future Income in Offer in Compromise Cases
The purpose of this memorandum is to provide revised guidance in the computation of the taxpayer's future income value during the evaluation of an offer in compromise.
Internal Revenue Manual (IRM) 5.8.5 defines future income as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer. In general, a taxpayer's current income will be used in the analysis of future ability to pay.
Attached to this memorandum is a revision to sections of IRM 5.8.5, Financial Analysis which discuss the calculation of future income and the use of collateral agreements.
The revisions include specific examples of when the use of income averaging and/or a collateral agreement is appropriate.
These procedures are effective upon the date of issuance and should be applied to any offer currently under consideration. Additionally, these procedures may be applied to offers previously rejected which are currently in their appeal period or where the taxpayer has requested appeals consideration. These procedures will be incorporated into the next revision of IRM 5.8 Offers in Compromise.
If you have any questions, you may contact me, or a member of your staff may contact Thomas B. Moore, OIC Senior Program Analyst. Territory or Campus personnel should direct any questions, through their management staff, to the appropriate Area or Campus contact.
Attachment
cc: Commissioner, Small Business/Self-Employed Division
National Chief, Appeals
Chief Counsel
National Taxpayer Advocate
5.8.5.6 Future Income
(1) Future income is defined as an estimate of the taxpayer's ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future.
(2) As a general rule, the taxpayer's current income will be used in the analysis of future ability to pay. This includes situations where the taxpayer's income is recently reduced based on a change in occupation or employment status.
(3) Consideration should be given to the taxpayer's overall general situation including such facts as age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.
(4) Situations that may warrant placing a different value on future income than current or past income indicates are discussed in the table below. Additionally, securing a future income collateral agreement based on the taxpayer's earnings potential may be appropriate and are discussed in more detail in IRM 5.8.5.19 and IRM 5.8.6, Collateral Agreements.

If… Then…

Income will increase or decrease or current necessary expenses will increase or decrease Adjust the amount or number of payments to what is expected during the appropriate number of months.

A taxpayer is temporarily or recently unemployed or underemployed Use the level of income expected if the taxpayer were fully employed and if the potential for employment is apparent. Each case should be judged on its own merit, including consideration of special circumstances or ETA issues.
Example: Unemployed - The taxpayer is a construction worker and between jobs. A review of the taxpayer's previous annual income and/or income averaging may be the appropriate method to determine taxpayer's income for calculation purposes.
Example: Underemployed - If a taxpayer is a teacher but recently moved and is currently at a lesser paying job until a teaching position becomes available, or has been hired and does not begin work until the school season begins, the taxpayer is considered to be currently underemployed. Use the anticipated income once the taxpayer is fully employed.

A taxpayer is unemployed and is not expected to return to their previous occupation or previous level of earnings Contact the taxpayer to discuss the expected future level of income. When considering future income, also allow anticipated increases in necessary living expenses and/or applicable taxes.
Each case should be judged on its own merit, including consideration of special circumstances or ETA issues.

A taxpayer is long-term unemployed Use of income averaging is not required; the taxpayer's current income may be used in the future income calculation.
Example: Taxpayer has been unemployed for over one year. There are currently no employment opportunities for the taxpayer and the household is living on one income. Use of the taxpayer's current income with a future income collateral agreement is appropriate.

A taxpayer is long-term underemployed Do not income average; use the taxpayer's current income.
Example: The taxpayer was previously employed in a manufacturing plant making $75,000 per year. There are currently no opportunities for the taxpayer to secure employment making the same rate of pay as their prior job. Their income is now $25,000 per year with no anticipated increase. Use the current income only.

A taxpayer has an irregular employment history or fluctuating income Average earnings over the three prior years. The use of a time period other than three years should be the exception and only when specific circumstances are present.
Example: The taxpayer is a stock broker whose income in 2007 was $150,000 and income in 2008 was $25,000. In this case, you should consider income averaging the prior three years or secure a future income collateral agreement if the offer is accepted.
Note: This practice does not apply to wage earners. Wage earners should be based on current income unless the taxpayer has unique circumstances.

A taxpayer is in poor health and their ability to continue working is questionable Reduce the number of payments to the appropriate number of months it is anticipated the taxpayer will continue working. Consider special circumstance situations when making any adjustments.
Example: Taxpayer has a serious health issue and it is anticipated they will be unable to work after six months. Use the taxpayer's current income for six months then reduce their income to the anticipated amount they will be receiving after they are unable to work.

A taxpayer is close to retirement and has indicated they will be retiring If the taxpayer can substantiate retirement is imminent, adjust the taxpayer's future earnings and expenses accordingly. If it cannot be substantiated, base the calculation on current earnings. At this point, it may be appropriate to discuss other options available to the taxpayer, for example an installment agreement.
Example: The taxpayer is 65 years of age and has indicated they will retire at the age of 66. They provide copies of documents that have been submitted to their employer discussing their retirement date. Use the taxpayer's current income until the taxpayer's anticipated retirement date, then adjust the taxpayer's income to reflect the amount expected in retirement.
Example: The taxpayer is 62 years of age, the taxpayer is in good health, and their income has remained stable for the past three years. The taxpayer states they would like to retire at age 65. Use the taxpayer's current income and if the RCP exceeds the offer amount, discuss the option of securing an installment agreement until the taxpayer actually retires, at which time an offer may be appropriate.

A taxpayer will file a petition for liquidating bankruptcy Consider reducing the value of future income. The total value of future income should not be reduced to an amount less than what could be paid toward non-dischargeable periods, or what would be recoverable through a bankruptcy proceeding. When considering a reduction in future income also consider the intangible value to the taxpayer of avoiding bankruptcy. Refer to IRM 5.8.10.2.

(5) Judgment should be used in determining the appropriate time to apply income averaging on a case by case basis. All circumstances of the taxpayer should be considered when determining the appropriate application of income averaging, including special circumstances and ETA considerations. Below are some examples of when income averaging may or may not be appropriate.
Example: Taxpayer's spouse has not worked for over two and one-half years and has no expectations of returning to work. Do not average income for the spouse's past employment.
Example: Taxpayer has been unemployed for over one year and provided proof that Social Security Disability is the sole source of income. Do not apply income averaging in this case but use current income to determine the taxpayer's future ability to pay.
Example: The taxpayer was incarcerated and unable to work for the past four years and provided proof that a relative is paying for all expenses, including child support payments. The taxpayer has no skills or promise of work in the near future but is planning on attending trade school to improve his chances of getting a job. Do not include income prior to the incarceration. In this case, since the taxpayer has no skills or promise of employment, their future income value may be determined to be zero. Consideration should be given whether it would be in the best interest of the government to accept the offer or reject the offer in favor of other case resolutions.
Example: The taxpayer recently began working after several months of unemployment. Use the most recent three months pay statements to determine future income. Since the taxpayer is a wage earner, the use of income averaging over the prior three years of income is not appropriate.
(6) In situations where the taxpayer's income does not appear to meet their stated living expenses the difference should not be included as additional income to the taxpayer, unless there are clear indications additional income not included on the collection information statement is being received and will continue to be received by the taxpayer. Discussion with the taxpayer/representative and a review of documents submitted by the taxpayer must take place to determine the appropriateness of including an additional amount in the calculation of future income. Verification of the source of unexplained bank deposits or statements from the source of gifts may be required to correctly determine the taxpayer's current income. Telephone contact is recommended to expedite case processing.
Example: The taxpayer has been receiving gifts from their parents to meet current living expenses for the past six months. The taxpayer has no guaranteed right to the funds in the future and the amount does not appear to be based on the transfer of assets to the parents. The gift amount should not be included as income.
Example: The taxpayer has been receiving an amount each month that only began recently, which they state is a gift from a friend. Further research has determined the taxpayer is in business with the friend and the amount is from their business. This amount should be included as income to the taxpayer. Additionally, consideration should be given to referring the taxpayer and the business income tax return to Examination.
Example: The taxpayer had gambling winnings over a period of time, but is not consistent. Do not include those winnings as additional income on the IET. This does not apply to professional gamblers.
Example: The collection information statement (CIS) submitted by the taxpayer included $ 3.000.00 of monthly income, which is verified by paystubs. The CIS submitted by the taxpayer includes $ 4,000.00 of expenses. An additional $ 1,000.00 should not be added to the taxpayer's income based solely on the fact it appears the taxpayer has been meeting the living expenses included on the CIS. Discussion with the taxpayer or representative is necessary to clarify the discrepancy prior to including the amount as additional income.
(7) Employees need to exercise good judgment when determining future income. The history must be clearly documented and support the known facts and circumstances of the case and include analysis of the supporting documents. Each case needs to be evaluated on its own particular set of facts and circumstances. The history must clearly explain the reasoning behind our actions.
Currently 5.8.5.6(7) Future Income Collateral Agreements
(1) In some instances, it may be difficult to calculate the taxpayer's anticipated income. While the use of income averaging is one method available and should be used when averaging the taxpayer's income provides a reasonable calculation of the taxpayer's future earnings potential, it may also be appropriate to use the taxpayer's current income and secure a future income collateral agreement. The use of a future income collateral agreement will protect the government's interest in any substantial increase in the taxpayer's earnings.
(2) A future income collateral agreement is most appropriate in situations where the taxpayer's future income is uncertain, but it is reasonably expected that the taxpayer will be receiving a substantial increase in income.
(3) A future income collateral agreement should not be used to accept an offer for a lesser amount than the calculated RCP. See IRM 5.8.6.3.1, Future Income, for instructions on completing collateral agreements.
Example: A taxpayer is currently in medical school; upon graduation income should increase dramatically. Consider securing a future income collateral agreement.
Example: A taxpayer recently secured a job as an attorney with a starting salary of $80,000 per year, with potential for significant increases in salary. Consider securing a future income collateral agreement.
Example: A taxpayer is a real estate agent who has had two years of high income and the current income is significantly diminished. Based on the current real estate market, it may be appropriate to use the taxpayer's current income and secure a future income collateral agreement in lieu of income averaging.
Example: A taxpayer's RCP is $12,000 but has offered $10,000 plus a future income collateral agreement. A future income collateral agreement is not appropriate in lieu of the taxpayer increasing their offer to the RCP amount. If the taxpayer is not willing to increase their offer to the RCP amount, the offer should be rejected.

What are your chances of being audited?

What are your chances for being audited?

IRS's 2009 data book provides some clues
IR 2010-30 ; 2009 Data Book (Pub 55), http://www.irs.gov/taxstats/article/0,,id=102174,00.html

IRS has issued its annual data book, which provides statistical data on its fiscal year (FY) 2009 activities. As this article explains, the data book provides valuable information about how many tax returns IRS examines (audits), and what categories of returns IRS is focusing its resources on, as well as data on other enforcement activities, such as collections. The figures and percentages in this article compare returns filed in calendar year 2008 and audited in FY 2009 to returns filed in calendar year 2007 and audited in FY 2008.

What are the chances of being audited?

Of the 138,788,744 total individual income tax returns with a filing requirement (this excludes returns filed only to receive an economic stimulus payment), 1,425,888 were audited. This works out to roughly 1%, the same percentage as for the previous year. Of the total number of individual income tax returns audited in FY 2009, 508,180 (35.64%) were for returns with an earned income tax credit (EITC) claim, roughly the same as for FY 2008.

Only 22.8% of the individual audits were conducted by revenue agents, tax compliance officers, and tax examiners; the bulk of the audits (about 77.1%) were correspondence audits. These percentages are comparable to those for FY 2008.
Following are the selected audit rates for individuals not claiming the EITC:

... For business returns other than farm returns showing total gross receipts of $100,000 to $200,000, 4.2% of returns were audited in FY 2009, versus 3.8% in FY 2008.
... For business returns other than farm returns showing total gross receipts of $200,000 or more, 3.2% of returns were audited in FY 2009, versus 3.1% in FY 2008.
... Of the returns showing farm (Schedule F) income, .3% were audited in FY 2009 versus .6% in FY 2008.
... For returns showing total positive income of $200,000 to $1 million, 2.3% of returns not showing business activity were audited, and 3.1% of returns showing business activity were audited; for FY 2008, these percentages were 2.6% and 2.8% respectively.
... For FY 2009, the audit rate for returns with total positive income of $1 million or more was 6.4%, versus 5.6% in FY 2008.
Not surprisingly, examination coverage increases for higher income earners, but coverage was less than it was for the prior year. For example, the percentage was .67% for those returns with adjusted gross income (AGI) between $100,000 and $200,000 (down from .98% for FY 2008), 1.86% for those with $200,000 to $500,000 of AGI (down slightly from 1.92% for FY 2008), and 5.35% for those with $1 to $2 million of AGI (down from 6.47% for FY 2008).
The audit rates for business returns were as follows:
• For all corporate returns other than Form 1120S, 1.3%, the same percentage as for the year before.
• For small corporations with total assets of: $250,000 to $1 million, 1.3%; $1–$5 million, 1.8%; and $5–10 million, 2.7%. For FY 2008, the percentages were, respectively, 1.4%, 2%, and 3.1%.
• For large corporations, those with total assets of $10 million or more, the overall audit rate was 14.5%, down from 15.3% for FY 2008. The audit rate for these corporations increased with the size of the entity. For example, the audit rates were 10.1% for those with total assets of $10–$50 million (versus 11.7% for FY 2008); 15.8% for those with $250–$500 million (versus 14.2% for FY 2008); 48.7% for those with $5–20 billion (versus 64.2% for FY 2008), and for both fiscal years, 100% for those with $20 billion or more. Actually, the FY audit rate for 2009 (or for FY 2008) may exceed 100% of the returns filed in calendar year 2008 (or calendar year 2007), since examinations may be conducted on returns filed in prior calendar years.
• For partnership and S corporation returns, the audit rate was .4%, the same as for the year before.
IRS's activity on other fronts. Here's a roundup of some of the other valuable information carried in the new IRS Data Book.
Number of returns filed. The number of business returns filed in FY 2009 versus those filed in FY 2008 illustrates the growing popularity of passthroughs. The number of partnership returns filed (Form 1065) grew by 7.8% and the number of S corporation returns (Form 1120S) grew by 1.3%. By contrast, the number of C or other corporation (e.g., for REMICs, REITs, RICs, etc.) returns dropped by 2.4%.
No doubt due to the general contraction of economic activity and growth in the ranks of the unemployed, the number of individual income tax returns (Forms 1040, 1040A, 1040EZ, 1040EZ-T) in FY 2009 versus FY 2008 fell 6.7%, from 153,308,000 to 142,983,000.

Math errors on individual returns. Of the close to 13.48 million math error notices that IRS sent out relating to the 2008 return, 74.4% were attributable to the Code Sec. 6428 recovery rebate credit which on the 2008 return provided for a refundable recovery rebate credit to an eligible individual—one other than a nonresident individual, an individual who could be a dependent, or an estate or trust. Any economic stimulus payment the taxpayer received in 2008 reduced the recovery rebate credit.
Of the total math error notices, 6.6% were for tax calculation/other taxes (which includes errors made relating to self-employment tax, alternative minimum tax, and household employment tax), 4.2% relating to exemption number/amount, 3.6% relating to the earned income tax credit, and 3.4% relating to the standard/itemized deduction.
Penalties. In FY 2009 IRS assessed 26.387 million civil penalties against individual taxpayers, down from 30.223 million civil penalties assessed in the previous year. Of the FY 2009 assessments, the “top three” penalties in percentage terms were 54.71% for failure to pay, 28.67% for underpayment of estimated tax, and 14.42% for delinquency. On the business side, there were a total of 970,098 civil penalty assessments, and 55.8% of these assessments was for either failure to pay or underpayment of estimated tax. (The data was organized differently for FY 2008 so comparisons can't be made to the previous year.)
Offers in compromise. In FY 2009 52,000 offers in compromise were received by IRS, and 11,000 (26%) were accepted. These figures reversed declines in the two preceding years.
Criminal cases. IRS initiated 4,121 criminal investigations in FY 2009. There were 2,570 referrals for prosecution and 2,105 convictions. Of those sentenced, 81.2% were incarcerated (a term that includes imprisonment, home confinement, electronic monitoring, or a combination thereof). By way of comparison, in FY 2008, IRS initiated 3,749 criminal investigations, there were 2,785 referrals for prosecution. Of those sentenced, 80.9% were incarcerated.

trust fund penalty - willfulness - section 6672

Wilfulness” for trust fund penalty found both before and after actual knowledge of delinquency
Frohnaple v. U.S., (DC NC 3/8/2010) 105 AFTR 2d ¶ 2010-577
A district court's Magistrate Judge has concluded that the president of a failing company was liable for the trust fund penalty because he “wilfully” failed to pay over payroll taxes under Code Sec. 6672 , for periods both before and after he actually knew that payroll taxes hadn't been paid. His knowledge of the company's inability to meet its debts and cash flow problems, as well as red flags raised as to the integrity of financial information, imposed an affirmative duty on him to ensure that the payroll taxes were being paid.
Background. Where an employer fails to properly pay over its payroll taxes, IRS can seek to collect a penalty equal to 100% of the unpaid taxes from a “responsible person,” i.e., a person who: (1) is responsible for collecting, accounting for and paying over payroll taxes; and (2) willfully fails to perform this responsibility. ( Code Sec. 6672(a) )
In determining whether there is “willfulness” for purposes of Code Sec. 6672 liability, courts have focused on whether the taxpayer had knowledge of non-payment or reckless disregard of whether the payments were being made. Thus, IRS can show willfulness by showing either actual knowledge of non-payment or reckless disregard as to non-payment. Courts have held that although mere negligence isn't enough to establish reckless disregard, gross negligence is. (Thomsen v. U.S. (CA 1 1989), 64 AFTR 2d 89-5752 )
IRS assessed a Code Sec. 6672 penalty against Frohnaple for the tax periods ending June 30, 2000, Sept. 30, 2000, Dec. 31, 2000, Mar. 31, 2001, and June 30, 2001, in the amount of roughly $515,600.

Willfulness found. The Magistrate Judge initially concluded that Frohnaple acted willfully for four of the five quarters at issue—the portion of the last two quarters of 2000 and the first two quarters of 2001—when he was specifically made aware that the payroll taxes had not been paid. On learning of Boling Group's failure to remit payroll taxes, he had an absolute duty to use all corporate funds to pay the currently accruing tax liability, as well as the outstanding tax liability. However, Frohnaple did nothing to ensure that the taxes were paid and, instead, made payments to other creditors. From August 2000 through January 2001, Boling Group's bank deposits totaled more than $1.7 million, none of which was used to pay the payroll taxes. Instead it was used to pay other creditors, as well as employee salaries, including Frohnaple's own salary. Frohnaple's failure to ensure that the delinquent taxes were paid with these funds meets the willful standard of Code Sec. 6672 as a matter of law.
The Magistrate Judge concluded that Frohnaple's reliance on statements by Boling Group's Controller Phyllis Younts (who started in September 2000) that she was “dealing with” the payroll taxes, without doing anything more to investigate and ensure that they were being paid, was simply more than mere negligence. By the time Younts was hired Frohnaple already knew that Boling Group was delinquent in its payment of the taxes and that it was floundering financially. By December 2000, he had questioned Younts' reliability; and he could have examined Boling Group's books to confirm the payments. The Magistrate Judge found that after Frohnaple became aware that the payroll taxes had not been paid by Dizon, he had a duty to exercise greater oversight over the finance department to independently ensure that the payroll taxes were being paid, and his failure to do so during Younts' tenure with Boling Group amounted to careless disregard.
Further, the Magistrate Judge also concluded that for the time period before Frohnaple became aware that the payroll taxes weren't being paid, Frohnaple's failure to confirm whether Boling Group was current with its tax obligations and his failure to take remedial action amounted to reckless disregard for the purpose of finding willfulness. Even if he was never specifically told until August 2000 that Boling Group was delinquent in paying employment taxes, his knowledge of the company's inability to meet its debts and its severe cash flow constraints before August 2000, as well as the red flags that had already been raised about Dizon by the outside accountant as to the integrity of the financial information, gave rise to a duty to confirm that Boling Group was meeting its payroll tax obligations. Frohnaple knew that Boling Group had ongoing financial difficulties, and as a result, Frohnaple extended numerous personal loans to Boling Group for more than $200,000. At least once, Frohnaple personally loaned Boling Group money to meet payroll, and he also knew that the ability to pay suppliers to keep up with production was an ongoing problem.

BARRETT, JR. v. U.S., Cite as 105 AFTR 2d 2010-XXXX, 03/09/2010
________________________________________
CHARLES W. BARRETT, JR., Petitioner-Appellant, v. UNITED STATES OF AMERICA, Respondent-Appellee.
AFFIRMED.
________________________________________

§ 6672 Failure to collect and pay over tax, or attempt to evade or defeat tax.
________________________________________
(a) WG&L Treatises General rule.
Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 or part II of subchapter A of chapter 68 for any offense to which this section is applicable.
(b) Preliminary notice requirement.
(1) In general.
No penalty shall be imposed under subsection (a) unless the Secretary notifies the taxpayer in writing by mail to an address as determined under section 6212(b) or in person that the taxpayer shall be subject to an assessment of such penalty.
(2) Timing of notice.
The mailing of the notice described in paragraph (1) (or, in the case of such a notice delivered in person, such delivery) shall precede any notice and demand of any penalty under subsection (a) by at least 60 days.
(3) Statute of limitations.
If a notice described in paragraph (1) with respect to any penalty is mailed or delivered in person before the expiration of the period provided by section 6501 for the assessment of such penalty (determined without regard to this paragraph ), the period provided by such section for the assessment of such penalty shall not expire before the later of—
(A) the date 90 days after the date on which such notice was mailed or delivered in person, or
(B) if there is a timely protest of the proposed assessment, the date 30 days after the Secretary makes a final administrative determination with respect to such protest.
(4) Exception for jeopardy.
This subsection shall not apply if the Secretary finds that the collection of the penalty is in jeopardy.
(c) Extension of period of collection where bond is filed.
(1) In general.
If, within 30 days after the day on which notice and demand of any penalty under subsection (a) is made against any person, such person—
(A) pays an amount which is not less than the minimum amount required to commence a proceeding in court with respect to his liability for such penalty,
(B) files a claim for refund of the amount so paid, and
(C) furnishes a bond which meets the requirements of paragraph (3) ,

no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until a 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) .
(2) Suit must be brought to determine liability for penalty.
If, within 30 days after the day on which his claim for refund with respect to any penalty under subsection (a) is denied, the person described in paragraph (1) fails to begin a proceeding in the appropriate United States district court (or in the Court of Claims) 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 30-day period referred to in this paragraph .
(3) Bond.
The bond referred to in paragraph (1) shall be in such form and with such sureties as the Secretary may by regulations prescribe and shall be in an amount equal to 11/2 times the amount of excess of the penalty assessed over the payment described in paragraph (1) .
(4) 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.
(5) Jeopardy collection.
If the Secretary makes a finding that the collection of the penalty is in jeopardy, nothing in this subsection shall prevent the immediate collection of such penalty.
(d) Right of contribution where more than 1 person liable for penalty.
If more than 1 person is liable for the penalty under subsection (a) with respect to any tax, each person who paid such penalty shall be entitled to recover from other persons who are liable for such penalty an amount equal to the excess of the amount paid by such person over such person's proportionate share of the penalty. Any claim for such a recovery may be made only in a proceeding which is separate from, and is not joined or consolidated with—
(1) an action for collection of such penalty brought by the United States, or
(2) a proceeding in which the United States files a counterclaim or third-party complaint for the collection of such penalty.
(e) Exception for voluntary board members of tax-exempt organizations.
No penalty shall be imposed by subsection (a) on any unpaid, volunteer member of any board of trustees or directors of an organization exempt from tax under subtitle A if such member—
(1) is solely serving in an honorary capacity,
(2) does not participate in the day-to-day or financial operations of the organization, and
(3) does not have actual knowledge of the failure on which such penalty is imposed.

The preceding sentence shall not apply if it results in no person being liable for the penalty imposed by subsection (a) .

Thomas Rosato, et ux. v. Commissioner, TC Memo 2010-39 , Code Sec(s) 3121; 3401; 6662; 7491.

--------------------------------------------------------------------------------
THOMAS & CAROL ROSATO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information: Code Sec(s): 3121; 3401; 6662; 7491
Docket: Docket No. 20353-08.
Date Issued: 02/25/2010
Judge: Opinion by COHEN


HEADNOTE
XX.

Reference(s): Code Sec. 3121 ; Code Sec. 3401 ; Code Sec. 6662 ; Code Sec. 7491

Syllabus
Official Tax Court Syllabus
Counsel
Alan J. Garfunkel, for petitioners.
Shawna A. Early, for respondent.

Opinion by COHEN

MEMORANDUM OPINION
Respondent determined a deficiency of $56,471 and an accuracy-related penalty of $11,294 under section 6662(a) in relation to petitioners' 2006 Federal income tax. After a concession by petitioners, the issues for decision are (1) whether Thomas Rosato (petitioner) was an independent contractor, statutory employee, or common law employee and (2) whether petitioners are subject to the section 6662(a) penalty. 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
This case was submitted fully stipulated under Rule 122, and the stipulated facts are incorporated as our findings by this reference. Petitioners resided in New York at the time the petition was filed.

Beginning in 1975 petitioner worked as a salesperson for O.C. Tanner (Tanner), a company headquartered in Salt Lake City, Utah, that provides products and services that assist companies with developing programs for recognizing and rewarding their employees. Petitioner entered into an employment agreement with Tanner dated April 21, 1975, that detailed petitioner's sales territory in the New York City area. Tanner also provided petitioner with a list of clients that he was not allowed to solicit, and petitioner was not permitted to work as a salesperson for Tanner's competitors or other employers while he was acting as a salesperson for Tanner. This noncompetition obligation was limited to the time petitioner was acting as a salesperson for Tanner.

The 1975 employment agreement identified petitioner as an “employee” of Tanner. Terms of the employment agreement included:

The Employee shall devote his full working time and his best efforts to the service of the Company in selling and promoting the Company's products in accordance with Company policies and under Company direction; and, during the term of this agreement, he shall not engage in outside business activities. He shall have no authority to bind or obligate the Company in any way without prior written authorization from an official of the Company in Salt Lake City. ***

Any expense incurred by the Employee in excess of his expense allowance shall be paid by him; and the Employee shall not obligate the Company in any way for any of his expenses without prior written authorization by an officer of the Company in Salt Lake City, Utah. ***

The Employee is not authorized to and shall not handle any money or other forms of payment by customers unless specifically directed to do so by an official of the Company in Salt Lake City, Utah in special instances. The employment agreement was supplemented with several addenda regarding compensation and expense allowances between 1976 and 1983. In August 1984, Tanner advised its salespeople by letter that the company was adopting the principles of the Golden Rule within the employer-employee relationship, eliminating signed or unsigned written agreements and that As a first step *** all contracts, whether signed or unsigned, are no longer necessary.

The company intends to honor the terms of these agreements as they relate to your compensation, your territory, and other general policy matters regarding your employment relationship with the company.

In the future, instead of stating policies in written contracts, the company will utilize letters, bulletins, staff memos, etc. to define company policies and explain company changes. A letter dated November 26, 1984, from Tanner and addressed to petitioner, instructed him that by signing and returning a copy of this letter he acknowledged that his prior written agreement with the company was terminated and that he supported Tanner's new policies. Petitioner signed and dated the letter December 2, 1984. Tanner did not alter the relationship with petitioner or salespersons holding similar situations and intended to continue treating them as employees.

In a letter dated January 23, 2002, Tanner notified petitioner of “the conditions of your employment at O.C. Tanner” because of several concerns regarding petitioner's actions at work. These conditions included that petitioner attend monthly counseling sessions (some of which Tanner scheduled for petitioner), conduct weekly meetings, and provide corresponding written reports to Tanner. During 2006 petitioner continued to work as a salesperson for Tanner in New York, New York. Tanner required petitioner to attend company sales meetings and training sessions and expected petitioner to have a presence in the New York office. However, Tanner did not set petitioner's work hours or instruct him when to work, he could take days off as he chose, and he could perform some of his sales work from home. According to Tanner, in 2006

Mr. Rosato was expected to devote his working hours to the advancement of O.C. Tanner's interests. We also expected him to work solely for O.C. Tanner and not to engage in side businesses that competed with O.C. Tanner. Mr. Rosato was free to engage in other business activities (e.g., leasing real estate) so long as it was done on his own time. If Mr. Rosato had left O.C. Tanner, he would not be prohibited from working for a competitor, although we would have insisted he maintain OCT's confidences and trade secrets. Tanner's understanding of the nature of its relationship with petitioner for the period of 1975 through 2006 was that at all times he was an at-will employee.In addition to working as a salesperson for Tanner during 2006, petitioner managed Tanner's regional office in New York, New York. In this capacity, petitioner supervised salespersons, secretaries, and other administrative personnel in the New York regional office whom Tanner hired.

With respect to the New York office and its employees, Tanner and petitioner followed a cost-sharing arrangement based on a formula set forth by Tanner. Petitioner paid for a portion of his office, half of the cost of his personal secretary, and half of the cost of his own administrative assistant. Petitioner also paid commissions to other New York-based Tanner salespersons from the commissions that he received from Tanner. Petitioner had input regarding the hiring of these salespersons.

Petitioner was permitted to participate in Tanner's Retirement Plan for Sales Representatives and in Tanner's profit- sharing plan. During 2006 petitioner was included in Tanner's medical insurance plan, section 401(k) plan, group term life insurance plan, and unemployment insurance plan. Petitioner made contributions toward the cost of the medical insurance plan, to the section 401(k) plan, and to the group term life insurance plan.

Tanner outlined expense reporting requirements in the Monthly Regional Expense Report Instructions dated January 2006. Tanner's expense report instructions identified expenses that were considered reimbursable and nonreimbursable. Accordingly, petitioner submitted monthly expense reports to Tanner for reimbursement of operating expenses such as phone, utilities, postage, customer entertainment, office supplies, and meals. Petitioner did not receive reimbursements from Tanner for all of his business expenses related to sales efforts on behalf of Tanner.

Petitioner received a Form W-2, Wage and Tax Statement, from Tanner for 2006 that reported his income as “Wages, tips, other compensation”. The Form W-2 also reported that Tanner withheld Federal and State income taxes and Social Security and Medicare taxes and that Tanner had established a section 401(k) plan account for petitioner. Tanner did not report that petitioner was a statutory employee on the Form W-2.

Petitioners jointly filed a Form 1040, U.S. Individual Income Tax Return, for 2006 and left blank line 7, “Wages, salaries, tips, etc.” On an attached Schedule C, Profit or Loss From Business, petitioner's wife reported profit from a “Real Estate Sales” business. On another attached Schedule C, petitioner reported his principal business or profession as “Outside Sales” and reported gross receipts or sales of $468,378, the wage amount shown on the Form W-2 that Tanner issued. Petitioner checked the box on line 1 of his outside sales Schedule C, misrepresenting that his Form W-2 identified him as a statutory employee. Petitioner did not claim expenses for the business use of a home on the Schedule C.

In the notice of deficiency, the IRS determined that petitioner was a common law employee and therefore was not permitted to report income and expenses on Schedule C. The explanation in the notice stated:

Only statutory employee income can be offset by expenses reported on Schedule C, Profit or Loss From Business, or Schedule C-EZ. Since your employer did not indicate on Form W-2, Wage and Tax Statement, that you were a statutory employee, we cannot allow the expenses used to offset that income on Schedule C or Schedule C-EZ. On the basis of this determination, the IRS reported petitioners' tax required to be shown on the 2006 return as $126,216—$56,471 more than petitioners had reported. The IRS further determined that petitioners are liable for the accuracy- related penalty under section 6662(a).

Discussion
An individual performing services as an employee may deduct expenses incurred in the performance of services as an employee as miscellaneous itemized deductions on Schedule A, Itemized Deductions, to the extent the expenses exceed 2 percent of the taxpayer's adjusted gross income. Secs. 62(a)(2), , 63(a), (d), 67(a) and (b), 162(a). Itemized deductions may be limited under section 68 and may have alternative minimum tax implications under section 56(b)(1)(A)(i).

An individual who performs services as an independent contractor is entitled to deduct expenses incurred in the performance of services on Schedule C and is not subject to limitations imposed on miscellaneous itemized deductions. A statutory employee under section 3121(d)(3)(D) is not an employee for purposes of section 62 and may deduct business expenses on Schedule C. See Rosemann v. Commissioner, T.C. Memo. 2009-185 [TC Memo 2009-185]; Rev. Rul. 90-93, 1990-2 C.B. 33.

Petitioners argue that in 2006 petitioner was an independent contractor or statutory employee and is entitled to deduct business expenses on Schedule C. Respondent contends that petitioner was a common law employee in 2006 and that unreimbursed employee expenses are thus properly reportable on Schedule A, subject to the 2 percent of adjusted gross income limitation.

An individual qualifies as a statutory employee under section 3121(d)(3) only if the individual is not a common law employee pursuant to section 3121(d)(2). See Ewens & Miller, Inc. v. Commissioner, 117 T.C. 263, 269 (2001); Rosemann v. Commissioner, supra. Section 3121(d) defines “employee”, in pertinent part, as follows:(2) any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of employee; or

(3) any individual (other than an individual who is an employee under paragraph (1) or (2)) who performs services for remuneration for any person— ***

(D) as a traveling or city salesman, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal (except for side-line sales activities on behalf of some other person) of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations; if the contract of service contemplates that substantially all of such services are to be performed personally by such individual; except that an individual shall not be included in the term “employee” under the provisions of this paragraph if such individual has a substantial investment in facilities used in connection with the performance of such services (other than in facilities for transportation), or if the services are in the nature of a single transaction not part of a continuing relationship with the person for whom the services are performed; *** Because an individual qualifies as a statutory employee only if the individual is not a common law employee, we will first decide whether petitioner was a common law employee of Tanner.

Although the income tax treatment of a taxpayer's trade or business expense deductions under section 62(a) depends on whether the taxpayer is "[performing] *** services *** as an employee”, subtitle A of the Internal Revenue Code does not define “employee”. Under these circumstances, we apply common law rules to determine whether the taxpayer is an employee. Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 323-325 (1992); Weber v. Commissioner, 103 T.C. 378, 386 (1994), affd. 60 F.3d 1104 [76 AFTR 2d 95-5782] (4th Cir. 1995).

Whether an individual is an employee must be determined on the basis of the specific facts and circumstances involved. Profl. & Executive Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), affd. 862 F.2d 751 [63 AFTR 2d 89-427] (9th Cir. 1988); Simpson v. Commissioner, 64 T.C. 974, 984 (1975). Relevant factors include: (1) The degree of control exercised by the principal; (2) which party invests in the work facilities used by the worker; (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; (7) the relationship the parties believed they were creating; and (8) the provision of employee benefits. See Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 429 [34 AFTR 2d 74-5882] (2d Cir. 1974); Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387. We consider all of the facts and circumstances of each case, and no single factor is determinative. Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387.

Although not the exclusive inquiry, the degree of control exercised by the principal over the worker is the crucial test in determining the nature of a working relationship. See Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440, 448 (2003); Leavell v. Commissioner, 104 T.C. 140, 149-150 (1995). To retain the requisite degree of control over a worker, the principal need not direct the worker's every move; it is sufficient if the right to do so exists. Weber v. Commissioner, supra at 387; see sec. 31.3401(c)-1(b), Employment Tax Regs.

Relying on Hathaway v. Commissioner, T.C. Memo. 1996-389 [1996 RIA TC Memo ¶96,389], petitioners assert that “Tanner's lack of control and lack of the right to control the manner and means by which petitioner solicited sales strongly supports a finding that petitioner was *** not an employee of Tanner”. Unlike petitioner, the traveling salesperson in Hathaway was not required to attend sales meetings or maintain an office presence and was permitted to sell nonconflicting lines of merchandise from other companies. Additionally, Tanner's January 2002 letter to petitioner that outlined “conditions of [petitioner's] employment” shows that petitioner had superiors at Tanner who oversaw and supervised his performance.

The fact that a worker provides his or her own tools, or owns a vehicle that is used for work, is indicative of independent contractor status. Ewens & Miller, Inc. v. Commissioner, supra at 271 (citing Breaux & Daigle, Inc. v. United States, 900 F.2d 49, 53 [65 AFTR 2d 90-1133] (5th Cir. 1990)). Additionally, maintenance of a home office is consistent with independent contractor status, although alone it does not constitute sufficient basis for a finding of independent contractor status. See Colvin v. Commissioner, T.C. Memo. 2007-157 [TC Memo 2007-157], affd. 285 Fed. Appx. 157 [102 AFTR 2d 2008-5301] (5th Cir. 2008).

Petitioner and Tanner followed a cost-sharing arrangement with respect to the New York office. The record does not reflect the detailed terms of this arrangement. Further, although petitioner incurred additional expenses related to Tanner sales activities and hired a personal secretary and administrative assistant, it was his decision to incur these additional costs, and Tanner shared some of these expenses. Cf. Hathaway v. Commissioner, supra (salesperson not reimbursed for office space expenses and only provided minimal supplies from company such as order forms, sample swatches, and preaddressed envelopes). Additionally, petitioner claimed that he worked from home on occasion, but he has not presented any evidence that he made expenditures to establish a home office qualifying under section See Cole v. Commissioner, T.C. Memo. 2006-44 [TC Memo 2006-44]; Lewis v. 280A. Commissioner, T.C. Memo. 1993-635 [1993 RIA TC Memo ¶93,635].

The opportunity for profit or loss indicates nonemployee Simpson v. Commissioner, supra at 988. Earning an status. hourly wage or fixed salary indicates that an employer-employee relationship exists. See Kumpel v. Commissioner, T.C. Memo. 2003-265 [TC Memo 2003-265]. Petitioner was not paid a fixed wage; and because he shared expenses with Tanner, he risked a net loss if his profits did not exceed his expenses.

Where the principal retains the right to discharge a worker, it is indicative of an employer-employee relationship. See Colvin v. Commissioner, supra. Tanner retained the right to discharge petitioner at will.

Petitioner's sales efforts were an integral part of Tanner's regular business of providing products and services relating to assisting companies with developing programs for recognizing and rewarding their employees. Where work is part of the principal's regular business, it is indicative of employee status. See Simpson v. Commissioner, supra at 989; Rosemann v. Commissioner, T.C. Memo. 2009-185 [TC Memo 2009-185].

Permanency of a working relationship is indicative of common law employee status. See Rosemann v. Commissioner, supra. The lengthy working relationship between Tanner and petitioner weighs in favor of petitioner's being a common law employee.

The record shows that Tanner considered petitioner a common law employee. Petitioner and Tanner did not have a written employment contract in place in 2006. However, after Tanner adopted the Golden Rule principle, the parties continued to honor the terms and conditions of the original employment contract, and in 2002 Tanner further mandated conditions that petitioner had to follow to maintain his position. The withholding of taxes is consistent with a finding that an individual is a common law See Packard v. Commissioner, 63 T.C. 621, 632 (1975). employee. Tanner provided petitioner a Form W-2 for 2006 and withheld Federal and State income taxes and Social Security and Medicare taxes from petitioner's pay.

Benefits such as health insurance, life insurance, and retirement plans are typically provided to employees. Weber v. Commissioner, 103 T.C. at 393-394. Petitioner participated in Tanner's medical insurance plan, section 401(k) plan, group term life insurance plan, and unemployment insurance plan. Tanner also reimbursed petitioner for business expenses according to outlined terms.

Considering the record and weighing the factors, we conclude that petitioner was a common law employee of Tanner in 2006. Thus petitioner is precluded from being a statutory employee pursuant to section 3121(d)(3). See Ewens & Miller, Inc. v. Commissioner, 117 T.C. at 269; Rosemann v. Commissioner, supra.

Respondent determined that petitioners are liable for an accuracy-related penalty under section 6662(a) for 2006. Section 6662(a) and (b)(1) and (2) imposes a 20-percent accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer's negligence or disregard of rules or regulations, or a substantial understatement of income tax. Section 6662(d)(1)(A) defines “substantial understatement of income tax” as an amount exceeding the greater of 10 percent of the tax required to be shown on the return or $5,000. A taxpayer is negligent when he or she fails “to do what a reasonable and ordinarily prudent person would do under the circumstances.” Korshin v. Commissioner, 91 F.3d 670, 672 [78 AFTR 2d 96-6056] (4th Cir. 1996) (quoting Schrum v. Commissioner, 33 F.3d 426, 437 [74 AFTR 2d 94-6174] (4th Cir. 1994), affg. in part and vacating in part T.C. Memo. 1993-124 [1993 RIA TC Memo ¶93,124]), affg. T.C. Memo. 1995-46 [1995 RIA TC Memo ¶95,046].

Under section 7491(c), the Commissioner bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is proper to impose penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). However, once the Commissioner has met the burden of production, the burden of proof remains with the taxpayer, including the burden of proving that the penalties are inappropriate because of Id. at 446-447. reasonable cause or substantial authority.

Respondent determined that petitioners have an underpayment of tax that is attributable to a substantial understatement of income tax in 2006. Respondent contends that the amount of tax required to be shown on petitioners' 2006 tax return is $126,216 and the understatement of income tax is $56,741, which is greater than $5,000 and than 10 percent of the amount of tax required to be shown and thus is substantial. Furthermore, respondent asserts that when they received a Form W-2 from Tanner that reported petitioner's 2006 earnings as salary or wages and did not classify petitioner as a statutory employee, petitioners were put on notice that these earnings were not eligible for reporting on Schedule C. Respondent's burden of production has been met.

Petitioners argue that they are not liable for the section 6662(a) penalty because Hathaway v. Commissioner, T.C. Memo. 1996-389 [1996 RIA TC Memo ¶96,389], “constitutes substantial authority on which *** [petitioners] relied”. Because the authority upon which petitioners rely is materially distinguishable from the instant case, it is not substantial authority for their erroneous position. See Antonides v. Commissioner, 91 T.C. 686, 703 (1988), affd. 893 F.2d 656 [65 AFTR 2d 90-521] (4th Cir. 1990).

The accuracy-related penalty under section 6662(a) will not be imposed with respect to any portion of the underpayment as to which the taxpayer acted with reasonable cause and in good faith. Sec. 6664(c)(1). The decision as to whether a taxpayer acted with reasonable cause and in good faith is made by taking into account all of the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess his or her proper This factor includes, in some circumstances, tax liability. Id. the taxpayer's reasonable and good faith reliance on the advice of a tax professional. Id.

Petitioners' substantial understatement of income tax resulted from claiming deductions on Schedule C that were properly reportable on Schedule A. Petitioners have failed to show that this position was taken with reasonable cause and in good faith within the meaning of section 6664(c)(1). Petitioners do not argue that they reasonably relied on the advice of a professional, such as an accountant, to support their claim that they had reasonable cause for, and acted in good faith with respect to, any portion of the underpayment of tax for 2006. See sec. 1.6664-4(b)(1), Income Tax Regs. Furthermore, on their 2006 tax return, petitioners misrepresented petitioner's employee status as reported on the Form W-2 from Tanner. Petitioners have failed to establish that they are not liable for the accuracy- related penalty under section 6662(a).

We have considered all arguments made by the parties. To the extent not mentioned or addressed, they are irrelevant or without merit. To reflect the foregoing,

Decision will be entered for respondent.

Reporting uncertain positions

Announcement 2010-17, 2010-13 IRB, 03/05/2010, IRC Sec(s).

Headnote:


Reference(s):

Full Text:

In Announcement 2010-9, 2010-7 I.R.B. 408, the Internal Revenue Service announced that it is developing a schedule requiring certain business taxpayers to report uncertain tax positions on their tax returns and requested comments by March 29, 2010.

Since that announcement, the Service has received a number of questions and comments on the proposal. Several informal comments asked the Service to clarify whether taxpayers will be required to file the new schedule with returns relating to 2009 tax years and whether a draft schedule and instructions will be released. Other comments asked for clarification regarding the scope and implementation of the proposal, such as its application to pass-through entities and tax-exempt entities, and potential duplication of reporting with disclosures made on other forms (such as the Form 8275, Disclosure Statement, and the Form 8275-R, Regulation Disclosure Statement) . Some informal and written comments also asked for an extension of the comment period for up to 60 days to allow sufficient time to study the proposal and analyze its impact.

The Service continues to work on developing the proposal contained in the Announcement, including development of the schedule and implementing instructions. The Service's target date for releasing a draft schedule based on the proposal described in Announcement 2010-9, along with draft instructions, is early April 2010 with a comment period ending on June 1, 2010. The Service expects the draft schedule and instructions will clarify some of the issues that have already been brought to the Service's attention, provide additional information concerning the proposal described in Announcement 2010-9, and facilitate comment on the proposal. The draft instructions may not completely resolve all questions about the proposal and may indicate that the Service will reserve making final decisions on certain issues until after the comment period has ended and all comments have been received and analyzed.

Additionally, as the proposal is further developed and finalized, the Service recognizes the need to adjust its programs to ensure the appropriate use of the data from the schedule, and to address possible increases in demand for guidance and issue resolution.

The Service plans to require the filing of the new schedule for returns relating to the calendar year 2010 and for fiscal years that begin in 2010. The schedule will not be implemented for 2009 tax returns filed in 2010. To allow taxpayers and practitioners the opportunity to provide comprehensive comments both on the proposal and on the implementing schedule and instructions, the time for submitting comments in response to Announcement 2010-9 is extended to June 1, 2010.

The Service invites comment on the following matters, as well as those described in Announcement 2010-9:

1. Do the disclosures required by the new schedule duplicate those required by other forms, thus making forms, such as the Form 8275 and 8275-R, unnecessary or redundant in some circumstances;

2. What type of uncertain tax positions should be reported by pass-through entities and tax-exempt entities; and

3. How uncertain tax positions should be reported in various related entity contexts, such as how members of a consolidated group for financial statement or tax return purposes or entities that are disregarded for federal tax purposes should report uncertain tax positions.

The principal author of this announcement is Kathryn Zuba of the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this announcement contact Ms. Zuba at (202) 622-3400 (not a toll-free call).

© 2010 Thomson Reuters/RIA. All rights reserved.

new 7602 reporting requirement

Announcement 2010-9, 2010-7 IRB 408, 01/26/2010, IRC Sec(s). 7602

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Examination of books and witnesses—requests for tax accrual workpapers.
Headnote:
While it intends to retain existing policy of restraint for requesting tax accrual workpapers during course of examinations described in IRM, IRS announced that it is developing schedule requiring certain business taxpayers to report uncertain tax positions on their tax returns. Schedule would be filed with corp. tax return, and would require concise description of each uncertain tax position for which taxpayer or related entity has recorded reserve in its financial statements and maximum amount of potential federal tax liability attributable to each uncertain tax position (determined without regard to taxpayer's risk analysis regarding its likelihood of prevailing on merits). Public comment on proposal should be submitted to IRS not later than 3/29/2010, as IRS intends to require that schedule be included with returns filed after that date.

Reference(s): ¶ 76,024.02; Code Sec. 7602;

Full Text:
The Internal Revenue Service is considering changes to reporting requirements regarding certain business taxpayers' uncertain tax positions in order to improve tax compliance and administration. The Service is developing a schedule requiring certain business taxpayers to report uncertain tax positions on their tax returns. This Announcement discusses the potential content of such a schedule and invites public comment on the Service's proposed approach. The schedule will require the annual disclosure of uncertain tax positions in the form of a concise description of those positions and information about their magnitude. The proposal does not require the taxpayer to disclose the taxpayer's risk assessment or tax reserve amounts, even though the Service can compel the production of this information through a summons. United States v. Arthur Young, 465 U.S. 805, 815 [53 AFTR 2d 84-866] (1984). While the Service intends to require the reporting of uncertain tax positions, the Service is proposing to otherwise retain its existing policy of restraint as described in Announcement 2002-63, 2002-2 C.B. 72, and IRM 4.10.20.

Background
Uncertain Tax Positions
The United States federal income tax system relies on taxpayers to make a self-assessment of tax and to file the appropriate form of return that shows the facts upon which tax liability may be determined and assessed. Section 601.103 of the Procedure and Administration Regulations. To discharge its obligation to fairly and uniformly administer the tax laws, the Service must be able to identify quickly and efficiently significant issues (including uncertain tax positions) underlying the tax return. Existing business tax returns do not currently require that taxpayers identify and explain uncertain tax positions underlying their returns.

Many taxpayers are required by FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48) 1 to identify and quantify uncertain tax positions taken in the return for financial accounting purposes. That is, taxpayers must identify and quantify for financial accounting purposes a tax position relating to a specific federal tax return for which a taxpayer is required to reserve an amount under FIN 48. A taxpayer's tax reserves and reporting regarding its uncertain tax positions may be reflected in its own books and records or financial statements, or in the books and records or financial statements of a related domestic or foreign entity. Taxpayers not subject to FIN 48 may be subject to other requirements regarding accounting for uncertain tax positions. For example, taxpayers may be subject to other generally accepted accounting standards, including International Financial Reporting Standards (IFRS) and country-specific generally accepted accounting standards.

The information developed in the course of complying with FIN 48 or other accounting standards is highly relevant to understanding the taxpayer's tax positions and assessing how those positions affect the taxpayer's tax liability. United States v. Arthur Young, 465 U.S. at 815. That information also would aid the Service in focusing its examination resources on returns that contain specific uncertain tax positions that are of particular interest or of sufficient magnitude to warrant Service inquiry, as well as allowing examination teams to identify all of the issues underlying the tax returns more quickly and efficiently.

Schedule
The Service is developing a schedule that will require certain filers to provide information about their uncertain tax positions that affect their United States federal income tax liability. This schedule will be filed with the Form 1120, U.S. Corporation Income Tax Return, or other business tax returns. The schedule will require (i) a concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements and (ii) the maximum amount of potential federal tax liability attributable to each uncertain tax position (determined without regard to the taxpayer's risk analysis regarding its likelihood of prevailing on the merits).

In addition to those positions for which a tax reserve must be established under FIN 48 or other accounting standards, uncertain tax positions will include any position related to the determination of any United States federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate the position, or (ii) the taxpayer has determined that the Service has a general administrative practice not to examine the position. For this purpose, a related entity is any entity that is related to the taxpayer under sections 267(b), 318(a), or 707(b).

The schedule will require a concise description of each uncertain tax position in sufficient detail so that the Service can determine the nature of the issue. The sufficiency of a description will depend on the taxpayer's particular facts and the nature of the underlying transaction. As currently contemplated, this concise description will include the rationale for the position and a concise general statement of the reasons for determining that the position is an uncertain tax position. To be sufficient, the description must contain:

1. The Code sections potentially implicated by the position;
2. A description of the taxable year or years to which the position relates;
3. A statement that the position involves an item of income, gain, loss, deduction, or credit against tax;
4. A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both;
5. A statement whether the position involves a determination of the value of any property or right; and
6. A statement whether the position involves a computation of basis.
In addition, the schedule will require a taxpayer to specify for each uncertain tax position the entire amount of United States federal income tax that would be due if the position were disallowed in its entirety on audit. This amount is the maximum tax adjustment for the position reflecting all changes to items of income, gain, loss, deduction, or credit if the position is not sustained.

The Service anticipates publishing a notice of proposed rulemaking to provide that certain businesses required to make a return (including corporations required to make a return under section 6012) will be required to file a form or schedule relating to the disclosure of uncertain tax positions as part of its return in accordance with the forms, instructions, or other appropriate guidance provided by the Service.

The Service is also evaluating additional options for penalties or sanctions to be imposed when a taxpayer fails to make adequate disclosure of the required information regarding its uncertain tax positions. One option being considered is to seek legislation imposing a penalty for failure to file the schedule or to make adequate disclosure.

Continuation of Policy of Restraint
Except as described in this Announcement, the Service intends to retain the existing policy of restraint for requesting tax accrual workpapers during the course of examinations described in IRM 4.10.20. The Service will continue to review the policy and to consider additional modifications, however, as appropriate or necessary to ensure it obtains complete and accurate information regarding a taxpayer's uncertain tax positions on a timely basis.

Scope
The Service intends the new schedule to be filed by a business taxpayer with total assets in excess of $10 million if the taxpayer has one or more uncertain tax positions of the type required to be reported on the new schedule. This includes a taxpayer who prepares financial statements, or is included in the financial statements of a related entity that prepares financial statements, if that taxpayer or related entity determines its United States federal income tax reserves under FIN 48, or other accounting standards relating to uncertain tax positions involving United States federal income tax.

Request For Comments
Given the importance of these issues to both the Service and taxpayers, the Service intends to publish the new schedule as quickly as possible and therefore invites the public to submit comments on the proposal described in this Announcement by March 29, 2010. The Service intends to mandate that the new schedule for uncertain tax positions be filed with returns filed after release of the schedule. The Service is particularly interested in comments regarding:

1. How the maximum tax adjustment should be reflected on the schedule so that it provides the Service with an objective and quantifiable measure of each reported tax position (e.g., specific dollar amount or by appropriate dollar ranges);
2. What alternative methods of disclosure of the amount at issue would allow the Service to identify the relative importance of the uncertain tax positions;
3. Whether the calculation of the maximum tax adjustment should relate solely to the tax period for which the return is filed or to all tax periods to which the position relates, and whether net operating losses or excess credits should be taken into account in determining the maximum tax adjustment;
4. How the related entity rules should be applied;
5. Whether the scope of the Announcement should be modified regarding the uncertain tax positions for which information is required to be reported (e.g., positions for which no tax reserve has been established because the taxpayer determined the Service has a general administrative practice not to examine the position);
6. Whether transition rules should be used or criteria modified to either include or exclude certain businesses taxpayers (e.g., the proposed threshold of $10 million total assets);
7. How the new schedule should address taxpayers that initially did not record a reserve for an issue, but in later years do record a reserve; and
8. Whether the list of information proposed to be included should be modified, including whether certain information should be requested in some circumstances upon examination rather than with tax return.
Comments should be submitted to: Internal Revenue Service, CC:PA:LPD:PR ( Announcement 2010-9), Room 5203, P.O. Box 7604, Ben Franklin Station, N.W., Washington, D.C. 20044. Alternatively, comments may be hand delivered between the hours of 8:00 a.m. and 4:00 p.m., Monday through Friday, to CC:PA:LPD:PR ( Announcement 2010-9), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. Comments may also be transmitted electronically via the following e-mail address: Announcement.Comments@irscounsel.treas.gov. Please include “ Announcement 2010-9” in the subject line of any electronic communications. All comments will be available for public inspection and copying.

Drafting Information
The principal author of this Announcement is Kathryn Zuba of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this Announcement, contact the Office the Associate Chief Counsel (Procedure and Administration) at (202) 622-3400 (not a toll-free call).


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1

Under the codification of accounting standards, the relevant portions of FIN 48 are now contained in Accounting Standards Codification subtopic 740-10, Income Taxes. FASB ASC 740-10.

section 6707A enforcement change

IRS won't enforce Sec. 6707A penalty for smaller transactions through May 31, 2009
On Mar. 3, 2010, IRS Commissioner Doug Shulman notified Congress that IRS is extending until June 1, 2010 the current moratorium on collection enforcement actions relating to tax shelter penalties assessed under Code Sec. 6707A . In addition, IRS will continue to hold off on filing new notices of lien on amounts due solely related to Code Sec. 6707A penalties until June 1, 2010.
Background. Code Sec. 6707A , an anti-tax-shelter provision added by the American Jobs Creation Act of 2004, imposes a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that IRS characterizes as a “listed transaction” or “substantially similar” to a listed transaction. The penalty provision has been criticized by many groups.
In a June 12 letter to Commissioner Shulman, Congressional leaders complained that Code Sec. 6707A can result in disproportionate penalties for small businesses that thought they were investing in legitimate benefits plans, but unknowingly invested in listed tax shelter transactions. Upon audit, these businesses were assessed substantial penalties for failing to disclose the transactions on their tax returns, even though the transactions produced modest tax benefits. The taxwriters said a “bipartisan, bicameral commitment” was under way to enact legislation that would ease Code Sec. 6707A 's application. In the meantime, they asked Commissioner Shulman to use the discretion provided to IRS with its effective tax administration authority to suspend efforts to collect Code Sec. 6707A liabilities in cases where the annual tax benefits resulting from the listed transactions are less than $100,000 for individuals and $200,000 for other cases.
In a July 6 letter to Congressional leaders, Commissioner Shulman said that in view of Congressional leaders' commitment to enact legislation to address the issue, and to provide the Congress that opportunity, IRS wouldn't undertake any Code Sec. 6707A collection enforcement action through Sept. 30, 2009, on cases where the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for other taxpayers (see Weekly Alert ¶ 5 07/09/2009 ). However, because the penalty determination is related to the underlying transaction, and IRS can only determine the amount of tax benefit through examination, Commissioner Shulman said IRS would continue its examination on these cases and thus be able to identify cases meeting the collection suspension threshold. In September of 2009, Commissioner Shulman extended the suspension through Dec. 31, 2009 (see Weekly Alert ¶ 2 10/01/2009 ), and then in January of this year, extended the suspension yet again through Feb. 28, 2010. Now, IRS has again extended the suspension through May 31, 2010.

Congressional fix is in the works. On Feb. 9, 2010, the Senate by unanimous consent passed S. 2917, the Small Business Penalty Fairness Act of 2009. The House of Representatives is likely to approve the legislation as well. The main purpose of this bill is to put new limits on Code Sec. 6707A , an anti-tax-shelter provision that has been strongly criticized as imposing draconian penalties on small businesses and other taxpayers that unwittingly invest in transactions that turn out to be tax shelters.
Click here for the text of S. 2917, the Small Business Penalty Fairness Act of 2009.
Under the Senate-passed S. 2917, Code Sec. 6707A(b) would be amended to provide that the amount of the penalty under Code Sec. 6707A(a) for any reportable transaction would be equal to 75% of the decrease in tax shown on the return as a result of the transaction (or which would have resulted from the transaction had it been respected for federal tax purposes). The minimum penalty would be $10,000 ($5,000 for a natural person). The maximum penalty would in the case of a listed transaction be $200,000 ($100,000 for a natural person) or, in the case of any other reportable transaction, $50,000 ($10,000 for a natural person).
The changes to Code Sec. 6707A would apply for penalties assessed after Dec. 31, 2006.
RIA observation: Thus, some taxpayers who were assessed and paid the penalty before IRS halted collection efforts could qualify for a refund.
S. 2917 also would provide that:
... IRS would have to issue an annual report to the House Ways & Means Committee and Senate Finance Committee on the penalties imposed during the preceding year under a number of tax shelter penalty provisions. The first report would be due no later than June 1, 2010.
... Effective for instruments tendered after the enactment date, the Code Sec. 6657 penalty for tendering a bad check to IRS would apply to any commercially acceptable payment instrument (including electronic payments), not just to checks or money orders.
... Effective for levies approved after the enactment date, the Code Sec. 6331(h)(3) continuous tax levy on payments to vendors for goods and services sold or leased to the federal government would be extended to include payments for property, goods, or services sold or leased to the federal government.
IRS suspends enforcement of Sec. 6707A penalty for smaller transactions through Sept. 30, 2009
Click here for the text of Commissioner Shulman's July 6 letter to Rep. John Lewis about IRS's suspended enforcement of Sec. 6707A penalties for smaller transactions. This letter is identical to the letters he sent to other Congressional leaders.
Click here for the text of a June 15 press release titled “Lawmakers Concerned About Unfair Penalties on Small Business,” and the taxwriters' June 12 letter to the IRS Commissioner about Sec. 6707A.
In a July 6, 2009, letter to Congressional leaders, IRS Commissioner Doug Shulman acquiesced to their request that IRS suspend collection enforcement action on Code Sec. 6707A issues where the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for other taxpayers. Enforcement action will be suspended through Sept. 30, 2009. Commissioner Shulman wrote in response to a June 12 letter on the subject from Senate Finance Chair Max Baucus (D-MT), Ranking Member Chuck Grassley (R-IA), Ways and Means Oversight Subcommittee Chair John Lewis (D-GA) and Ranking Member Charles Boustany (R-LA).
Background. Code Sec. 6707A , an anti-tax-shelter provision added by the American Jobs Creation Act of 2004, imposes a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that IRS characterizes as a “listed transaction” or “substantially similar” to a listed transaction. The penalty provision has been criticized by, among others, the Small Business Council of America, the American Bar Association Section of Taxation, and National Taxpayer Advocate Nina Olson, for its harsh rules. For example, the Taxpayer Advocate said the penalty imposes strict liability (it applies without regard to whether the taxpayer has knowledge that the transaction has been listed and without regard to whether the transaction is reported correctly on the taxpayer's return) and applies even if the taxpayer derived little or no tax savings from the transaction. The penalty, which must be imposed by IRS and cannot be rescinded under any circumstances, may not be appealed in court.
In their June 12 letter to Commissioner Shulman, Congressional leaders complained that Code Sec. 6707A can result in disproportionate penalties for small businesses that thought they were investing in legitimate benefits plans, but unknowingly invested in listed tax shelter transactions. Upon audit, these businesses were assessed substantial penalties for failing to disclose the transactions on their tax returns, even though the transactions produced modest tax benefits. The taxwriters said a “bipartisan, bicameral commitment” was under way to enact legislation that would ease Code Sec. 6707A 's application. In the meantime, they asked Commissioner Shulman to use the discretion provided to IRS with its effective tax administration authority to suspend efforts to collect Code Sec. 6707A liabilities in cases where the annual tax benefits resulting from the listed transactions are less than $100,000 for individuals and $200,000 for other cases.
Reprieve from the Commissioner. In his July 6 letter, Commissioner Shulman said that in view of Congressional leaders' commitment to enact legislation to address the issue, and to provide the Congress that opportunity, IRS won't undertake any Code Sec. 6707A collection enforcement action through Sept. 30, 2009, on cases where the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for other taxpayers. However, because the penalty determination is related to the underlying transaction, and IRS can only determine the amount of tax benefit through examination, Commissioner Shulman said IRS would continue its examination on these cases and thus be able to identify cases meeting the collection suspension threshold.
Commissioner Shulman also reiterated that while his letter relates to certain taxpayers who were caught up in a penalty regime in a way that the legislation did not intend, the basic underlying premise of the statute applying severe penalties where taxpayers employ abusive tax shelters in an attempt to avoid paying tax remains “sound and critically important” to IRS.



§ 6707A Penalty for failure to include reportable transaction information with return.
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(a) WG&L Treatises Imposition of penalty.
Any person who fails to include on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay a penalty in the amount determined under subsection (b).
(b) WG&L Treatises Amount of penalty.
(1) WG&L Treatises In general.
Except as provided in paragraph (2), the amount of the penalty under subsection (a) shall be—
(A) $10,000 in the case of a natural person, and
(B) $50,000 in any other case.
(2) WG&L Treatises Listed transaction.
The amount of the penalty under subsection (a) with respect to a listed transaction shall be—
(A) $100,000 in the case of a natural person, and
(B) $200,000 in any other case.
(c) WG&L Treatises Definitions.
For purposes of this section —
(1) WG&L Treatises Reportable transaction.
The term “reportable transaction” means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion.
(2) Listed transaction.
The term “listed transaction” means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.
(d) Authority to rescind penalty.
(1) In general.
The Commissioner of Internal Revenue may rescind all or any portion of any penalty imposed by this section with respect to any violation if—
(A) the violation is with respect to a reportable transaction other than a listed transaction, and
(B) rescinding the penalty would promote compliance with the requirements of this title and effective tax administration.
(2) No judicial appeal.
Notwithstanding any other provision of law, any determination under this subsection may not be reviewed in any judicial proceeding.
(3) Records.
If a penalty is rescinded under paragraph (1), the Commissioner shall place in the file in the Office of the Commissioner the opinion of the Commissioner with respect to the determination, including—
(A) a statement of the facts and circumstances relating to the violation,
(B) the reasons for the rescission, and
(C) the amount of the penalty rescinded.
(e) Penalty reported to SEC.
In the case of a person—
(1) which is required to file periodic reports under section 13 or 15(d) of the Securities Exchange Act of 1934 or is required to be consolidated with another person for purposes of such reports, and
(2) which—
(A) is required to pay a penalty under this section with respect to a listed transaction,
(B) is required to pay a penalty under section 6662A with respect to any reportable transaction at a rate prescribed under section 6662A(c), or
(C) is required to pay a penalty under section 6662(h) with respect to any reportable transaction and would (but for section 6662A(e)(2)(B)) have been subject to penalty under section 6662A at a rate prescribed under section 6662A(c),
the requirement to pay such penalty shall be disclosed in such reports filed by such person for such periods as the Secretary shall specify. Failure to make a disclosure in accordance with the preceding sentence shall be treated as a failure to which the penalty under subsection (b)(2) applies.
(f) Coordination with other penalties.
The penalty imposed by this section shall be in addition to any other penalty imposed by this title.

Get ready for the Employment Tax Audit Initiative

The Employment Tax Audit Initiative (the Initiative), in which the IRS will audit 2,000 U.S. companies annually, commenced in February 2010.

The Initiative was originally announced in September 2009 and will provide data for the IRS's National Research Program (NRP) study of employment tax compliance.

This will mark the first such study conducted by the IRS since 1984. The IRS is expected to focus during the audits initiated pursuant to the Initiative on the following five employment tax issues:

1. Worker classification (employee vs. independent contractor). 2. Fringe benefits. 3. Officer's compensation. 4. Reimbursed expenses. 5. Non-filers. The Initiative is intended to help reduce the size of the tax gap—i.e., the difference between the tax the IRS estimates is due and the amount actually paid by taxpayers.

No more F-Bar reporting requirement

Announcement 2010-16, 2010-11 IRB, 02/26/2010,

Reference(s):

Full Text:

This Announcement suspends, for persons who are not United States citizens, United States residents, or domestic entities (corporations, partnerships, trusts, or estates), the requirement to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), for the 2009 and earlier calendar years.

In October 2008, the Internal Revenue Service published a revised FBAR form together with accompanying instructions that changed the definition of “United States person.” The IRS received numerous questions and comments from the public concerning the changed definition. In response, and to reduce the burden on the public, the IRS issued Announcement 2009-51, 2009-25 I.R.B. 1105, which directed people to refer to the definition of “United States person” in the July 2000 version of the FBAR instructions to determine if they had a filing obligation. This effectively suspended the filing of FBARs due on June 30, 2009, by persons who were not United States citizens, United States residents, or domestic entities. Announcement 2009-51 stated that additional FBAR guidance would be issued for subsequent filing years and invited public comments concerning the FBAR form and instructions.

Since the issuance of Announcement 2009-51, and receipt of a significant number of public comments, the Treasury Department has published proposed FBAR regulations under 31 CFR Part 103, as well as proposed revisions that clarify instructions for the FBAR (Form TD F 90-22.1). To provide taxpayers with guidance on who is required to file FBARs due on June 30, 2010, and in particular to provide immediate guidance to taxpayers on how to answer FBAR-related 2009 federal income tax return questions (e.g., Schedule B of Form 1040, the “Other Information” section of Form 1041, Schedule B of Form 1065, and Schedule N of Form 1120), the IRS and Treasury Department believe it is appropriate to provide the following administrative relief:

The requirement to file an FBAR due on June 30, 2010, is suspended for persons who are not United States citizens, United States residents, or domestic entities. Additionally, all persons may rely on the definition of “United States person” found in the July 2000 version of the FBAR instructions to determine if they have an FBAR filing obligation for the 2009 and earlier calendar years. The definition of “United States person” from the July 2000 version of the FBAR is:

United States Person The term “United States person” means (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.

This substitution of the definition of “United States person” applies only with respect to FBARs for the 2009 calendar year and, as originally provided in Announcement 2009-51, to earlier calendar years.

All other requirements of the 2008 version of the FBAR form and instructions, as modified by Notice 2010-23, remain in effect until changed by subsequent guidance issued by the Treasury Department, including the IRS.

Effect On Other Documents
Announcement 2009-51 is supplemented and superseded.

The principal author of this announcement is Emily M. Lesniak of the Office of Associate Chief Counsel (Procedure and Administration). For further information regarding this announcement, contact Emily M. Lesniak at (202) 622-4940 (not a toll-free call).