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2010-03-11T14:02:00.000-05:00

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

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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

2010-03-09T21:26:00.000-05:00

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

2010-03-05T13:03:00.000-05:00

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

2010-03-04T08:57:00.001-05:00

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

2010-03-03T09:08:00.001-05:00

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

2010-03-02T13:06:00.001-05:00

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).

Innocent Spouse case

2010-02-28T13:01:00.001-05:00

GREER v. COMM., Cite as 105 AFTR 2d 2010-XXXX, 02/17/2010
________________________________________
Winnie L. Greer, Petitioner-Appellant, v. Commissioner of Internal Revenue, Respondent-Appellee.
Case Information:
Code Sec(s):
Court Name: UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT,
Docket No.: No. 09-1420,
Date Argued: 01/20/2010
Date Decided: 02/17/2010.
Disposition:
HEADNOTE
.
Reference(s):
OPINION
ARGUED: Kenton L. Ball, SLONE & BENTON PSC, Lexington, Kentucky, for Appellant. Kenneth W. Rosenberg, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.
ON BRIEF: Kenton L. Ball, SLONE & BENTON PSC, Lexington, Kentucky, for Appellant. Kenneth W. Rosenberg, Jonathan S. Cohen, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.
UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT,
On Appeal from the United States Tax Court. No. 24062-06.
Before: SILER, MOORE, and CLAY, Circuit Judges.
OPINION
Judge: KAREN NELSON MOORE, Circuit Judge.
RECOMMENDED FOR FULL-TEXT PUBLICATION
Pursuant to Sixth Circuit Rule 206
File Name: 10a0044p.06
Petitioner Winnie L. Greer (“Mrs. Greer”) appeals a judgment of the U.S. Tax Court finding her ineligible for relief from joint and several liability for federal income tax deficiencies and additions to tax arising from disallowed investment credits claimed on her 1982 tax return and carryback refunds claimed for the previous three years. Mrs. Greer sought relief based on the tax code's innocent-spouse provision, 26 U.S.C. § 6015(b), and equitable-relief provision, § 6015(f). The Tax Court denied innocent-spouse relief because Mrs. Greer failed to discharge her duty to inquire into the benefits reflected in her and her husband's joint tax filings. The Tax Court denied equitable relief largely on the same basis. Because we cannot say that the Tax Court clearly erred or abused its discretion, we AFFIRM.
I. BACKGROUND
The Tax Court set forth the relevant facts, which the parties do not dispute:
At the time the petition was filed, petitioner resided in Kentucky.
Petitioner graduated from high school in Floyd County, Kentucky, in 1965. She then attended the University of Kentucky, for 2 years and transferred to Louisiana State University from where she graduated with a bachelor of arts degree in music in 1969. Petitioner also received a master's degree in music education from Marshall University in 1973. Petitioner did not pursue studies in economics, finance, or accounting in her formal education.
Petitioner married Daniel C. Greer [(“Mr. Greer”)] in 1967, and they remain married. Petitioner and Mr. Greer have two daughters, born in 1974 and in 1977. Mr. Greer is a licensed chemical engineer and was employed by Ashland Oil Co., Inc., from 1969 through July 1993.
From September 1969 through May 1972 petitioner was employed as a high school music teacher. After that she pursued graduate studies and raised her daughters. From 1975 to 1985 she acted as a part-time choir director at the Episcopal church where she and Mr. Greer became members sometime in 1982 and 1983.
In 1979 petitioner began a photography business. She specialized in wedding and portrait photography. She opened her first photography studio in late 1979 in the family home. Improvements were made to the home in 1982, and the structure remained petitioner's photography studio even after petitioner and her family moved their residence in 1986.
Throughout the years of her marriage up to and including the years in issue, petitioner relied upon Mr. Greer to manage their financial affairs. Mr. Greer did not conceal any financial activities from petitioner or mislead her with respect to those activities. However, he was the primary decisionmaker, and she relied upon him to direct their investments and make decisions regarding their finances and taxes.
In 1979 Mr. Greer and petitioner's father founded G & L Communications, Inc. (G & L), a closely held cable television business that operated in Boyd and Greenup Counties of Kentucky. G & L was taxed as an S corporation until the sale of its assets in November 1982. Petitioner and Mr. Greer each owned 61 shares of G & L stock. Petitioner was not active in G & L's management, nor was she an employee of G & L. In 1982 petitioner and Mr. Greer each continued to own 61 shares. They each received a cash distribution of $146,918.02 attributable to their respective portions of the proceeds of the sale. Thus their combined distribution from G & L was $293,836. Following the sale of G & L's assets in 1982, two identical Forms 1099-DIV, Statement For Receipts of Dividends and Distributions, were issued to petitioner and Mr. Greer, each reflecting a dividend distribution of $35,976, a capital gain distribution of $82,072, and a nontaxable distribution of $28,869 for a total distribution to each of $146,917.
Motivated by the anticipated income tax consequences of the G & L dividends and distributions, Mr. Greer invested in Madison Recycling Associates, Inc. (Madison). 1 The background of this transaction and its consequences are fully described in previous judicial opinions,Greer v. Commissioner [(Greer I), 93 T.C.M. (CCH) 1216, 2007 [TC Memo 2007-119] WL 1373821 (2007)],Madison Recycling Associates v. Commissioner , 295 F.3d 280 [90 AFTR 2d 2002-5132] (2d Cir. 2002), affg. [ 81 T.C.M. (CCH) 1496, 2001 [TC Memo 2001-85] WL 339433 (2001)], and Madison Recycling Associates v. Commissioner, [ 64 T.C.M. (CCH) 1063, 1992 [1992 RIA TC Memo ¶92,605] WL 277821 (1992)]. We simply note here that the result of those opinions is that respondent has assessed joint deficiencies in income tax and additions to tax against petitioner and Mr. Greer for the years 1979 through 1982. These deficiencies and additions to tax are the liabilities from which petitioner seeks section 6015 relief. The parties previously agreed that any request by petitioner for relief from joint and several liability under section 6015 would not be determined in the most recent Tax Court litigation reflected in [Greer I].
The 1982 joint income tax return for petitioner and Mr. Greer was prepared by John W. Artis, C.P.A. Mr. Artis advised Mr. Greer that because the tax benefits associated with Madison significantly exceeded the dollars invested, the Madison investment was “fairly aggressive.” Petitioner was not a party to those discussions and relied totally on Mr. Greer to make the decision to claim the tax benefits associated with Madison. Mr. Greer chose not to seek an opinion from Mr. Artis regarding the merits of the Madison transaction. In [Greer I], we found as fact that Mr. Greer expected that Madison would provide tax savings of approximately $1.75 for each dollar invested, and the record in this case is consistent with that finding.
On December 16, 1982, Mr. Greer signed a check for $50,000 payable to Madison and drawn on the joint checking account of petitioner and Mr. Greer to purchase a 5.5-percent limited partnership interest in Madison. This was the only checking account that petitioner and Mr. Greer had at the time. At the time of the Madison investment, petitioner knew Mr. Greer was purchasing an interest in Madison, and they briefly discussed the Madison transaction before the investment.
In March 1983 Madison filed a partnership return for the taxable year ended December 31, 1982, which reported a loss of $704,111 and a tax credit basis of $7 million. Petitioner and Mr. Greer filed joint individual income tax returns for the years 1979, 1980, 1981, and 1982. The Madison-related pass-through losses and investment credits reported on the joint returns for 1979, 1980, 1981, and 1982 were as follows:
Year Loss Investment Credit
1979 -0- $177.28
1980 $9,808 7,153.00
1981 3,146 4,128.00
1982 38,726 51,131.00
Of the $51,131 credit reported on the 1982 joint Federal income tax return, the net credit used in 1982 from Madison totaled $33,066 because $22,012 was eliminated in the alternative minimum tax computation, and only an additional $3,947 was allowed as a credit against alternative minimum tax. As a result, credits were available to be carried back to 1979, 1980, and 1981.
The distributions from G & L were reported on the 1982 joint return. Reflecting the listed ownership of 61 shares by each, the dividends and capital gain distributions reflected on the Federal income tax return were divided equally between Mr. Greer and petitioner on two separate Forms 740, Kentucky Individual Income Tax Return, which were filed using the status married filing separately. Petitioner signed both the Federal joint income tax return and her separate Kentucky form 740 for 1982. On February 28, 1983, petitioner and Mr. Greer signed a Form 1045, Application for Tentative Refund, for the years 1979, 1980, and 1981, seeking a refund totaling $39,534 as a result of carrying back to those years the credits from the Madison investment. Subsequently in August 1983 petitioner also signed a declaration relating to the Form 1045, which was requested by the Internal Revenue Service to confirm the execution of the original Form 1045. Petitioner discussed the execution of this declaration with Mr. Greer. In October 1983 three refund checks related to the Form 1045 were deposited into the joint account of petitioner and Mr. Greer. The total deposit resulting from these checks was $39,532. There is no explanation in the record for the discrepancy of $2 between this amount and the amount claimed on the Form 1045. Petitioner did not review the 1982 joint Federal income tax return, nor did she review the Form 1045. Petitioner did not ask Mr. Greer for details about the Madison investment, and she did not ask Mr. Greer or Mr. Artis any questions about the 1982 joint Federal income tax return or the Form 1045. However, petitioner was aware of the Madison investment.
Greer v. Comm'r (Greer II), 97 T.C.M. (CCH) 1075, 2009 [TC Memo 2009-20] WL 211433, at 1–3 (2009).
The Internal Revenue Service (“IRS”) began auditing Madison in 1984 and issued a notice of Final Partnership Administrative Adjustment (“FPAA”) disallowing the partnership's claimed tax benefits in 1987. Greer v. Comm'r (Greer III), 557 F.3d 688, 689 [103 AFTR 2d 2009-927] (6th Cir. 2009). 2 In 1988 Madison's partners challenged the FPAA on statute-of-limitations grounds, beginning what would be a fourteen-year legal battle. In 1992, the Greers filed amended returns for 1979–1981, remitting a check for $189,769 to cover the disallowed benefits plus interest and penalties. The Greers then brought suit in federal district court to recover those funds. The case was dismissed pending the outcome of the Madison litigation, but the court ordered the IRS in the meantime to refund the money, plus interest, which it did.
The Tax Court upheld the FPAA for Madison in 2001, and the Second Circuit affirmed in 2002. Madison, 81 T.C.M. (CCH) 1496 [TC Memo 2001-85] (2001), aff'd, 295 F.3d 280 [90 AFTR 2d 2002-5132] (2d Cir. 2002). On September 29, 2003, the IRS issued the Greers a notice of deficiency for $87,627 in tax and $544,125 in interest. The Greers challenged the amount, but both the Tax Court and the Sixth Circuit denied relief. Greer I, 93 T.C.M. (CCH) 1216 [TC Memo 2007-119], aff'd, Greer III, 557 F.3d 688 [103 AFTR 2d 2009-927]. On September 26, 2005, Mrs. Greer submitted Form 8857, requesting relief from the deficiency as an innocent spouse. On December 22, 2005, the IRS denied her request, finding that she knew of the Madison investment, that the money for the investment was drawn from the Greers' joint bank account, that she signed the Form 1045 requesting refunds, and that she received the benefit of those refunds. An appeals officer then denied her appeal, based on her failure to inquire into the claimed deductions:
[Mrs. Greer] acknowledges that she was aware of [Mr. Greer's] investment in [Madison] and that she did not inquire about the large deduction and credits claimed with respect to [Madison].... [T]he [Madison] loss deduction and [investment tax credit (“ITC”)/business energy investment credit (“BEIC”)] were large enough to put [Mrs. Greer] on notice (even given her limited involvement in the family financial affairs and educational background) that further inquiry was warranted to determine the legitimacy of those tax benefits. This is especially true given that the carryback of the ITC/BEIC from [Madison] to 1979, 1980 and 1981 essentially eliminated the tax the couple previously paid for these years, respectively.
Supplemental Appendix (“S.A.”) at 185. The appeals officer also determined that it would not be inequitable to hold Mrs. Greer liable, noting that her claim that the debt would wipe out over half of her net worth did not amount to economic hardship. The appeals officer noted that Mrs. Greer had declined a settlement offer of “fifty percent relief of the deficiency.” S.A. at 192.
Mrs. Greer then petitioned for review by the Tax Court. The Tax Court held a trial on January 29, 2008. In addition to the evidence summarized above, the court heard testimony that Mr. Greer never believed that the IRS would disallow his claimed losses, that Mrs. Greer generally felt she should not question Mr. Greer's financial decisions, and that Mrs. Greer probably would support Mr. Greer if she were granted innocent-spouse relief and the IRS collected all of his assets. The documentary record reflected that as of September 30, 2007, Mrs. Greer's assets totaled $2,134,256. As of June 2007, the IRS estimated the accrued liability at $1,456,420.
On January 29, 2009, the Tax Court entered judgment for the IRS, finding that Mrs. Greer did not qualify as an innocent spouse because she “should have at least made further inquiry about the extraordinary tax benefits reflected on the joint return for 1982.” Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. The court found that rather than having “no reason to know” of the tax understatement, as required for relief, she “chose not to know.” Id. The court next considered several factors in determining whether Mrs. Greer merited equitable relief. It found that she had failed to prove that economic hardship would result from full liability, that she had not shown that she had no reason to know of the understatement, that she had not received any unusual financial benefit from the money withheld, and that she had complied with the tax laws following the years in question. Id. at 7. Placing special emphasis on her failure to establish that she had no reason to know of the deficiency, the court denied relief.Id. Mrs. Greer timely filed this appeal.
II. ANALYSIS
A. Standard of Review
The Tax Court's decision that an individual does not qualify for innocent-spouse relief under § 6015(b) is a factual finding reviewed for clear error. Golden v. Comm'r, 548 F.3d 487, 495 [102 AFTR 2d 2008-7084] (6th Cir. 2008), cert. denied, 129 S. Ct. 1647 (2009). “[F]actual determinations are not clearly erroneous unless we are left with a definite and firm conviction that a mistake has been made.” Kearns v. Comm'r, 979 F.2d 1176, 1178 [70 AFTR 2d 92-6129] (6th Cir. 1992). The Tax Court's decision not to award equitable relief under § 6015(f) is reviewed for abuse of discretion. Cheshire v. Comm'r, 282 F.3d 326, 338 [89 AFTR 2d 2002-900] (5th Cir. 2002). The Tax Court “abuses its discretion when it relies on clearly erroneous findings of fact, ... improperly applies the law or uses an erroneous legal standard,” Tompkin v. Philip Morris USA, Inc., 362 F.3d 882, 891 (6th Cir. 2004), or “bases its ruling on ... a clearly erroneous assessment of the evidence,” Rentz v. Dynasty Apparel Indus., Inc., 556 F.3d 389, 395 (6th Cir. 2009).
B. Section 6015(b): Innocent-Spouse Relief
Pursuant to 26 U.S.C. § 6013(d)(3), taxpayers filing joint returns are jointly and severally liable for any understatement of tax. A taxpayer is excepted from this general rule if he or she can establish status as an “innocent spouse” under § 6015. A taxpayer who is still married, as Mrs. Greer is, bears the burden of establishing each of the following five elements to qualify for the innocent-spouse exception:
((A)) a joint return has been made for a taxable year;
((B)) on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return;
((C)) the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement;
((D)) taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement; and
((E)) the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election.
26 U.S.C. § 6015(b)(1) 3;Richardson v. Comm'r , 509 F.3d 736, 745–46 [100 AFTR 2d 2007-6970] (6th Cir. 2007). Here, the government agreed that Mrs. Greer meets elements (A) and (E). See Greer II, 2009 WL 211433 [TC Memo 2009-20], at 4. Mrs. Greer now makes arguments about element (B), contending under a nominee theory that the understatement is attributable only to Mr. Greer because he was the true owner of the sixty-one shares of G & L whose sale profits the Madison losses offset, and about element (D), noting that she did not benefit from the tax windfall and that liability would cause her economic hardship. The Tax Court, however, did not reach these issues, and they are not properly before us on appeal. The Tax Court denied relief entirely on the basis of element (C), the requirement that the taxpayer “did not know, and had no reason to know,” of the deficiency. The parties stipulate that Mrs. Greer had no actual knowledge of the tax deficiency. Pet'r Br. at 27. Thus, the sole issue that we confront in reviewing the denial of innocent-spouse relief here is whether Mrs. Greer established that she had “no reason to know” of the understatement resulting from the Madison losses.
Courts have interpreted the reason-to-know element to encompass two separate types of constructive knowledge. First, a spouse may have reason to know of an understatement reflected on the tax filings. Second, even if a spouse does not have reason to know of an understatement, he or she nonetheless may have reason to know of a possible understatement, giving rise to a duty to inquire into that possibility. Kistner v. Comm'r, 18 F.3d 1521, 1525 [73 AFTR 2d 94-1026] (11th Cir. 1994); Price v. Comm'r, 887 F.2d 959, 965 [64 AFTR 2d 89-5822] (9th Cir. 1989). As the Ninth Circuit has explained:
Even if a spouse is not aware of sufficient facts to give her reason to know of the substantial understatement, she nevertheless may know enough facts to put heron notice that such an understatement exists. Such notice is provided if the spouse knows sufficient facts such that a reasonably prudent taxpayer in her position would be led to question the legitimacy of the deduction. In such a scenario, a duty of inquiry arises, which, if not satisfied by the spouse, may result in constructive knowledge of the understatement being imputed to her.
Price, 887 F.2d at 965 (citations omitted). Here, the Tax Court invoked the latter ground, holding that Mrs. Greer knew enough to trigger a duty of inquiry, which she failed to discharge. Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. We therefore review whether the Tax Court clearly erred in determining that Mrs. Greer had a responsibility to inquire about a possible understatement on the Greers' 1982 tax-year filings.
1. Applicable Legal Test
As an initial matter, this case presents us the opportunity to decide what test should be used in determining whether a taxpayer had a reason to know of an understatement, or to suspect a possible understatement, resulting from disallowed deductions or credits. The Tax Court previously has stated that in all tax-deficiency cases—that is, in both omitted-income and erroneous-deduction cases—it will find that a taxpayer had reason to know of an understatement if he or she had knowledge of the transaction giving rise to the claimed tax benefits.See Bokum v. Comm'r , 94 T.C. 126, 146 (1990),aff'd on other grounds , 992 F.2d 1132 [72 AFTR 2d 93-5111] (11th Cir. 1993). We have followed this knowledge-of-the-transaction test in omitted-income cases. See Kosinski v. Comm'r, 541 F.3d 671, 681 [102 AFTR 2d 2008-5955] (6th Cir. 2008) (holding that taxpayer was not entitled to innocent-spouse relief when she knew of and played an active role in fraudulent transactions that allowed couple to under-report income); Richardson, 509 F.3d at 746 (same, when taxpayer knew of trust-scheme transactions that shielded couple's income from taxation); Purcell v. Comm'r, 826 F.2d 470, 473–74 [60 AFTR 2d 87-5516] (6th Cir. 1987) (denying relief from liability for omitted income when taxpayer knew of transaction giving rise to that income, and denying relief from liability for impermissible deductions when taxpayer could not prove that the deductions that her spouse had taken had no basis in law or fact, as required by an older version of the innocent-spouse provision). We have not applied the knowledge-of-the-transaction test to erroneous-deduction cases.
In Price v. Commissioner, the Ninth Circuit pointed out that the knowledge-of-the-transaction test is appropriate in omitted-income cases, but not in erroneous-deduction cases:
We decline to follow the tax court's literal superimposition of the legal standard developed in omission cases onto deduction cases in part because to do so would for the most part wipe out innocent spouse protection in the latter category. Such a standard may be workable in omission cases simply because the understatement is caused by includable income being left off a return. Therefore, it is considerably easier for a spouse to show that she was unaware of the transaction giving rise to the omission, and thus to qualify for relief. But because deductions are necessarily recorded, any spouse who at least reads the joint return will be put on notice that some transaction allegedly has occurred to give rise to the deduction. As a result, if knowledge of the transaction, operating of itself, were to bar relief, a spouse would be extremely hard-pressed ever to be able to satisfy the lack of actual and constructive knowledge element of section [6015(b)(1)] in a deduction case.
Thus, adoption of such an interpretation would do violence to the intent Congress clearly expressed when it expanded coverage of the provision to include relief for spouses from deficiencies caused by deductions for which there is no basis in fact or law. It would also hinder Congress's broader purpose in enacting section [6015(b)]—that of seeking to remedy an injustice—by giving the section an unduly narrow and restrictive reading.
Price, 887 F.2d at 963 n.9 (citations omitted). The court went on to hold that in erroneous-deduction cases, “[a] spouse has “reason to know” of the substantial understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the substantial understatement.” Id. at 965. It identified four factors to be considered in making that inquiry: (1) the spouse's education, (2) the spouse's involvement in the family's financial affairs, (3) the presence of unusual or lavish expenditures beyond the family's norm, and (4) the other spouse's evasiveness or deceitfulness concerning the family's finances.Id.
All circuits to have ruled on the Price approach have adopted its test for erroneous-deduction cases. See Hayman v. Comm'r, 992 F.2d 1256, 1261 [71 AFTR 2d 93-1763] (2d Cir. 1993);Reser v. Comm'r , 112 F.3d 1258, 1267 [79 AFTR 2d 97-2743] (5th Cir. 1997); Resser v. Comm'r, 74 F.3d 1528, 1536 [77 AFTR 2d 96-477] (7th Cir. 1996); Erdahl v. Comm'r, 930 F.2d 585, 589 [67 AFTR 2d 91-790] (8th Cir. 1991); Kistner v. Comm'r, 18 F.3d 1521, 1527 [73 AFTR 2d 94-1026] (11th Cir. 1994). One circuit has declined to decide the issue.See Doyle v. Comm'r , 94 F. App'x 949, 951–52 [93 AFTR 2d 2004-1864] (3d Cir. 2004) (unpublished opinion) (holding that the petitioner could not prevail under either the knowledge-of-the-transaction test or the Price test). In an unpublished order, a panel of this court applied the Price factors in an erroneous-deduction situation, but it did not citePrice. See Streck v. Comm'r , No. 98-1064, 1999 WL 427381 [83 AFTR 2d 99-3014], at 2–3 (6th Cir. June 16, 1999) (unpublished order); see also Alt, 101 F. App'x at 41 (citingStreck and applying the factors in an omitted-income case). In the instant case, the Tax Court appliedPrice , and the Commissioner has briefed the test's four factors.
Based on the persuasive logic of the Ninth Circuit and on our own case law, we now join our sister circuits in formally adopting the Price test for erroneous-deduction cases. The knowledge-of-the-transaction test leaves room for a taxpayer to claim innocent-spouse relief in omitted-income claims, because the understatement arises in such cases from information being left off a return, and the spouse otherwise may not have known or had reason to know that information. In erroneous-deduction cases, the understatement arises from information being included on the return, so a spouse who signs a tax return necessarily learns of the transaction. 4 The knowledge-of-the-transaction test writes the innocent-spouse provision out of the law in such cases. A more nuanced approach is thus required, especially given that an understatement arising from a deduction usually is not obvious from the face of a tax return. A taxpayer who knows how much money the family earned will know that tax has been understated if income is omitted from the return, as it is common knowledge that income is taxable. See Price, 887 F.2d at 963 n.9. By contrast, a taxpayer who is aware of an investment may or may not know that tax benefits claimed on its basis are impermissible, depending on that taxpayer's level of sophistication and how much he or she knows about the investment.See Reser , 112 F.3d at 1267 (“[I]n the 1980's, it was common knowledge that investors could legally obtain large tax benefits through clever investment strategies.”). The Price test takes account of this difference.
The Price test also is consistent with our own binding case law. In Shea v. Commissioner, 780 F.2d 561 [57 AFTR 2d 86-625] (6th Cir. 1986), we applied a context-specific test under which a taxpayer's reason to know of an understatement depends on “(1) the circumstances which face the [taxpayer]; and (2) whether a reasonable person in the same position would infer that omissions or erroneous deductions had been made.”Id. at 565–66. In establishing this test, we relied on Sanders v. United States, 509 F.2d 162, 167 [35 AFTR 2d 75-935] (5th Cir. 1975), which set out three of the four factors later adopted by the Ninth Circuit in Price. Shea, 780 F.2d at 565. The Price test provides a helpful way of guiding the totality-of-the-circumstances inquiry that we established for innocent-spouse cases years ago inShea.
While the Price factors are used to determine whether a spouse had reason to know of an understatement, they may also be employed to determine whether a spouse had a duty of inquiry. Park, 25 F.3d at 1293;Kistner , 18 F.3d at 1525; Erdahl, 930 F.2d at 590–91. In duty-of-inquiry cases, courts have also considered whether the tax returns set forth deductions or credits large enough, relative to the size of the underlying investment or of reported income, to prod a reasonable taxpayer into further investigation. See Reser, 112 F.3d at 1267–68, 1269; Friedman v. Comm'r, 53 F.3d 523, 531 [75 AFTR 2d 95-1974] (2d Cir. 1995); Park, 25 F.3d at 1298;Price , 887 F.2d at 961.
2. Application
The Tax Court held that Mrs. Greer had a duty to inquire into the legitimacy of the tax benefits claimed on the basis of the Madison investment:
Three of the four Price factors would support the conclusion that petitioner should have at least made further inquiry about the extraordinary tax benefits reflected on the joint return for 1982. She knew there was substantial additional income, yet she signed forms reflecting tax refunds generated in the years 1979 through 1981 as a result of the reporting of the 1982 Madison investment. Almost $40,000 in refunds was deposited into the same joint checking account on which the check of $50,000 for the Madison investment was drawn. These refunds were in addition to tax savings of over $33,000 sought through the aggressive reporting of the Madison transaction on the joint return for 1982. Petitioner chose not to know; she was not deceived or misled.
Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. We review thePrice factors to determine whether the Tax Court clearly erred in holding that a reasonable person with Mrs. Greer's background and in her circumstances would have known to inquire into the stated tax liability.
((1)) Education: Mrs. Greer has a master's degree in music education, but she has no specific education in financial affairs. The Tax Court emphasized that she is “an intelligent, well-educated person” and weighed this factor against her. Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. The cases are clear, however, that it is financial education, not education in general, that matters. See Reser, 112 F.3d at 1268 (noting that taxpayer with law degree had an education that “albeit advanced, provided her with no special knowledge of complex tax issues”);Resser , 74 F.3d at 1537 (holding that education factor favored spouse who had master's degree in medical communications because her training gave her “no special understanding” of finance); Alt, 101 F. App'x at 41 (evaluating taxpayer with master's degree in education and noting that “courts have examined the type of education received, specifically, whether the education provided a special knowledge of complex tax issues” (internal quotation marks omitted)); Korchak, 2006 WL 2506626 [TC Memo 2006-185], at 22 (in granting relief, emphasizing that taxpayer with Ph.D. in physiology had no financial training).
((2)) Involvement in Family Finances: The Tax Court observed that Mrs. Greer knew of the G & L distributions, signed tax returns and the Form 1045 request for refunds, and shared a joint checking account with Mr. Greer from which the Madison investment was made. Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. These facts, however, mainly go to Mrs. Greer's awareness of the Madison transaction. The facts relevant to her involvement in family finances are her management of her photography business and her collection of that business's records at tax time. This level of involvement in family finances is comparable to or less than that of taxpayers found to qualify for innocent-spouse relief by other courts, whose cases constitute persuasive precedent. See Reser, 112 F.3d at 1268 (taxpayer worked full time as a lawyer and “was the family's sole source of financial support,” but was not significantly involved in finances of husband's professional corporation); Resser, 74 F.3d at 1538 (taxpayer served as family check-writer); Price, 887 F.2d at 965 (taxpayer paid household expenses and mortgage);Sanders , 509 F.2d at 166 (taxpayer balanced husband's checkbooks and typed business letters for him);cf. Stevens v. Comm'r , 872 F.2d 1499, 1501 [64 AFTR 2d 89-5589], 1507 (11th Cir. 1989) (taxpayer who served as officer and employee of husband's corporations and frequently was present for business discussions was not entitled to relief). That said, we note that Mrs. Greer was probably familiar enough with basic budgeting and accounting to understand representations made on a tax return, even if the ultimate legitimacy of sheltering income was beyond her experience.
((3)) Lavish or Unusual Expenses: While observing that the Greers “lived a very comfortable lifestyle during 1982 and for all the years thereafter,” the Tax Court found no “extravagant change in petitioner's lifestyle,” the relevant consideration. Greer II, 2009 WL 211433 [TC Memo 2009-20], at 6. This finding was correct and is not disputed.See Resser , 74 F.3d at 1540 (citing the relative difference from the family's ordinary standard of living);Kistner , 18 F.3d at 1525 (same);Sanders , 509 F.2d at 168 (same).
((4)) Spouse's Evasiveness or Deceit: Mrs. Greer argues that Mr. Greer “took advantage” of her, Pet'r Br. at 43, 55; Reply Br. at 12, but that argument cannot be reconciled with her position that she purposely left him in charge of all financial matters. The Tax Court correctly found that Mr. Greer was neither deceitful nor evasive regarding the family's finances. The Tax Court weighed this factor against Mrs. Greer, which is consistent with the approach of the courts of appeals. See, e.g., Friedman, 53 F.3d at 532 (husband concealed enormous financial losses). 5
We think the Tax Court's finding that three of the four factors weighed against Mrs. Greer was incorrect. These factors cannot be discussed in an abstract sense or tallied and set against each other as on a ledger. We must ask whether a reasonable person with the background that emerges from our review of the Price factors should have raised a question, upon reviewing the tax filings, about the extent of the benefits claimed therein. See Shea, 780 F.2d at 565 (quoting Restatement (Second) of Agency § 9, cmt. d (1958) (“A person has reason to know of a fact if he had information from which a person of ordinary intelligence, or of the superior intelligence which such person may have, would infer that the fact in question exists or that there is such a substantial chance of its existence that, if exercising reasonable care with reference to the matter in question, his action would be predicated upon the assumption of its possible existence.”)). Here, we must determine whether Mrs. Greer, knowing that she and her husband earned additional income in 1982 from the G & L sale, should have questioned how they nonetheless could claim $33,000 in tax savings for 1982 and $40,000 in carryback refunds for 1979, 1980, and 1981 based on a $50,000 investment.
Having reviewed the record, we cannot say that the Tax Court clearly erred in finding that Mrs. Greer should have inquired into the favorable tax benefits thrown off by the Madison investment. First, the low level of taxes owed relative to the income reported on the 1982 return should have given Mrs. Greer pause. The front page of the 1982 return reflects an adjustable gross income, after deducting $38,726 in losses attributable to the Madison investment, of $183,340. S.A. at 38. The second page of the return reflects a total tax liability of $32,742. S.A. at 39. Although the Greers submitted a check for $10,265 to the IRS (the amount due in excess of the tax withheld), the benefits they claimed resulted in an average tax rate of only 17.86% in a year when their income put them in the highest marginal tax bracket, 50% for income over $85,600.See Tax Foundation, U.S. Federal Individual Income Tax Rates History, Income Years 1913–2010, at 8,available at http://www.taxfoundation.org/publications/show/151.html. Second, the Form 1045 that the Greers filed, carrying Madison-based credits back to 1979 through 1981 and claiming refunds of $33,000, should have raised a question in Mrs. Greer's mind. In addition to reducing their tax burden in 1982, the Greers were able to zero out their income tax for two of the three preceding years. These reductions are reflected clearly on the first page of the Form 1045, at Line 21 in side-by-side columns labeled “Before carryback” and “After carryback,” just above Mrs. Greer's signature. S.A. at 60. Income tax was reduced from $9,654 to $0 for 1979, from $22,161 to $1,363 for 1980, and from $9,082 to $0 for 1981. 6 Over these three years, the couple's adjusted gross income totaled over $220,000. These figures provided the Tax Court adequate grounds for finding that Mrs. Greer, who had sufficient familiarity with financial matters to understand the claimed tax benefits and whose husband neither deceived nor abused her, 7 at least should have inquired into the propriety of the Madison benefits. See Hayman, 992 F.2d at 1258–59, 1262 (holding that deductions that reduced tax liability to zero for two years and to near zero for a third year put taxpayer on notice of a possible understatement).
Mrs. Greer contends that a recent Tax Court case,Korchak v. Commissioner , 92 T.C.M. (CCH) 199, 2006 [TC Memo 2006-185] WL 2506626 (2006), requires the opposite conclusion. Helen Korchak's husband invested $75,000 in Madison at the same time as Mr. Greer. On their 1982 joint return, the Korchaks claimed $58,000 in losses and $114,000 in credits when their salaries totaled $481,000 and their adjusted gross income totaled $310,000. The IRS later issued a notice of deficiency in the amount of $140,000. Mrs. Korchak had a Ph.D. in physiology and worked as a research scientist at a university, but she had no financial coursework, left financial decisions to her husband, and took primary responsibility for raising their three children. She knew that her husband made investments for the family, but she did not know what those investments were, although he was never deceitful or evasive about them. She signed the tax return at her husband's direction without reading it. The Tax Court found that Mrs. Korchak had no reason to know of the Madison understatement and, further, no duty to inquire into a possible understatement. Id. at 21–24.
The facts of Korchak are remarkably similar to those of the instant case. Nonetheless, the Tax Court here distinguished Korchak on three bases: (1) Mrs. Korchak did not even know her husband had made the Madison investment; (2) Mrs. Korchak had no practical business experience; and (3) the Madison benefits did not stand out on the Korchaks' tax return because they sat among other losses and credits. We find the first and third distinctions persuasive. It is clear that Mrs. Greer's knowledge of the Madison transaction was not itself enough to put her on notice of a possible understatement; to hold otherwise would be to revert to the knowledge-of-the-transaction test. However, the fact that her husband informed her of the investment, that the amount of the investment was evident from the check drawn on their joint bank account, and that Madison was the lone entry on Schedule E, Part II 8 and the only investment that could have resulted in the regular and business energy investment credits claimed on Form 3468 9 should have helped Mrs. Greer connect the dots in ways that Mrs. Korchak did not. This was enough, the Tax Court fairly found, to cause a reasonable person in Mrs. Greer's situation to question how a $50,000 investment in Madison could have produced such a low tax rate in the year of the family's highest reported income and simultaneously almost completely wipe out their taxes for the previous three years.
The main thrust of Mrs. Greer's argument is that she left financial decisions to Mr. Greer and had no reason to suspect his errors. Several courts, including our own, have held that being a homemaker cannot alone relieve a spouse of joint and several tax liability on a joint return and that one spouse cannot bury his or her head in the sand or turn a blind eye to the other's accounting. Shea, 780 F.2d at 566;Kistner , 18 F.3d at 1525; Stevens, 872 F.2d at 1505–06; Doyle, 94 F. App'x at 952. Here, the Tax Court found that Mrs. Greer did just that, failing to question her husband even when the documents she signed should have pushed her to do so. Were this de novo review, we might view the matter differently. For the reasons we have discussed, however, we cannot say that the Tax Court committed clear error in denying innocent-spouse relief based on the reason-to-know element of 26 U.S.C. § 6015(b)(1).
C. Section 6015(f): Equitable Relief
Mrs. Greer also challenges the Tax Court's denial of discretionary relief under 26 U.S.C. § 6015(f). That section of the tax code provides that if a still-married taxpayer does not meet all the requirements under § 6015(b), the IRS nonetheless has discretion to grant relief from liability if, “taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either).” 26 U.S.C. § 6015(f). IRS regulations provide that the following nonexclusive list of factors should be considered in determining whether to grant § 6015(f) relief: (1) marital status, (2) economic hardship that would result absent relief, (3) knowledge or reason to know of the item giving rise to the deficiency, (4) any legal obligation of the nonrequesting spouse to pay the income tax liability pursuant to a divorce agreement, (5) whether the requesting spouse significantly benefited from the understatement, (6) the requesting spouse's compliance with income tax laws since the years in question, and (7) other factors, such as spousal abuse and poor mental and physical health. Rev. Proc. 2003-61, § 4.03.
Here, the Tax Court found that factors (1), (4), and (7) were inapplicable or neutral. Greer II, 2009 WL 211433 [TC Memo 2009-20], at 7. It also found that Mrs. Greer's failure to establish economic hardship and the fact that she had reason to know of a possible understatement weighed against relief, while the fact that she did not obtain “an unusual financial benefit” from the claimed tax benefits and her consistent compliance with tax laws since 1982 weighed in favor of relief. Id. Noting that the applicable factors split two-to-two, the Tax Court then concluded that its finding that Mrs. Greer had reason to know of a possible understatement “pushes the scale against granting relief under section 6015(f).” Id. Mrs. Greer now argues that the Tax Court abused its discretion with respect to its findings on economic hardship and reason to know. We have already determined that the Tax Court did not err in concluding that Mrs. Greer had reason to suspect a possible understatement of taxes. Therefore, we will not reverse its ruling unless its conclusion as to economic hardship was based on clearly erroneous factual findings or amounted to a clearly erroneous assessment of the evidence. Rentz, 556 F.3d at 395; Tompkin, 362 F.3d at 891.
The Tax Court found that Mrs. Greer “has failed to establish that respondent's determination regarding a lack of economic hardship was incorrect.” Greer II, 2009 WL 211433 [TC Memo 2009-20], at 7. The record evidence supports this conclusion. As of June 30, 2007, the total liability, including accruing penalties and interest, was $1,456,420. S.A. at 19 (Stipulation of Facts at 51). The IRS now estimates the liability at over $1.5 million. Resp't Br. at 61. As of September 30, 2007, Mrs. Greer's assets totaled $2,134,256; of that amount, $869,048 was attributable to an inheritance from her parents, $575,332 to her individual retirement account, and $220,000 to her share of the family home. See S.A. at 25, 181. Mrs. Greer estimated the tax liability on her retirement account to be $161,000. Pet'r Br. at 57. Mr. Greer testified at the Tax Court trial that his assets totaled $214,000. Id. at 58. Subtracting Mrs. Greer's expected retirement taxes from her assets, the couple as of late 2007/early 2008 had $2,187,256 to satisfy a tax debt now estimated at over $1.5 million. On this accounting, it would seem that Mrs. Greer could still pay ““reasonable basic living expenses”” after satisfying the liability. Comm'r v. Neal, 557 F.3d 1262, 1278 [103 AFTR 2d 2009-801] (11th Cir. 2009) (quoting Treas. Reg. § 301.6343-1(b)(4) to define economic hardship).
Mrs. Greer makes two responses to this analysis. She first notes that the stock and real estate markets plummeted after the Tax Court trial in 2008. She estimates a thirty-percent decline in the family's assets, putting their net worth at $1,674,000. Pet'r Br. at 58. As the Commissioner points out, however, the thirty-percent figure is a mere estimate; there is no evidence in the record of the actual decline in value of the Greers' holdings. Resp't Br. at 59. Moreover, if this court could reverse an economic-hardship determination based on subsequent fluctuations in the market, “[f]indings of ability to pay ... always would be subject to reversal based on changes in economic conditions and the vagaries of timing.”Id. Furthermore, Mrs. Greer could have avoided this market-decline problem had she paid the liability to the IRS years ago and then litigated her innocence.See Resp't Br. at 61 (citing Rev. Proc. 2005-18). Mrs. Greer responds that she did not know of a tax problem that would affect her until 2003, when the IRS sent her the deficiency notice. We find this unconvincing, however, as Mr. and Mrs. Greer remitted to the IRS $189,769 to cover the alleged liability in 1992 and subsequently filed suit to recover the funds (on a basis other than innocent-spouse relief). See Greer III, 557 F.3d at 689. It is not credible that Mrs. Greer could have believed that the dispute concerned her husband only and missed that the disallowance of benefits would affect her, as well.
Mrs. Greer next argues that even if her net worth is large enough to satisfy the outstanding liability, she cannot do so without wiping out her personal retirement account and family inheritance. Pet'r Br. at 58–59. Now 62 years old, she is nearing retirement and had expected to rely on her savings to support her. See id. at 60. The Tax Court has taken such situational factors into account in previous cases.See, e.g., Campbell v. Comm'r , 91 T.C.M. (CCH) 735, 2006 [TC Memo 2006-24] WL 345827, at 9 (2006) (granting equitable relief to a woman “in her sixties with a limited number of working years” who “ha[d] only a small retirement account, her home, and a 1993 Ford explorer”). We are indeed sympathetic to Mrs. Greer's situation, and again might decide her case differently had we the opportunity to rule in the first instance rather than on deferential review. But we cannot say that the prospect of financial ruin is so plain on the record that the Tax Court abused its discretion in denying equitable relief. We therefore must affirm.
III. CONCLUSION
This is a close case, and ultimately we are guided by the deferential standard of review applicable to factual findings and discretionary decisions of the Tax Court. As we can find neither clear error nor abuse of discretion in the Tax Court's rulings, we AFFIRM the denial of both innocent-spouse and equitable relief.
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1
Madison was a limited partnership formed to lease equipment for use in recycling scrap polystyrene, a type of plastic, which could then be sold on the open market.Korchak v. Comm'r , 92 T.C.M. (CCH) 199, 2006 [TC Memo 2006-185] WL 2506626, at 3 (2006). The partnership's offering memorandum warned that it was a tax shelter. Greer v. Comm'r (Greer I), 93 T.C.M. (CCH) 1216, 2007 [TC Memo 2007-119] WL 1373821, at 3 (2007).
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2
Greer III concerned the period of time over which a continuing-interest penalty could be assessed against Mr. and Mrs. Greer.
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3
Section 6015(b)(1) was formerly codified in almost identical terms at 26 U.S.C. § 6013(e)(1)(D). Cases interpreting the old provision are therefore relevant. Alt v. Comm'r, 101 F. App'x 34, 39 [93 AFTR 2d 2004-2561] (6th Cir. 2004) (unpublished opinion).
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4
A taxpayer who signs a tax return will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents. Park v. Comm'r, 25 F.3d 1289, 1299 [74 AFTR 2d 94-5231] (5th Cir. 1994) (citing Hayman, 992 F.2d at 1262);see also Schneller v. Comm'r , No. 96-1910, 1997 WL 720388 [80 AFTR 2d 97-7707], at 3 (6th Cir. Nov. 10, 1997) (unpublished opinion) (rejecting taxpayers' argument that penalty for understatement of tax attributable to negligence was improper because they relied on their accountant to prepare their return and did not read it before signing).
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5
We note, however, that some courts have treated evasiveness as a warning sign of a possible understatement. See, e.g., Stevens, 872 F.2d at 1507 (“Mr. Stevens' evasiveness should have prompted Mrs. Stevens to question Mr. Stevens' activities and the validity of the items reported on the tax returns.”). If that approach is sound, then a taxpayer's spouse's lack of evasiveness should weigh in the taxpayer's favor.
________________________________________
6
The figures for total tax liability, which added self-employment taxes to income taxes and which is reflected on Line 27, also reflect these stark reductions: total tax fell from $9,654 to $0 for 1979, from $22,398 to $1,600 for 1980, and from $9,493 to $411 for 1981. S.A. at 60.
________________________________________
7
See Kistner, 18 F.3d at 1526–27 (granting innocent-spouse relief when husband denied wife access to financial records and threatened physical violence if she questioned the tax returns); Erdahl, 930 F.2d at 587–88, 591 (granting innocent-spouse relief when husband kept wife on a strict allowance, refused her access to credit cards, cheated on her with other women, and twice left her and their children).
________________________________________
8
“Income or Losses from Partnerships, Estates or Trusts, or Small Business Corporations.” S.A. at 47.
________________________________________
9
“Computation of Investment Credit.” S.A. at 52.

§ 6015 Relief from joint and several liability on joint return.
________________________________________
(a) In general.
Notwithstanding section 6013(d)(3) —
(1) an individual who has made a joint return may elect to seek relief under the procedures prescribed under subsection(b) , and
(2) if such individual is eligible to elect the application of subsection (c) , such individual may, in addition to any election under paragraph (1) , elect to limit such individual's liability for any deficiency with respect to such joint return in the manner prescribed under subsection (c) .

Any determination under this section shall be made without regard to community property laws.
(b) WG&L Treatises Procedures for relief from liability applicable to all joint filers.
(1) WG&L Treatises In general.
Under procedures prescribed by the Secretary, if—
(A) a joint return has been made for a taxable year;
(B) on such return there is an understatement of tax attributable to erroneous items of one individual filing the joint return;
(C) the other individual filing the joint return establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement,
(D) taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement, and
(E) the other individual elects (in such form as the Secretary may prescribe) the benefits of this subsection not later than the date which is 2 years after the date the Secretary has begun collection activities with respect to the individual making the election,

then the other individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such understatement.
(2) Apportionment of relief.
If an individual who, but for paragraph (1)(C) , would be relieved of liability under paragraph (1) , establishes that in signing the return such individual did not know, and had no reason to know, the extent of such understatement, then such individual shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent that such liability is attributable to the portion of such understatement of which such individual did not know and had no reason to know.
(3) Understatement.
For purposes of this subsection , the term “understatement” has the meaning given to such term by section 6662(d)(2)(A) .
(c) WG&L Treatises Procedures to limit liability for taxpayers no longer married or taxpayers legally separated or not living together.
(1) In general.
Except as provided in this subsection, if an individual who has made a joint return for any taxable year elects the application of this subsection, the individual's liability for any deficiency which is assessed with respect to the return shall not exceed the portion of such deficiency properly allocable to the individual under subsection (d) .
(2) Burden of proof.
Except as provided in subparagraph (A)(ii) or (C) of paragraph (3) , each individual who elects the application of this subsection shall have the burden of proof with respect to establishing the portion of any deficiency allocable to such individual.
(3) Election.
(A) Individuals eligible to make election.
(i) In general. An individual shall only be eligible to elect the application of this subsection if—
(I) at the time such election is filed, such individual is no longer married to, or is legally separated from, the individual with whom such individual filed the joint return to which the election relates; or
(II) such individual was not a member of the same household as the individual with whom such joint return was filed at any time during the 12- month period ending on the date such election is filed.
(ii) Certain taxpayers ineligible to elect. If the Secretary demonstrates that assets were transferred between individuals filing a joint return as part of a fraudulent scheme by such individuals, an election under this subsection by either individual shall be invalid (and section 6013(d)(3) shall apply to the joint return).
(B) Time for election. An election under this subsection for any taxable year may be made at any time after a deficiency for such year is asserted but not later than 2 years after the date on which the Secretary has begun collection activities with respect to the individual making the election.
(C) Election not valid with respect to certain deficiencies. If the Secretary demonstrates that an individual making an election under this subsection had actual knowledge, at the time such individual signed the return, of any item giving rise to a deficiency (or portion thereof) which is not allocable to such individual under subsection (d) , such election shall not apply to such deficiency (or portion). This subparagraph shall not apply where the individual with actual knowledge establishes that such individual signed the return under duress.
(4) Liability increased by reason of transfers of property to avoid tax.
(A) In general. Notwithstanding any other provision of this subsection , the portion of the deficiency for which the individual electing the application of this subsection is liable (without regard to this paragraph ) shall be increased by the value of any disqualified asset transferred to the individual.
(B) Disqualified asset. For purposes of this paragraph —
(i) In general. The term “disqualified asset” means any property or right to property transferred to an individual making the election under this subsection with respect to a joint return by the other individual filing such joint return if the principal purpose of the transfer was the avoidance of tax or payment of tax.
(ii) Presumption.
(I) In general. For purposes of clause (i) , except as provided in subclause (II) , any transfer which is made after the date which is 1 year before the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals is sent shall be presumed to have as its principal purpose the avoidance of tax or payment of tax.
(II) Exceptions. Subclause (I) shall not apply to any transfer pursuant to a decree of divorce or separate maintenance or a written instrument incident to such a decree or to any transfer which an individual establishes did not have as its principal purpose the avoidance of tax or payment of tax.
(d) Allocation of deficiency.
For purposes of subsection (c) —
(1) In general.
The portion of any deficiency on a joint return allocated to an individual shall be the amount which bears the same ratio to such deficiency as the net amount of items taken into account in computing the deficiency and allocable to the individual under paragraph (3) bears to the net amount of all items taken into account in computing the deficiency.
(2) Separate treatment of certain items.
If a deficiency (or portion thereof) is attributable to—
(A) the disallowance of a credit; or
(B) any tax (other than tax imposed by section 1 or 55 ) required to be included with the joint return,

and such item is allocated to one individual under paragraph (3) , such deficiency (or portion) shall be allocated to such individual. Any such item shall not be taken into account under paragraph (1) .
(3) Allocation of items giving rise to the deficiency.
For purposes of this subsection —
(A) In general. Except as provided in paragraphs (4) and (5) , any item giving rise to a deficiency on a joint return shall be allocated to individuals filing the return in the same manner as it would have been allocated if the individuals had filed separate returns for the taxable year.
(B) Exception where other spouse benefits. Under rules prescribed by the Secretary, an item otherwise allocable to an individual under subparagraph (A) shall be allocated to the other individual filing the joint return to the extent the item gave rise to a tax benefit on the joint return to the other individual.
(C) Exception for fraud. The Secretary may provide for an allocation of any item in a manner not prescribed by subparagraph (A) if the Secretary establishes that such allocation is appropriate due to fraud of one or both individuals.
(4) Limitations on separate returns disregarded.
If an item of deduction or credit is disallowed in its entirety solely because a separate return is filed, such disallowance shall be disregarded and the item shall be computed as if a joint return had been filed and then allocated between the spouses appropriately. A similar rule shall apply for purposes of section 86 .
(5) Child's liability.
If the liability of a child of a taxpayer is included on a joint return, such liability shall be disregarded in computing the separate liability of either spouse and such liability shall be allocated appropriately between the spouses.
(e) Petition for review by tax court.
(1) In general.
In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply , or in the case of an individual who requests equitable relief under subsection (f) —
(A) In general. In addition to any other remedy provided by law, the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section if such petition is filed—
(i) at any time after the earlier of—
(I) the date the Secretary mails, by certified or registered mail to the taxpayer's last known address, notice of the Secretary's final determination of relief available to the individual, or
(II) the date which is 6 months after the date such election is filed or request is made with the Secretary, and
(ii) not later than the close of the 90th day after the date described in clause (i)(I).
(B) Restrictions applicable to collection of assessment.
(i) In general. Except as otherwise provided in section 6851 or 6861 , no levy or proceeding in court shall be made, begun, or prosecuted against the individual making an election under subsection (b) or (c) or requesting equitable relief under subsection (f) for collection of any assessment to which such election or request relates until the close of the 90th day referred to in subparagraph (A)(ii) , or, if a petition has been filed with the Tax Court under subparagraph (A) , until the decision of the Tax Court has become final. Rules similar to the rules of section 7485 shall apply with respect to the collection of such assessment.
(ii) Authority to enjoin collection actions. Notwithstanding the provisions of section 7421(a) , the beginning of such levy or proceeding during the time the prohibition under clause (i) is in force may be enjoined by a proceeding in the proper court, including the Tax Court. The Tax Court shall have no jurisdiction under this subparagraph to enjoin any action or proceeding unless a timely petition has been filed under subparagraph (A) and then only in respect of the amount of the assessment to which the election under subsection (b) or (c) relates or to which the request under subsection (f) relates.
(2) Suspension of running of period of limitations.
The running of the period of limitations in section 6502 on the collection of the assessment to which the petition under paragraph (1)(A) relates shall be suspended—
(A) for the period during which the Secretary is prohibited by paragraph (1)(B) from collecting by levy or a proceeding in court and for 60 days thereafter, and
(B) if a waiver under paragraph (5) is made, from the date the claim for relief was filed until 60 days after the waiver is filed with the Secretary.
(3) Limitation on Tax Court jurisdiction.
If a suit for refund is begun by either individual filing the joint return pursuant to section 6532 —
(A) The Tax Court shall lose jurisdiction of the individual's action under this section to whatever extent jurisdiction is acquired by the district court or the United States Court of Federal Claims over the taxable years that are the subject of the suit for refund, and
(B) the court acquiring jurisdiction shall have jurisdiction over the petition filed under this subsection .
(4) Notice to other spouse.
The Tax Court shall establish rules which provide the individual filing a joint return but not making the election under subsection (b) or (c) or the request for equitable relief under subsection (f) with adequate notice and an opportunity to become a party to a proceeding under either such subsection.
(5) Waiver.
An individual who elects the application of subsection (b) or (c) or who requests equitable relief under subsection (f) (and who agrees with the Secretary's determination of relief) may waive in writing at any time the restrictions in paragraph (1)(B) with respect to collection of the outstanding assessment (whether or not a notice of the Secretary's final determination of relief has been mailed).
(f) WG&L Treatises Equitable relief.
Under procedures prescribed by the Secretary, if—
(1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either); and
(2) relief is not available to such individual under subsection (b) or (c) ,
the Secretary may relieve such individual of such liability.
(g) Credits and refunds.
(1) In general.
Except as provided in paragraphs (2) and (3) , notwithstanding any other law or rule of law (other than section 6511 , 6512(b) , 7121 , or 7122 ), credit or refund shall be allowed or made to the extent attributable to the application of this section .
(2) Res judicata.
In the case of any election under subsection (b) or (c) or of any request for equitable relief under subsection (f) , if a decision of a court in any prior proceeding for the same taxable year has become final, such decision shall be conclusive except with respect to the qualification of the individual for relief which was not an issue in such proceeding. The exception contained in the preceding sentence shall not apply if the court determines that the individual participated meaningfully in such prior proceeding.
(3) Credit and refund not allowed under subsection (c) .
No credit or refund shall be allowed as a result of an election under subsection (c) .
(h) Regulations.
The Secretary shall prescribe such regulations as are necessary to carry out the provisions of this section , including—
(1) regulations providing methods for allocation of items other than the methods under subsection (d)(3) ; and
(2) regulations providing the opportunity for an individual to have notice of, and an opportunity to participate in, any administrative proceeding with respect to an election made under subsection (b) or (c) or a request for equitable relief made under subsection (f) by the other individual filing the joint return.

no negligence when law is not clear

2010-02-24T09:16:00.001-05:00

This case is worth saving because it makes the conclusion that "reasonable basis" standard is met where the law is unclear. That is an argument that can be made in a host of cases.

Karl L. Matthies, et ux. v. Commissioner, 134 T.C. No. 6, Code Sec(s) 61; 402; 6662.
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KARL L. MATTHIES AND DEBORAH MATTHIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s): 61; 402; 6662
Docket: Docket No. 22196-07.

Date Issued: 02/22/2010

Judge: Opinion by THORNTON
A return that has a “reasonable basis” is not negligent. Sec. 1.6662-3(b)(1), Income Tax Regs. The “reasonable basis” standard is “significantly higher than not frivolous or not 12 (...continued) and (3) that the “Annual Reserve Increase” was $305,866.76. Petitioners' own brief indicates that at the end of policy year 2, Hartford Life's reserves in the insurance policy were $1,035,030. Petitioners have offered no explanation why the interpolated terminal reserve value was purportedly only $305,866.74 in the light of their representation that Hartford Life maintained a reserve of $1,035,030. patently improper.” Sec. 1.6662-3(b)(3), Income Tax Regs. This standard is satisfied if the return position is reasonably based on various types of enumerated authorities, including statutory provisions, regulations, revenue rulings, and notices published by the IRS, taking into account the relevance and persuasiveness of the authorities and subsequent developments. Secs. 1.6662- 3(b)(3), 1.6662-4(d)(3)(iii), Income Tax Regs. The “reasonable basis” standard is less stringent than the “substantial authority” standard (which entails “an objective standard involving an analysis of the law and application of the law to relevant facts”), which in turn is less stringent than the “more likely than not standard” (which asks whether there is “a greater than 50-percent likelihood of the position being upheld”). Secs. 1.6662-3(b)(3), 1.6662-4(d)(2), Income Tax Regs. The negligence penalty may be inappropriate where an issue to be resolved by the Court is one of first impression involving unclear statutory Bunney v. Commissioner, 114 T.C. 259, 266 (2000); language. Lemishow v. Commissioner, 110 T.C. 110, 114 (1998); Hitchins v. Commissioner, 103 T.C. 711, 719-720 (1994); see Everson v. United States, 108 F.3d 234, 238 [79 AFTR 2d 97-1335] (9th Cir. 1997) (stating that “When a legal issue is unsettled, or is reasonably debatable” a negligence penalty is generally not appropriate).
This Court has not previously addressed the tax treatment of a bargain sale of a life insurance policy under section 61 or 402(a) or the application of the “entire cash value” standard under the applicable regulations. In adopting the 2005 final section 402(a) regulations, the IRS stated that it was responding to the question under the then-existing regulations of whether “entire cash value” includes a reduction for surrender charges. T.D. 9223, 2005-2 C.B. 591. Furthermore, the amended section 402(a) regulations, which dispense with the “entire cash value” standard, indicate that for a bargain sale of an insurance contract that occurs before August 29, 2005, the bargain element is includable in income under section 61 but is not treated as a “distribution” under the subchapter of the Code that includes section 402. Sec. 1.402(a)-1(a)(1)(iii), Income Tax Regs. On supplemental brief respondent has modified his original position as to the applicability of this amended regulation. Respondent's shift in this regard, together with his explanation of his reasons for promulgating the amended section 402(a) regulations, is indicative of the uncertainty under the applicable regulations of the tax consequences of the transaction in question. We conclude that petitioners had a reasonable basis for their return position. 13 We hold that petitioners are not liable for the accuracy-related penalty for negligence.
Other contentions raised by the parties but not addressed in. this Opinion we deem to be moot or without merit. 14 To reflect the foregoing and concessions by respondent,

civil fraud penalty case

2010-02-23T12:05:00.001-05:00

Dec. 58,137(M)
Code Sec. 61, Code Sec. 446, Code Sec. 6501, Code Sec. 6663

Individuals: Income: Reconstruction of income: Specific items method: Penalties: Fraud: Assessment: Limitations

T.C. Memo. 2010-31

LISA R. AND DARREN T. COLE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent. SCOTT C. AND JENNIFER A. COLE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
UNITED STATES TAX COURT. Docket Nos. 16991-08, 17275-08. Filed February 22, 2010.
Darren T. Cole and Scott C. Cole , for petitioners.

Stewart Todd Hittinger and Timothy Lohrstorfer , for respondent.

MEMORANDUM OPINION
KROUPA, Judge: Respondent determined deficiencies in petitioners' 1 Federal income taxes and fraud penalties under section 6663 2 for 2001. Specifically, respondent determined a $102,227 deficiency and a $76,670 section 6663 fraud penalty against Darren and Lisa Cole for 2001. 3 Respondent also determined a $556,187 deficiency and a $417,140 section 6663 fraud penalty against Scott and Jennifer Cole for 2001.

There are two primary issues for decision. The first issue is whether petitioners understated their income in the amounts respondent determined for 2001 as adjusted. We hold that they did. The second issue is whether petitioners are liable for the fraud penalty for 2001. We hold that they are. Because we find fraud, respondent is not time barred from assessing petitioners' taxes for 2001.

Background
Lisa and Darren Cole resided in California at the time they filed their petition. Jennifer and Scott Cole resided in Indiana at the time they filed their petition.

The Bentley Group
Petitioners Scott C. Cole (Scott) and Darren T. Cole (Darren) are brothers. Scott and Darren are attorneys who practiced law in Indiana through an entity known as the Bentley Group during 2001. Bentley was the maiden name of Darren's wife, Lisa Cole (Lisa). The brothers formed the Bentley Group in 1998 and also did business under the name Cole Law Offices. The Bentley Group and Cole Law Offices were different names for the same business, but there were no assumed name filings for either entity.

The law practice was a family affair, with Scott, Darren, and Lisa all taking an active part in the business. Scott's legal practice focused in part on business planning and taxation. Scott created limited liability companies (LLCs) for his clients, prepared corporate and individual tax returns, and represented clients before the Internal Revenue Service (IRS). Scott and Darren also performed criminal defense work, including work for the public defender's office in Boone County, Indiana. Darren, a graduate of Creighton University School of Law, was responsible for the management of the law practice. Lisa, a college graduate, acted as a paralegal.

Darren opened a business checking account for Cole Law Offices but used the Bentley Group's employer identification number. Scott, Darren, and Lisa all had signature authority over this account. The brothers agreed to share equally the law practice's profits and losses, though petitioners failed to present any documentation regarding this sharing arrangement. Darren and Scott also agreed that they could withdraw money from the Bentley Group's account. Any money withdrawn from the account other than money they earned for their legal services was considered “borrowed.” Petitioners failed to report any money they withdrew, however, as income for providing legal services and they also failed to provide any loan documents, notes, or any other investment account records evidencing loan transactions between Scott, Darren, and the Bentley Group's account.

Scott and Darren advised their individual clients, and they also advised clients together. These joint clients were the law practice's clients. Clients made payments either directly to the respective brother, through the Bentley Group, or to Cole Law Offices. Scott also received payment from a client with a check made payable to Scott C. Cole and Associates even though there was no such entity. The brothers did not keep records, nor did they produce or maintain invoices for their services. They also failed to keep records or invoices for Lisa's paralegal services.

The taxable deposits in the Bentley Group's account for 2001 totaled $1,430,802. The earnings came from many sources involving the efforts of both brothers and Lisa. The Bentley Group received most of its legal fees from Constance J. Gestner and Terri L. Haynes, co-trustees of the George Sandefur Living Trust (Sandefur Trust), which paid Scott $1.2 million in 2001 to represent the trust in all estate matters. The Sandefur Trust paid the fees in four installments of $300,000. The first check was payable to “Scott Cole and Associates,” a fictional business, and the remaining checks were made payable to “Cole Law Offices.”

Scott, Darren, and Lisa withdrew in excess of $1 million from the Bentley Group's account during 2001. They then transferred the funds into numerous other accounts with no business explanation for doing so. The brothers were unclear as to which account they used for Interest on Lawyer Trust Accounts (IOLTA) purposes. No records were kept for any of the transfers from the Bentley Group's account. The withdrawals made by or on behalf of Darren or Lisa totaled $198,308, while the withdrawals made by or on behalf of Scott included $1,173,263 in 2001.

Scott and Jennifer Cole's Personal Financial Activities
Scott did not always deposit his legal services fees into the Bentley Group's account. Scott deposited $79,294 into the personal checking account of his wife, Jennifer Cole (Jennifer), and deposited $6,475 into his personal bank account in 2001. Scott and Jennifer used the funds in these accounts to pay a variety of personal expenses including their children's school tuition and music lessons and residential landscaping.

Scott failed to report the legal services fees he generated in 2001 as taxable wage or self-employment income regardless of which account the amounts were credited. In addition, Scott failed to report any amounts he withdrew from the Bentley Group's account as taxable wage or self-employment income even though he withdrew $1 million plus for personal nonbusiness purposes.

Scott freely transferred amounts in the Bentley Group's account to his family and friends without keeping sufficient documentation of the transfers or reporting the transactions. For example, he transferred $50,000 from the Bentley Group's bank account to his mother. Scott also lent his father $40,000 from the Bentley Group's account. Scott used this transaction to further convolute the tracing of his income and told his father, rather than paying him back directly, to make a contribution to his church for $40,000 in Scott's name. Scott and Jennifer, thereafter, claimed a $40,000 charitable contribution deduction yet failed to report any of that amount as taxable wage or self-employment income. Scott also lent $300,000 to a friend for options trading and made a loan to his brother Mark for Mark's roofing company. Scott has not provided any records or other documentation to show that any amount withdrawn from the Bentley Group's account was not taxable. In addition, he has failed to show any business purpose for these transfers.

Scott also created an LLC known as JAC Investments, LLC (JAC). JAC are the initials for Jennifer A. Cole. JAC reported its principal business activity as “Investments” although there is nothing in the record to show any stock transactions. Rather, JAC operated as a conduit to which Scott transferred and assigned income from his legal services. JAC reported taxable deposits for 2001 of $79,652 and claimed $28,647 of expenses, though none of these expenses have been substantiated. Deposits into JAC's bank account were almost exclusively checks made payable to Scott individually, not JAC. Jennifer is a college graduate and had previously worked as an accountant. In 2001 she was a homemaker and had no income of her own, yet Scott reported her as owning a 99-percent interest in JAC with him owning a 1-percent interest in JAC. Scott reported self-employment tax on only $1,162 of income for 2001.

Scott formed and solely owned Scott C. Cole, P.C. (SCC), an Indiana professional corporation in 1997. 4 The Indiana Secretary of State administratively dissolved SCC in 2001 because SCC did not file its required business entity reports. SCC had no assets and did not appear to serve any business purpose. In 2005 Scott filed a tax return for SCC for 2001, the first and only tax return filed for SCC. SCC did not report receiving any income from the Bentley Group's account in 2001. SCC reported gross receipts of $158,553 and taxable income of $738 with a reported tax due of $258.

Scott transferred or assigned over $1 million in legal services fees in 2001 from the Bentley Group to at least seven different accounts. Scott commingled amounts in the Bentley Group's account with amounts in other accounts including JAC's account, SCC's account, Jennifer's personal account, Scott's personal account, his father's business account, and his mother's account. Scott and Jennifer failed to report, however, any wages or salaries, Schedule C income, or income from the Bentley Group or Cole Law Offices on their joint tax return for 2001. Instead, the joint tax return reflected only $341 of tax liability and $164 of self-employment tax liability. Scott subsequently filed for bankruptcy in 2002, at which time he failed to disclose any interest in the Bentley Group, Cole Law Offices, or any other law practice.

Darren and Lisa Cole's Personal Financial Activities
Darren also failed to report the amounts he withdrew from the Bentley Group's account on any tax return for 2001. Darren's primary source of income during 2001 was from the practice of law. This income was paid through the Bentley Group or directly to Darren. Like Scott, Darren transferred his legal services fees to multiple accounts. Darren maintained no bank account in his own name during 2001. Darren deposited checks totaling $24,847, paid to him for legal services he performed, into Lisa's bank account in 2001 but failed to report this amount on their joint tax return for 2001.

Scott formed an LLC for Darren and Lisa's benefit known as LRC Investment, LLC (LRC). LRC are the initials for Lisa R. Cole. LRC, similar to JAC, served no business purpose. Darren used it as a conduit to transfer and assign his legal services fees. Darren opened a bank account in LRC's name with an initial $20,000 deposit. No explanation has been given as to where the $20,000 originated or whether it was taxable. Darren and Lisa claimed to be 50-percent partners in LRC. Darren filed an information return for LRC for 2001 reporting LRC's principal business as “Management Consulting” and concealed that he was an attorney. The Bentley Group distributed $145,930 to LRC, which LRC reported as its total gross receipts. No amount was reported on any investment or stock transaction. LRC claimed unsubstantiated expenses of $135,636. In addition to lacking documentation, no claimed expense bore any relationship to the claimed business of LRC.

Lisa represented on a car loan application that she was employed by the Bentley Group and that she received a yearly salary of $51,996. Lisa made a similar representation on a home mortgage loan application. Her yearly salary on the mortgage loan application was represented at an increased $72,000 even though the representations were only days apart. In addition, Lisa deposited a total of $138,248 into her personal bank account during 2001. Despite these deposits and representations, Lisa failed to report any wage or self-employment income on any tax return for 2001.

Darren and Lisa withdrew a total of $198,308 from the Bentley Group's bank account in 2001 yet failed to report any amount. Lisa received at least $45,527 from the Bentley Group and other sources during 2001 but failed to report even a fraction of this amount. Lisa also made a $28,873 down payment on a house at the same time the Bentley Group's bank account reflected a withdrawal of the same amount, yet she failed to report any of this amount. Instead, Darren and Lisa reported only $10,201 in adjusted gross income on their joint tax return for 2001 and sought a $2,477 refund. They reported two minimal sources of income on the joint tax return. They reported only $2,978 from the Bentley Group and $10,294 from LRC. Darren filed for bankruptcy in 2003, at which time he failed to disclose any interest in the Bentley Group or any other law practice.

Respondent's Examination
Respondent began an examination of Scott and Jennifer's joint tax return for 2001 in 2003. Respondent assigned the audit to Revenue Agent Loretta Reed. Revenue Agent Reed met with Scott and learned of Scott and Darren's involvement in the Bentley Group, which still had not submitted a tax return for 2001.

Revenue Agent Reed thereafter requested, due to Darren's involvement in the Bentley Group, that Darren and Lisa's joint tax return for 2001 be selected for examination. Respondent assigned Revenue Agent Reed to audit Darren and Lisa. Neither Lisa nor Darren cooperated with Revenue Agent Reed during the audit. Darren threatened that Revenue Agent Reed would be arrested if she came upon his property, and Revenue Agent Reed received no response from Lisa after sending audit notices and summonses to her. Revenue Agent Reed eventually obtained audit information by issuing third-party summonses to Darren and Lisa's banks and mortgage company.

The Bentley Group's 2001 Information Return, Form 1065
Darren filed the information return for the Bentley Group for 2001 in 2004 after the audit of both partners had begun. The Bentley Group reported gross receipts and ordinary income of $1,583,900. It also reported there were no cash distributions or transfers of partnership interests for the 2001 tax year. This was inconsistent with all the distributions made to entities and persons during 2001. The K-1s attached to the Bentley Group's information return also did not reflect reality. The K-1 on the late-filed information return reflected that Darren had a 0-percent interest in the profits and losses of the Bentley Group and had only a 1-percent interest in its capital. The K-1 reflected that Scott's defunct SCC owned all the profits and losses of the Bentley Group and had a 99-percent interest in its capital. SCC had not filed any tax return for 2001. There was no K-1 for Scott individually.

Neither Scott nor Darren filed employment tax returns for the Bentley Group, and the Bentley Group claimed no deduction on the information return for payment of unemployment taxes. It also claimed no other expenses normally associated with operating a law practice. Further, despite the significant legal services income the Bentley Group received during 2001, the Bentley Group did not report any legal services income for 2001. At trial, Scott and Darren both asserted that SCC was the only partner of the Bentley Group. Neither Darren nor Scott reported any sale of his interest in the Bentley Group to SCC on his joint tax return.

Deficiency Notices Issued
Respondent used the specific items method to reconstruct Scott's and Darren's respective incomes from the Bentley Group in 2001. Respondent used the available records for the withdrawals that petitioners made from the Bentley Group's bank account. Respondent also did bank deposit analyses with respect to their incomes from other sources. Respondent determined that petitioners had omitted wages and self-employment income from their joint tax returns, and respondent issued petitioners deficiency notices and asserted fraud penalties against them. Petitioners timely filed petitions with this Court.

Discussion
We are asked to decide whether petitioners, two attorney brothers and their spouses, failed to report over $1.5 million in income from providing legal and tax preparation services, and if so, whether such underreporting of income was attributable to fraud. Petitioners created so many different legal entities and distributed money to so many entities and individuals in 2001 that petitioners themselves were confused at trial. Petitioners failed to keep adequate invoices and records, thus making their financial dealings even more convoluted. We begin by discussing the unreported income.

I. Unreported Income
Gross income generally includes all income from whatever source derived. Sec. 61(a) . Taxpayers must keep adequate books and records from which their correct tax liability can be determined. Sec. 6001 . When a taxpayer fails to keep records, the Commissioner has discretion to reconstruct the taxpayer's income by any reasonable means. Sec. 446(b) ; Webb v. Commissioner , 394 F.2d 366, 371-372 (5th Cir. 1968), affg. T.C. Memo. 1966-81; Factor v. Commissioner , 281 F.2d 100, 117 (9th Cir. 1960), affg. T.C. Memo. 1958-94.

The Commissioner's determinations are generally presumed correct, and the taxpayer bears the burden of proving that these determinations are erroneous. Rule 142(a); Welch v. Helvering , 290 U.S. 111, 115 (1933). Both brothers acknowledge they are attorneys and earned income from providing legal services. In addition, Scott prepared taxes for others and testified that he understood that income earned from legal services must be reported on tax returns. They argue nonetheless that all the income deposited in the Bentley Group's account should be assigned to SCC, a defunct entity, not them individually.

Taxpayers may not avoid their tax liability on income they earned by simply assigning income to others. Trousdale v. Commissioner , 16 T.C. 1056, 1065 (1951), affd. 219 F.2d 563 (9th Cir. 1955). When a taxpayer creates an entity as a pure tax avoidance vehicle, the assignment of income theory applies to tax the taxpayer for the income attributed to the entity. See Jones v. Commissioner , 64 T.C. 1066, 1076 (1975). There is no written evidence for 2001 to suggest that SCC was involved with the Bentley Group. In fact, SCC was a defunct corporation that had been dissolved in 2001. The only document suggesting that SCC was a partner of the Bentley Group was the K-1 attached to the Bentley Group's information return for 2001, but this return was not filed or prepared until after Scott and Darren were being audited. All other evidence, including testimony at trial, shows that Scott and Darren were the only two partners of the Bentley Group in 2001. Furthermore, not only was SCC defunct in 2001 but it reported no taxable income and paid no income tax in 2001. Accordingly, we find any money deposited into the Bentley Group's account is income allocated to Scott and Darren, not SCC.

Petitioners failed to maintain adequate records of their income. Revenue Agent Reed therefore collected financial information through third-party summonses issued to their banks and mortgage lenders. The Commissioner may use indirect methods of reconstructing a taxpayer's income. Holland v. United States , 348 U.S. 121 (1954). The reconstruction of a taxpayer's income need only be reasonable in light of all surrounding facts and circumstances. Giddio v. Commissioner , 54 T.C. 1530, 1533 (1970). The specific items and bank deposits methods of income reconstruction used by the Commissioner have long been sanctioned by the courts. Clayton v. Commissioner , 102 T.C. 632, 645 (1994); Estate of Mason v. Commissioner , 64 T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir. 1977).

The bank deposits method assumes that all money deposited in a taxpayer's bank account during a given period constitutes income, but the Commissioner must take into account any nontaxable sources or deductible expenses of which the Commissioner has knowledge. Clayton v. Commissioner , supra at 645-646. The burden is on petitioners to show that respondent's method of computation is unfair or inaccurate. See DiLeo v. Commissioner , 96 T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992). We now focus on respondent's reconstruction of each couple's income for 2001.

A. Scott and Jennifer—Unreported Income

Scott and Jennifer filed a joint tax return for 2001 and reported gross income of $100,276, taxable income of $18,265, and a tax liability of $505. Respondent determined, however, that Scott received legal services and tax preparation fees far in excess of what they reported. The Sandefur Trust paid Scott $1.2 million for his legal services, though Scott and Jennifer did not report any of the amount on their joint tax return. In addition, Scott withdrew $1,173,263 from the Bentley Group's account in 2001, but failed to report any of the withdrawals as income. Scott claims he lent most of this money to his father, friends, and brothers and mistakenly asserts that loan proceeds are tax-exempt. Scott's misconception about amounts lent to others does not absolve Scott from paying taxes on income he earned by providing legal services.

In addition, JAC had taxable deposits of $79,652, all coming from Scott's legal services fees, yet Scott reported self-employment tax on only $1,162 of income for 2001. Moreover, a total of $79,294 was deposited into Jennifer's personal bank account in 2001, of which $59,264 was from Scott's legal services and tax preparation fees. Neither Scott nor Jennifer reported these deposits as income. Instead, Scott and Jennifer failed to report, in toto, over $1 million in legal services fees. They failed to report any of the legal services fees, yet they claimed a $40,000 charitable contribution deduction for amounts of legal services fees they had contributed to their church.

Respondent determined that Scott and Jennifer omitted $1,215,183 of income from their joint tax return for 2001. Respondent also allocated income for self-employment tax purposes between the brothers and determined that Scott had $1,329,689 of unreported self-employment income for 2001 after reviewing the checks deposited into the Bentley Group's account for 2001.

We conclude that the specific items and bank deposits methods respondent used to reconstruct Scott and Jennifer's income for 2001 were reasonable and substantially accurate. Scott and Jennifer have introduced no documentary evidence to show otherwise. Any inaccuracies in the income reconstruction are attributable to Scott and Jennifer's failure to maintain books and records. Accordingly, we find Scott and Jennifer had unreported income in the amounts respondent determined in the deficiency notices as adjusted.

B. Darren and Lisa—Unreported Income

Darren and Lisa reported $10,201 of adjusted gross income and claimed a $2,477 refund on their joint tax return for 2001. Darren testified that all of his income from the practice of law went through the partnership, yet he reported only $2,978 of the money deposited in the Bentley Group's account and $10,294 of the money deposited in LRC's account. Darren and Lisa withdrew, however, a total of $198,308 from the Bentley Group's account in 2001. Moreover, Lisa represented that she was employed and paid by the law practice, but she failed to report any income. Lisa also made a $28,873 down payment on her house directly from funds in the Bentley Group's account but failed to report any of this amount as income.

Darren and Lisa have failed to explain several omissions of income and have failed to substantiate the claimed expenses on their joint tax return. Darren and Lisa reported LRC received gross receipts of $145,930 in 2001, all coming from the Bentley Group, yet they offset the gross receipts with $135,636 of unsubstantiated expenses. We find it inconsistent that Darren and Lisa would be able to pay such excessive amounts of expenses for LRC if they had only a small amount of reportable income. The records support respondent's determination that Darren and Lisa omitted $261,684 of income from their joint tax return for 2001.

Darren earned significant legal fees working for a law practice that had ordinary income in excess of $1.5 million. Respondent determined that Darren had $198,282 of self-employment income from the practice of law, yet Darren failed to report any self-employment income. Lisa also failed to report any earnings from the Bentley Group on their joint tax return. This conflicts with her representations about her earnings on loan and mortgage documents. Moreover, the record reflects she received funds from the Bentley Group in 2001 yet failed to report any income. Deposits totaling $138,248 were made into Lisa's bank account in 2001, and only $21,550 can be attributed to nontaxable sources. Lisa also made a $28,873 down payment on her house directly from the Bentley Group's account. Respondent determined that Lisa earned $74,399 of self-employment income in 2001.

We conclude that the specific items and bank deposits methods respondent used to reconstruct Darren and Lisa's income were reasonable and substantially accurate. Darren and Lisa have introduced no documentary evidence to show otherwise. Any inaccuracies in the income reconstruction are attributable to Darren and Lisa's failure to maintain books and records and to their failure to cooperate with respondent during the audit. We find Darren and Lisa had unreported income in the amounts respondent determined in the deficiency notice as adjusted.

II. Fraud Penalty
We next consider whether any of petitioners is liable for the fraud penalty for 2001. The Commissioner must prove by clear and convincing evidence that the taxpayer underpaid his or her income tax and that some part of the underpayment was due to fraud. Secs. 7454(a) , 6663(a); Rule 142(b); Clayton v. Commissioner , 102 T.C. at 646.

Fraud is a factual question to be decided on the entire record and is never presumed. Rowlee v. Commissioner , 80 T.C. 1111, 1123 (1983); Beaver v. Commissioner , 55 T.C. 85, 92 (1970). The Commissioner must show that the taxpayer acted with specific intent to evade taxes that the taxpayer knew or believed he or she owed by conduct intended to conceal, mislead, or otherwise prevent the collection of the tax. Sec. 7454 ; Recklitis v. Commissioner , 91 T.C. 874, 909 (1988); Stephenson v. Commissioner , 79 T.C. 995, 1005 (1982), affd. 748 F.2d 331 (6th Cir. 1984).

Direct evidence of fraud is seldom available, and its existence may therefore be determined from the taxpayer's conduct and the surrounding circumstances. Stone v. Commissioner , 56 T.C. 213, 223-224 (1971). Courts have developed several indicia or badges of fraud. These badges of fraud include understating income, failure to deposit receipts into a business account, maintaining inadequate records, concealing income or assets, commingling income or assets, establishing multiple entities with no business purpose, failing to cooperate with tax authorities, and giving implausible or inconsistent explanations for behavior. Spies v. United States , 317 U.S. 492, 499 (1943); Bradford v. Commissioner , 796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601. Although no single factor is necessarily sufficient to establish fraud, a combination of several of these factors may be persuasive evidence of fraud. Solomon v. Commissioner , 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per curiam T.C. Memo. 1982-603. We will look at each couple to determine whether the fraud penalty applies with respect to either spouse.

A. Scott and Jennifer—Fraud Penalty

We now consider whether Scott or Jennifer is liable for the fraud penalty. A taxpayer's intelligence, education, and tax expertise are relevant in determining fraudulent intent. Stephenson v. Commissioner , supra at 1006. Jennifer is college educated and worked as an accountant. Scott is an attorney and, as such, took an oath to uphold the law. In addition, Scott's legal practice included tax law and preparing tax returns for others. Scott testified that he understood that income from providing legal services is taxable, yet he failed to report the income as taxable on any return for 2001. In addition, Scott diverted most of the legal fees from the Bentley Group's account into numerous other accounts ostensibly as loans. Scott wants the Court to believe that such substantial withdrawals were loans, yet there is no documentation or records to show that a loan was made or that the person receiving the funds paid any interest. Further, even if such transactions were loans, that would not excuse Scott from reporting his legal services fees as income, whether directly payable to him or as a distributive share.

Scott and Jennifer commingled personal and business income without hesitation. Scott deposited earnings from his law practice into JAC's account, in which Jennifer was a 99-percent owner, and into Jennifer's personal account. Jennifer was aware of these deposits and wrote checks from these accounts to pay personal expenses, including her children's school tuition, landscaping payments, and her children's music lessons.

Scott and Jennifer did not report any income from the law practice on their joint tax return for 2001 even though more than $1.5 million was deposited into the Bentley Group's account. Scott had unfettered control over the Bentley Group's account and treated the money deposited in the Bentley Group's account as his personal funds. Scott transferred most of the money in the Bentley Group's account to relatives and friends including a transfer of $50,000 to his mother. Scott failed to produce any records documenting his deposits and withdrawals from the Bentley Group's account and has not rebutted respondent's determination that he received over $1 million in legal services fees in 2001. The lack of records indicates that Scott was not concerned with respecting the existence of different entities or the partners in the Bentley Group.

Scott also concealed assets. Scott deposited his legal services fees into numerous other accounts to hide income. We divine no business purpose for the LLCs Scott established. It appears they served as conduits to hide income Scott earned from providing legal services and preparing tax returns. Scott did not indicate he practiced law on any return filed or indicate that any income earned would be subject to self-employment taxes. Rather, he generally indicated he was an investor. Scott and Jennifer received over $1.2 million in income in 2001, but their joint tax return reflected only $341 of tax liability. Scott and Jennifer avoided income and self-employment taxes by assigning income from Scott's law practice to JAC and using those funds for personal purposes.

Scott also gave inconsistent answers regarding his legal and tax preparation practice. Scott testified that he considered himself a partner in the Bentley Group, and apparently he represented to others that he was a partner. He also represented that he was practicing law under Scott Cole and Associates, Cole Law Offices, and individually. He accepted checks made payable to any of these “persons” and deposited them in the Bentley Group's account regardless to whom the check was made payable. Scott showed little respect for business formalities and effectively made the Bentley Group nothing more than a checking account. Scott asserts that he transferred his entire interest in the Bentley Group to SCC, yet there are no documents to reflect such a transfer. Scott did not even know whether the IOLTA account was a Scott C. Cole account or a Cole Law Offices account. All the while he was transferring his legal services fees into seven different accounts.

We find that Scott and Jennifer used a scheme where they assigned income to an LLC to conceal the true nature of the earnings subject to income and self-employment taxes. Scott and Jennifer claimed that JAC was an investment company. If it was an operating company, however, it did not have any employees nor can we find that it was created for any valid business purpose. JAC was merely created in an attempt to avoid taxation.

Several of the badges of fraud apply to Scott and Jennifer. We conclude that respondent has proven by clear and convincing evidence that Scott and Jennifer each fraudulently understated their tax liabilities for 2001, and they have failed to show that any portion of the underpayment is not due to fraud. Accordingly, we find that the fraud penalty under section 6663 applies to Scott's and Jennifer's underpayment of tax for 2001 as adjusted.

B. Darren and Lisa—Fraud Penalty

We now consider whether Darren and Lisa are each liable for the fraud penalty. We agree with respondent that many of the badges of fraud are equally present for Darren's and Lisa's underpayment. Lisa worked as a paralegal at the law practice, and she had access to and signing authority over the Bentley Group's account. Darren, an attorney, was responsible for keeping the financial records of the law practice and prepared the information return for the Bentley Group for 2001. Darren failed to maintain or produce any records, however, evidencing deposits, withdrawals or loan transactions involving the Bentley Group's account. Darren also did not file the requisite information return for the Bentley Group until 2004, after he and Scott were being audited. In addition, the Bentley Group failed to file employment tax returns for Lisa, or any other employees of the law practice. Lisa failed to report any wage income from the Bentley Group.

Darren and Lisa both earned substantial amounts from the Bentley Group, yet reported only a nominal amount on their joint tax return. Darren never established a personal account in his name, but, like Scott, established multiple other accounts to avoid paying taxes. Darren and Lisa reported only $10,000 of income on their joint tax return after they claimed $135,636 of unsubstantiated expenses on the information return for LRC. Darren maintained no records to support his withdrawals and transfers to and from the Bentley Group's account. Darren and Lisa reported that the Bentley Group paid LRC $150,000 of income, not an insignificant amount, but there was no written explanation for the payment. Darren and Lisa also failed to cooperate with Revenue Agent Reed. Darren threatened that he would have Revenue Agent Reed arrested if she came on his property, and Lisa was unresponsive after receiving summonses from her.

We find that Darren and Lisa, like Scott and Jennifer, used a scheme where they assigned income to an LLC to conceal the true nature of the earnings subject to income and self-employment taxes. Darren and Lisa claimed that LRC was an investment company. If it was an operating company, however, it did not have any employees nor can we find that it was created for any valid business purpose. LRC was merely created in an attempt to avoid taxation. While Darren and Lisa did pay self-employment tax on the $10,000 of net income of LRC, they claimed expenses totaling 92.9 percent of the income. They cannot substantiate these expenses. Perhaps no documentation was kept because LRC had no business purpose and was merely a conduit for the assignment of income.

Several of the badges of fraud apply to both Darren and Lisa. We conclude that respondent has proven by clear and convincing evidence that Darren and Lisa each fraudulently understated their tax liabilities for 2001, and they have failed to prove that any portion of the underpayment is not due to fraud. We find that the fraud penalty under section 6663 applies to Darren's and Lisa's underpayment of tax for 2001 as adjusted.

III. Limitations Period
Because of our findings of fraud, the limitations periods for assessing petitioners' taxes have not expired. See sec. 6501(c)(1) .

We have considered all remaining arguments the parties made and, to the extent not addressed, we conclude they are irrelevant, moot, or meritless.

To reflect the foregoing,

Decisions will be entered for respondent for the reduced amounts .

Footnotes

1 These cases have been consolidated for purposes of trial, briefing, and opinion.

2 All section references are to the Internal Revenue Code in effect for 2001, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.

3 Respondent issued petitioners “whipsaw” deficiency notices because of the inconsistent positions petitioners took. The amounts provided, however, are the amounts respondent ultimately determined are due rather than the amounts set forth in the deficiency notices.

4 Scott asserts that SCC was a partner in the Bentley Group, rather than he as an individual. We find no evidence to support this claim.

6694 penalty

2010-02-18T08:51:00.002-05:00

U.S. v. RENFROW, Cite as 104 AFTR 2d 2009-5497, 01/26/2009 , Code Sec(s) 7407; 7408; 7402; 6700; 6694

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UNITED STATES OF AMERICA, PLAINTIFF v. Raymond A. RENFROW, individually and d/b/a Ideal Tax Service and First Class Limousine, DEFENDANTS.

Case Information:
Code Sec(s): 7407; 7408; 7402; 6700; 6694
Court Name: U.S. District Court, Eastern Dist. of North Carolina,
Docket No.: 5:07-CV-117-FL,

Date Decided: 01/26/2009.

Prior History: Adopted at (2009, DC NC) 103 AFTR 2d 2009-1277.
Disposition: Decision for Govt.

HEADNOTE
1. Return preparer penalties—abusive tax shelter promotion—injunctions—summary judgment—deemed admissions. Magistrate judge recommended granting govt. summary judgment on its claim to permanently enjoin return preparer and his businesses from preparing or assisting in preparation of returns, giving tax advice to or representing other persons or entities before IRS, organizing or selling abusive tax shelters, advising clients they could use such things as certain trust transfers or coin purchases to avoid taxes, and engaging in other conduct subject to penalty under IRC or that otherwise hindered tax law enforcement. Considering matters which, following preparer's non-response to govt.'s admission requests, were deemed admitted, plus other undisputed evidence, it was clear that preparer violated Code Sec. 6700 , by promoting abusive tax or trust schemes and making representations in respect thereto which he knew or should have known were false and pertained to material matter. It was also clear that he violated Code Sec. 6694 since he prepared client returns that understated tax liabilities on basis of meritless or frivolous [pg. 2009-5498] positions. And, his conduct both caused grave harm and was likely to continue absent injunction. Magistrate recommended that injunction include requirement that preparer provide govt. with client list and give clients and employees injunction copy.

Reference(s): ¶ 74,075 Code Sec. 7407 ; Code Sec. 7408 ; Code Sec. 7402 ; Code Sec. 6700 ; Code Sec. 6694

OPINION
UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF NORTH CAROLINA WESTERN DIVISION,

MEMORANDUM AND RECOMMENDATION
Judge: James E. Gates United States Magistrate Judge

This case comes before the court on the motion for summary judgment (DE #25) of plaintiff United States (“Government”) pursuant to Rule 56 of the Federal Rules of Civil Procedure. The motion was referred to the undersigned Magistrate Judge for review and recommendation, pursuant to 28 U.S.C. § 636(b)(1)(B). For the reasons set forth below, it will be recommended that the Government's motion be allowed.

PROCEDURAL HISTORY

On 22 March 2007, the Government commenced this action against defendant Raymond A. Renfrow (“defendant”) in his individual capacity and doing business as Ideal Tax Service and First Class Limousine alleging that defendant was engaging in conduct that was subject to penalty under the Internal Revenue Code, 26 U.S.C. (“I.R.C.”), specifically I.R.C. §§ 6694 and 6700, and conduct that substantially interferes with the proper enforcement of the internal revenue laws, see I.R.C. § 7402(a). On the basis of this alleged conduct, the Government seeks to restrain and enjoin defendant from further engaging in this activity as provided by I.R.C. §§ 7402, 7407, and 7408. On 14 March 2008, the Government filed a motion for summary judgment asserting that it was entitled to the injunction against defendant because there was no dispute of material fact.

On 19 March 2008, the Clerk advised defendant, who is pro se, of the summary judgment dismissal procedure and the possible consequences if he failed to adequately respond to the motion. (Rule 56 Letter (DE #27)). On 11 April 2008, 1 defendant filed a “Petition for Abatement” (DE #28) in which he asserts that the complaint fails to name him as a party on the grounds that his name appears in all upper case letters. This filing by defendant does not respond in any form to the arguments raised in the Government's motion for summary judgment, and defendant has failed to otherwise respond to the motion.

FACTUAL BACKGROUND

I. REQUESTS FOR ADMISSIONS
An initial matter for determination by the court is whether the three sets of requests for admissions served by the Government on defendant should be deemed admitted, as the Government requests. (See Govt.'s Requests for Admissions (“RFA”) (DE #26-2) at 4–18). 2 The Government bases its request on the grounds that defendant failed to respond to the requests for admissions within the period of time required by the Federal Rules of Civil Procedure or thereafter. (Noyes Decl. (DE #26-2) at 1–2, ¶¶ 3–8).

Rule 36 of the Federal Rules provides, in relevant part, that a “matter is admitted unless, within 30 days after service of the request ... the party to whom the request is directed serves upon the party requesting the admission a written answer or objection addressed to the matter, signed by the party or by the party's attorney.” Fed. R. Civ. P. 36(a). Further, a “matter admitted under this rule is conclusively established unless the court on motion permits withdrawal or amendment of the admission.” Fed. R. Civ. P. 36(b). “A party's failure to respond to a request for admissions under Federal Rule of Civil Procedure 36 may result in a material fact being deemed admitted and subject the party to an adverse grant of summary judgment.” In re Savage , 303 B.R. 766, 772 (Bkrtcy.D.Md. 2003) (citing Carney v. IRS, 258 F.3d 415, 417–18 [88 AFTR 2d 2001-5154] (5th Cir. 2001)); see also Adventis, Inc. v. Consol. Prop. Holdings, Inc., 124 Fed. Appx. 169, 173 (4th Cir. 2005) (“Rule 36 admissions are conclusive for purposes of the litigation and are sufficient to support summary judgment.” (quoting Langer v. Monarch Life Ins. Co. , 966 F.2d 786, 803 (3d Cir. 1992)).

Nevertheless, some courts have been reluctant to award summary judgment on the basis of a pro se party's default on requests for admissions on the grounds that such a party may not have understood the effect of failure to respond to the requests. See Jones v. Jack Henry & [pg. 2009-5499] Assocs., Inc., Civ. No. 3:06cv428, 2007 WL 4226083, at 2 (W.D.N.C. 30 Nov. 2007) (declining to deem unanswered requests admitted where there was no evidence in the record that pro se plaintiff was ever notified of the consequences of failing to respond); United States v. Turk, 139 F.R.D. 615, 618 (D. Md. 1991) (court declined to grant summary judgment against a pro se defendant based solely upon failure to answer requests for admissions (emphasis added)); In re Savage, 303 B.R. at 773 (“Federal Rule of Civil Procedure 36 was not intended to be used as a technical weapon to defeat the rights of pro se litigants to have their cases fairly judged on the merits.”). However, under the circumstances presented in this case, the court concludes that it is appropriate to deem the unanswered requests admitted for the purpose of the motion for summary judgment.

First, defendant was provided sufficient notice of the effect of failing to respond to the government's requests. In each of the three requests for admissions, the Government specifically informed defendant that “these requests may be used for summary judgment” and that the requests “must be answered or properly objected to within 30 days of service or they are deemed admitted, pursuant to the Federal Rules of Civil Procedure.” (See RFA at 5 ¶ 4, 8 ¶ 4, 12 ¶ 4). Further, unlike a less knowledgeable pro se party as may be found in some cases, defendant appears to have a good general awareness of the requirements of litigation and the Federal Rules of Civil Procedure as evidenced by the level of sophistication of defendant's prose filings. (See, e.g., Def.'s Resp. to Mot. for Entry of Default (DE #6); Answer (DE #8)). Another important distinction from the cases cited above is that the Government is not relying solely on the admissions to support its summary judgment motion, but rather has provided the court substantial evidence in support of each of its claims. In fact, the court has concluded that even if it had not considered any of the defaulted admissions, it would still recommend that the motion for summary judgment be allowed based on the undisputed evidence presented in support of the motion. Accordingly, the court will deem each of the Government's requests admitted for the purpose of the motion.

II. UNDISPUTED FACTS
The undisputed facts are as follows. This action arises out of defendant's involvement with Concept Marketing International Trust (“CMI”). Founded in 1991 by James Aldridge, CMI purports to be a financial education company. (Grimaldi Decl. (DE #26-3) ¶ 6). However, through its seminars and other marketing techniques, CMI promotes a multi-level marketing scheme involving the sale of American Silver Eagle coins. (Compl. (DE #1) ¶ 8; Answer ¶ 8). CMI members recruit new members by inviting them to attend a free CMI seminar. (Grimaldi Decl. ¶ 6). This initial presentation lasts approximately one and a half hours. (Id.). The new recruits become members by entering into a purchase agreement which requires them to make monthly purchases of the coins and provides for them to be paid commissions for coin sales to new CMI members they recruit. (Def.'s Dep. (DE #26-5) at 24; Grimaldi Decl. ¶¶ 6, 7). The lowest membership level at CMI requires a purchase of one to three American Silver Eagle coins at a monthly cost of around $165. (Def.'s Dep. at 25). CMI members receive varying levels of commission payments for purchases by members they have recruited, by members recruited by their recruit, and by members brought in by a recruit of the recruit. (Id. 35–37; Grimaldi Decl. ¶ 7).

In marketing the scheme, CMI represents that the program is a means of savings, investment, quick income, and significant tax relief. (Silver Streak Pamphlet (DE #26-7) at 39–42; S. Galley Decl. (DE #26-9) ¶¶ 4, 6; Fields Dep. (DE #26-8) at 11; Grimaldi Decl. ¶¶ 6, 8, 9). Specifically, CMI promotes tax relief in three forms. The first is in the form of “Tangible Assets Savings Accounts” (“TASA Scheme”) whereby members are encouraged to hold their coins as an investment and are told that the purchase price of the coins is a deductible business expense. (Grimaldi Decl. ¶¶ 6, 8; Fields Dep. at 11–12; TASA Brochure (DE #26-6) at 38–41). Second, members are told that their sale of the CMI memberships constitutes a home-based business for which members can take deductions for personal expenses such as vehicles and groceries that have little if any connection to business activities (“Home-Based Business Scheme”). (Fields Dep. at 21–25; Grimaldi Decl. ¶ 8; T. Galley Dep. (DE #26-10) at 44; CMI promotional materials (DE #26-6) at 23–24). Finally, CMI promoted the establishment of sham trusts (“Trust Scheme”) to allow members to exempt their income and assets from taxation. (Grimaldi Decl. ¶ 9; RFA 18, 22; T. Galley Dep. at 34). Specifically, members are told that they can place their personal assets in a family trust, a business trust, and a charitable trust, thereby allowing them to deduct personal living expenses to reduce their tax liability by up to 97%. (Grimaldi Decl. ¶ 9; T. Galley Dep. at 29–30, 34–36; Silver Streak Pamphlet (DE #26-7) at 39).

Defendant first became involved with CMI as a customer sales associate in 1993. (Def.'s [pg. 2009-5500] Dep. at 13–14). A 10 May 2000 letter provided by defendant to the Internal Revenue Service (“IRS”) indicates his appointment as a member of the CMI board of trustees with responsibility for “Field Communications.” (Grimaldi Decl. ¶ 10; Def.'s Dep. at 14; Letter of Appointment (DE #26-6) at 3). Defendant is also one of CMI's National Training Coordinators, and travels to cities across the country giving presentations promoting the CMI program. (Def.'s Dep. at 14–16). Defendant is listed in CMI literature, including the company newsletter, as the North Carolina state contact person. (Id. at 90–91; CMI Newsletter (DE #26-6) at 35). His address, phone number, and email address appear in CMI member information packets as the Eastern Regional Office of CMI. (Def.'s Dep. at 127–28; CMI Contact Information (DE #26-6) at 42).

Defendant also operates a trust known as Ideal Tax Services (“ITS”), purportedly to provide financial education, tax planning, and tax return preparation to CMI members. (Def.'s Dep. at 65–66; Grimaldi Decl. ¶¶ 6, 12). In 2000 or 2001, CMI gave defendant and ITS an exclusive contract for preparation of federal and state income tax returns for CMI's national client base in return for 10% of ITS's gross annual revenue. (Grimaldi Decl. ¶ 16; Compl. ¶ 43; Answer ¶ 43).

In addition, defendant presented a seminar on the tax benefits of CMI membership, known as the “Income Tax Boot Camp.” (Grimaldi Decl. ¶¶ 5, 12; Def.'s Dep. at 16). These tax seminars were given in cities across the country, including Chicago, Detroit, Milwaukee, and Kansas City. (Def.'s Dep. at 16). Defendant also created a workbook organizer for his tax return preparation business, and distributed it at the CMI Income Tax Boot Camp. (Grimaldi Decl. ¶ 12; Def.'s Dep. at 132–33). This organizer is used to obtain information from customers needed to complete their tax returns. (Def.'s Dep. at 132–33). Defendant does not request documentation to support the information provided in the organizer. (Grimaldi Decl. ¶ 12). Based upon the IRS's examination of defendant-prepared returns, it has determined that the questions in the organizer do not solicit sufficient information to accurately determine the propriety of certain business related deductions. (Id.).

An August 2006 IRS audit of 77 returns prepared by defendant and/or one of his subcontractors at ITS revealed understatements of tax liability in at least 58 of the returns. (Grimaldi Decl. ¶ 13 & Sum. of Exam. Results (DE #26-3 at 9–10)). The IRS estimates a total loss of $1,454,579.40 to the U.S. Treasury as a result of the understatements of tax liability in returns prepared by defendant in tax years 2000 to 2003. (Grimaldi Decl. ¶ 14). Additional facts will be provided as necessary for the court's discussion below.

DISCUSSION
I. STANDARD OF REVIEW
A. Summary Judgment Standard
It is well established that a motion for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure should be granted only “if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, 322–23 (1986). In analyzing whether there is a genuine issue of material fact, all facts and inferences drawn from the facts must be viewed in the light most favorable to the nonmoving party. Evans v. Techs. Applications & Serv. Co., 80 F.3d 954, 958 (4th Cir. 1996).

The burden is on the moving party to establish the absence of genuine issues of material fact and “a complete failure of proof concerning an essential element of the nonmoving party's case necessarily renders all other facts immaterial.” Celotex Corp., 477 U.S. at 323; Teamsters Joint Council No. 83 v. Centra, Inc. , 947 F.2d 115, 119 (4th Cir. 1991) (“[W]here the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, disposition by summary judgment is appropriate.”).

If the movant meets its burden, then the non-moving party must provide the court with specific facts demonstrating a genuine issue for trial in order to survive summary judgment. Celotex , 477 U.S. at 323. In this case, defendant has not responded to the Government's motion for summary judgment, and, consequently, the court can grant summary judgment “if appropriate.” Fed. R. Civ. P. 56(e)(2). “Although the failure of a party to respond to a summary judgment motion may leave uncontroverted those facts established by the motion, the moving party must still show that the uncontroverted facts entitle the party to “a judgment as a matter of law.”” Custer v. Pan Am. Life Ins. Co., 12 F.3d 410, 416 (4th Cir. 1993). Accordingly, the court must review the record to determine whether the Government is entitled to summary judgment. [pg. 2009-5501]

B. Standard for Relief under I.R.C. §§ 7402, 7407, and 7408
[2] As indicated, the Government is seeking injunctive relief under I.R.C. §§ 7402, 7407, and 7408. Generally, the equitable remedy of permanent injunctive relief requires a showing of irreparable injury and inadequacy of a legal remedy. See Weinberger v. Romero-Barcelo, 456 U.S. 305 (1982). However, “[a]n injunction may issue without resort to the traditional equitable prerequisites if a statute expressly authorizes the injunction.” Abdo v. IRS, 234 F. Supp. 2d 553, 564 [90 AFTR 2d 2002-7484] (M.D.N.C. 2002), aff'd, 63 Fed. Appx. 163 [91 AFTR 2d 2003-2276] (4th Cir. 2003). These traditional factors need not be established under I.R.C. §§ 7402, 7407, and 7408 because these statutes authorize injunctive relief if certain criteria are met. See Abdo, 234 F. Supp. 2d at 564; Duke v. Uniroyal, Inc., 777 F. Supp. 428, 433 (E.D.N.C. 1991) (finding that where an injunction is expressly authorized by statute and the statutory conditions have been satisfied, the moving party is not required to establish irreparable injury before obtaining injunctive relief); United States v. Music Masters, LTD., 621 F. Supp. 1046, 1058 [56 AFTR 2d 85-6452] (W.D.N.C. 1985) (“Traditional equity grounds need not be proven in order for an injunction that is authorized by statute.”). Specifically, each of these statutes authorizes injunctive relief if a person engages in specified conduct prohibited under the I.R.C. Once the prohibited conduct is established and injunctive relief is thereby authorized, the court must determine whether injunctive relief is appropriate to prevent a recurrence of such conduct. Abdo, 234 F. Supp. 2d at 564. The courts have developed a test for determining whether injunctive relief should be issued that applies to all the statutes at issue. Id. at 565.

Therefore, in the instant case, the court will first determine whether the record establishes that defendant engaged in the conduct prohibited under each of the statutes at issue. (See Sections II–IV below). The court will then address whether injunctive relief is appropriate with respect to any prohibited conduct which has been established. (See Section V below).

II. CLAIM FOR INJUNCTIVE RELIEF UNDER I.R.C. § 7408
A. Requirements for I.R.C. § 7408 Injunctive Relief
I.R.C. § 7408 permits the Government to commence an action in a district court to enjoin a person from engaging in conduct subject to penalty under I.R.C. § 6700, among other I.R.C. provisions. I.R.C. § 7408(a), (b), (c)(1). I.R.C. § 6700(a) penalizes the organization and sale of abusive tax shelter plans. 3 See Music Masters, 621 F. Supp. at 1053. Under I.R.C. § 6700, an “abusive tax shelter” can be “any entity whose principal purpose is the avoidance or evasion of federal income tax,” United States v. Kaun, 827 F.2d 1144, 1149 [60 AFTR 2d 87-5623] (7th Cir. 1987), or any plan or arrangement “having some connection to taxes” and which makes “false or fraudulent statements concerning the tax benefits of participation.” United States v. Raymond, 228 F.3d 804, 811 [86 AFTR 2d 2000-6196] (7th Cir. 2000).

To establish that a defendant engaged in conduct subject to penalty under I.R.C. § 6700, the Government must prove: “(1) that [he] has organized or sold (or assisted in the organization of) an entity, plan, or arrangement; (2) that he made or furnished statements concerning tax benefits to be derived from the entity, plan, or arrangement; (3) that he knew or had reason to know the statements were false or fraudulent; and (4) that the false or fraudulent statements pertained to a material matter.” Abdo, 234 F. Supp. 2d at 561 (citing United States v. Campbell, 897 F.2d 1317, 1320 [65 AFTR 2d 90-1003] (5th Cir. 1990)). The court will review each of these elements in turn. [pg. 2009-5502]

B. Defendant's Organization and Sale of Covered Entities, Plans, and Arrangements
The record establishes that CMI promoted three principal tax shelters, each an entity, plan, or arrangement under I.R.C. § 6700(a)— namely, the TASA Scheme, Home-Based Business Scheme, and Trust Scheme. As discussed, the TASA Scheme was promoted as a program that would allow CMI members to take a tax deduction for all amounts spent on the coins purchased from CMI. The Home-Based Business Scheme advised members that personal living expenses could be deducted as business expenses in connection with the new home-based business of marketing CMI memberships. The Trust Scheme promoted the creation of complex trusts to allow members to exempt their income and assets from taxation.

The evidence in the record also clearly shows that defendant actively helped organize and sell these schemes through CMI. Defendant himself has acknowledged his significant involvement with CMI. He served as a trustee, a National Training Coordinator, and the North Carolina state contact person; housed MCl's Eastern Regional Office in his home; and provided tax preparation services to CMI members. Defendant has received compensation from CMI for his work as a CMI sales representative and for serving as a trustee. (Def.'s Dep. at 19–20.). CMI provided Forms 1099 for non-employee compensation to defendant in the amounts of $14,544 in 2001 and $40,987 in 2002. (Forms 1099 (DE #26-6) at 1–2).

As one of CMI's National Training Coordinators, defendant has traveled to cities all across the country over a period of several years giving presentations promoting the CMI program and conducting the Income Tax Boot Camp. Defendant began conducting CMI training seminars in 2001, and the most recent training seminar reported by defendant was in December of 2007 in Silver Spring, Maryland. (Def.'s Dep. at 17).

Defendant has even continued to promote CMI programs during the pendency of this action. On 25 February 2008, while attending a court-hosted settlement conference in this case at the Terry Sanford Federal Building and Courthouse in Raleigh, defendant posted a business card on the bulletin board in the snack bar. (Hudgins Decl. (DE #26-11) ¶¶ 2–4, and attached image at 3). The card reads as follows:

EXTRA INCOME!
Working From Home
Raymond Renfrow
Mktg Consultant
$2,000–$10,000 Monthly
FREE Silver & Gold Coins
[Cellular telephone number]
[Office telephone number]
[email address]
(Hudgins Decl. at 3).

C. Defendant's Statements and Knowledge of Their Falsity
It is also undisputed that the tax benefits promoted in each of the three schemes were false. As described above, the TASA Scheme was promoted by defendant as a program that would allow CMI members to deduct all amounts spent on the silver coins. CMI and defendant distributed a brochure which asserted that the TASA was “the only government based program that does not tax the American taxpayer.” (Def.'s Dep. at 98–99; TASA Brochure (DE #26-6) at 39). The TASA brochure also compares the TASA with an Individual Retirement Account (“IRA”). The brochure provides the following example:

You put $500 a month into a conventional account (IRA) for a year. At the end of the year you have deposited $6,000. The IRS only allows you a $2,000 ($4,000 if married, filing jointly) dollar tax advantage for your current year taxes.
With a TASA plan, you deposit the same $500 a month for the year for the total of $6,000. The IRS now permits you the full $6,000 reduction on your taxable income for the year. You may do this every year and you have no limit on how much you may save, with the full amount tax deductible. Dollar for dollar!
(TASA Brochure at 39). At his deposition taken 9 January 2008, defendant admitted that this brochure is still being used and distributed. (Def.'s Dep. at 99.) There is no basis in law for claiming a deduction for the price of silver coins purchased as an investment or savings. See generally 26 U.S.C. ch. 1, subch. B, pt. III (“Items Specifically Excludable from Gross Income”).

The Home-Based Business Scheme was also promoted with false statements regarding tax benefits. I.R.C. § 162(a) 4 allows deductions [pg. 2009-5503] only for those expenses that are both “ordinary and necessary” for a “trade or business.” I.R.C. § 162(a). To be engaged in a “trade or business,” the taxpayer's “primary purpose for engaging in the activity must be for income or profit.” C.I.R. v. Groetzinger, 480 U.S. 23, 35 [59 AFTR 2d 87-532] (1987).

CMI promoted CMI membership as a home-based business and advised members that with a home-based business “basically all” personal expenses could become deductible business expenses. (Grimaldi Decl. ¶ 8; T. Galley Dep. at 44). For example, CMI members were told to have an office in the home in the biggest room in the house and to hire family members as employees, even if their only role in the business is to do shopping for the family. (Grimaldi Decl. ¶ 8; Fields Dep. at 21–23). Defendant also advised members to “blend” personal and business expenses, so that all dual purpose items would become deductible. (Fields Dep. at 24). Members were encouraged to have as many business expenses as possible, and CMI founder James Aldridge promoted having a loss on the home-based business for its tax advantages. (T. Galley Dep. at 8–10).

An illustration of the extent to which CMI and defendant promoted the inappropriate use of business deductions can be found in the following example in defendant's ITS workbook organizer:

$30,000 Family Income-Married with 2 Children
12% Federal Example
5.5% State Example
Without With
H.B.B. H.B.B.
Wages $30,000 $30,000
H.B.B. 0 1,000
Taxable Income 30,000 31,000
Standard Deductions -7,350 -7,350
Exemptions -11,200 [-]11,200
H.B.B. Deductions 0 -21,560
Taxable Income 11,450 -9,110
Federal Tax 1,721 0
State Tax 902 0
Total Paid 2,623 0
Earned Income Credit 237 1,000
Federal Tax Withheld 3,600 3,600
State Tax Withheld 1,650 1,650
Refund 2,864 6,250
(ITS Workshop Materials (DE #26-6) at 14). In this example, a home-based business created through CMI membership for the purpose of purchasing silver coins and recruiting other CMI members which earned $1,000 is claiming $21,000 in business expenses such that the family with $30,000 in wage earnings has negative taxable income. It is inconceivable that such an example could be based on legitimate business deductions for the type of home-based business promoted by CMI. See Kassel v. United States, No. 06-3237 SC, 2007 WL 1100312 [99 AFTR 2d 2007-2200], at 3 (N.D. Cal. 12 April 2007) (finding that an example in materials used to promote a “Tax Relief System” which claimed $29,980.00 in home-based business deductions on the same return where only $2,000.00 in home-based business income is reported was a false statement for the purpose of I.R.C. § 6700 penalty due to being inconsistent with the necessary profit motive).

Finally, defendant and CMI, in conjunction with Trust Educational Services (“TES”), formerly known as National Trust Services (“NTS”), promoted the Trust Scheme with false representations about the viability of the trusts for tax purposes. CMI customers pay up to $15,000 to attend “trust academies” run by TES. (Alderidge Trial Tr. at 1287–88, 1295; T. Galley Dep. at 28; S. Galley Decl. ¶¶ 8–9). At these trust academies, customers set up a col [pg. 2009-5504] lection of trusts for the purposes of holding title to customers' assets and paying their expenses, thereby allowing customers to deduct most of their personal expenses. (RFA 18, 22). CMI and defendant represent that these trusts will allow conversion of up to 97% of income to a tax shelter with “full disclosure to the IRS.” (S. Galley Decl. ¶¶ 14, 22; RFA 16; Fields Dep. at 41–42).

The IRS may disregard an entity for tax purposes where such entity lacks economic substance. Richardson, 509 F.3d at 741; see also Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1354 [98 AFTR 2d 2006-5249] (Fed.Cir. 2006) (holding that the “economic-substance” doctrine is “a judicial tool for effectuating the underlying Congressional purpose that, despite literal compliance with the statute, tax benefits not be afforded based on transactions lacking in economic substance”). To determine whether a trust has sufficient economic substance, courts consider the following factors:

(1) whether the relationship of the grantors to the transferred property changed materially; (2) whether any independent trustee exists to prevent the grantors from acting solely in their own interests; (3) whether any economic interest in the trust assets passed to other beneficiaries; and (4) whether the trust imposes any restrictions on the grantors' use of the assets.
Richardson, 509 F.3d at 741.

The trusts promoted to and created for CMI customers clearly do not satisfy these criteria. CMI customers have testified that their relationship to the transferred property did not change materially after it was transferred to the trusts. (S. Galley Decl. ¶¶ 15, 16). The CMI customers are not prevented from acting in their own interests because the NTS trustee serves for only a few days before being replaced by the grantor CMI customers. (Hutson Dep. at 48, 54; Grimaldi Decl. ¶ 9; T. Galley Dep. 30–31, 36; RFA 27). There are no regular disbursements from trust revenue to the named beneficiaries, and there are no restrictions upon the grantors' use of trust assets. (Hutson Dep. at 42–43, 48–49; T. Galley Dep. at 35). Consequently, it is clear that these trusts have no legitimate purpose and are set up solely to avoid tax obligations.

Importantly, courts have repeatedly found these types of trusts to be shams for tax purposes. See United States v. Scott, 37 F.3d 1564 [74 AFTR 2d 94-6454] (10th Cir. 1994); Richardson v. Comm'r., 509 F.3d 736 [100 AFTR 2d 2007-6970] (6th Cir. 2007); Buckmaster v. Comm'r., T.C.Memo 1997-236 [1997 RIA TC Memo ¶97,236] (1997); Markosian v. Comm'r., 73 T.C. 1235 (1980). Further, Roderick Prescott, who founded NTS and TES, was enjoined by a federal court from promoting these fraudulent trust systems on 2 June 2003. (Prescott Order of Perm. Inj. (DE #26-13)).

There is no dispute that defendant knew or should have known that the representations he made with respect to each of the three schemes were false. First, by holding himself out as a tax professional, he is charged with knowledge of the I.R.C. as well as the applicable regulations and case law. See United States v. Venie, 691 F. Supp. 834, 839 [61 AFTR 2d 88-1133] (M.D. Pa. 1988). Consequently, defendant is presumed to know that the courts have rejected the types of trusts he was promoting and that his representations regarding business deductions were inconsistent with the express language of I.R.C. § 162. Also, defendant agreed to prepare returns for CMI customers who were turned away by their own accountants who questioned the legality of CMI trusts. (S. Galley Decl. 18, 21). Further, the injunction against Prescott as well as the criminal charges and ultimate conviction of James Aldridge, CMI's founder, for aiding and abetting the filing of false tax returns would have lead a reasonable person in defendant's position to question the tax benefits being promoted in the CMI programs. Importantly, defendant admitted at the criminal trial of James Aldridge that CMI continued to do business with NTS and TES after defendant learned that an injunction had been entered against Prescott and those entities. (Aldridge Trial Tr. at 1289). For this and the other reasons stated, the court concludes that there is no dispute that defendant made false representations as to the tax ramifications of the CMI programs and that he knew or should have known that such representations were false.

D. Materiality of Defendant's False Statements
Finally, the record is replete with evidence that the false statements to customers and CMI members were material. Statements are material if they “would have a substantial impact on the decision-making process of a reasonably prudent investor and includes matters relevant to the availability of a tax benefit.” United States v. Campbell, 897 F.2d 1317, 1320 [65 AFTR 2d 90-1003] (5th Cir. 1990). Most significantly, many customers testified that they would have never followed the CMI program had they not been assured of its legality, and many of them were later audited and subjected to significant penalties or litigation as a result of the returns prepared by or under the advice of defendant. (Fields Dep. at 16–17; S. Galley Decl. ¶ 22). As discussed above, an August 2006 IRS audit [pg. 2009-5505] of returns prepared by defendant applying the tax principles he promoted revealed 58 out of 77 returns defendant prepared to have understatements of tax liability. (Def.'s Dep. (DE #26-5) at 132–33; RFA 2, 3, 11, 12, 13, 21; Grimaldi Decl. ¶¶ 8, 15; Kutka Decl. (DE #26-15) ¶¶ 6, 7). Accordingly, the court concludes that the representations were material. The undisputed facts of record thereby show that defendant is subject to penalty under I.R.C. § 6700.

III. CLAIM FOR INJUNCTIVE RELIEF UNDER I.R.C. § 7407
Pursuant to I.R.C. § 7407, the Government may seek an injunction against a tax return preparer to prevent such individual from engaging in certain unlawful conduct relating to tax preparation activities. I.R.C. § 7407(a). The court may grant such injunctive relief if it finds that a tax return preparer has, among other things, “engaged in any conduct subject to penalty under section 6694 or 6695, or subject to any criminal penalty provided by this title.” I.R.C. § 7407(b)(1)(A) (emphasis added).

Here, the Government contends that defendant violated I.R.C. § 6694. It imposes a penalty upon a tax return preparer who prepares a tax return which understates liability due to either an unreasonable position, 5 see I.R.C. § 6694(a), or willful or reckless conduct, see I.R.C. § 6694(b).

As discussed in detail above, defendant has prepared tax returns for CMI customers based on positions for which there was no “realistic possibility of being sustained on the merits” (for disclosed 6 positions), I.R.C. §6694(a)(1), or which were frivolous (for undisclosed positions), I.R.C. § 6694(a)(3). These returns have been determined by the IRS to contain significant understatements of liability totaling over $1 million. Accordingly, the court concludes that defendant is subject to penalty under I.R.C. § 6694.

IV. CLAIM FOR INJUNCTIVE RELIEF UNDER I.R.C. § 7402
In addition to the injunctions sought under I.R.C. §§ 7407 and 7408, the Government also seeks an injunction pursuant to I.R.C. § 7402. This statute grants the district courts of the United States the authority “to render such judgments and decrees as may be necessary or appropriate for the enforcement of the internal revenue laws.” As set out above, the conduct of defendant has resulted, inter alia, in significant understatements of tax liability and, consequently, is subject to an injunction under I.R.C. § 7402. See United States v. Cohen, 222 F.R.D. 652, 657 [93 AFTR 2d 2004-2586] (W.D. Wash. 2004) (holding that U.S. was entitled to injunction under § 7402 for defendant's provisions of false and fraudulent tax advice through his website and his sales of forms and documents that result in substantial understatements tax liabilities); United States v. Franchi, 756 F. Supp. 889, 893 [67 AFTR 2d 91-631] (W.D. Pa. 1991) (injunction under § 7402 justified where defendant tax return preparer inflated expenses and deductions on returns); Music Masters, 621 F. Supp. at 1057 (holding that an injunction was necessary under § 7402 due to defendant's continuing representation to investors that the deductions and credits attributable to an abusive tax shelter plan were allowable).

V. GOVERNMENT'S ENTITLEMENT TO INJUNCTIVE RELIEF
As indicated, injunctive relief is authorized under I.R.C. § 7402(a) “as necessary or appropriate for the enforcement of the internal revenue laws.” Further, having found relevant conduct under I.R.C. §§ 7407 and 7408, the court may award injunctive relief which is “appropriate to prevent the recurrence” of the prohibited conduct, including enjoining a defendant from acting as a tax return preparer. I.R.C. §§ 7407(b)(2), 7408(b)(2). To determine whether an injunction is necessary or appropriate under I.R.C. § 7407, 7408, and 7402, courts ““assess the totality of the circumstances surrounding [defendant] and his violation, including such factors as”: (1) “the gravity of harm caused by the offense;” (2) “the extent of the defendant's participation and his degree of scienter;” (3) “the isolated or recurrent nature of the infraction and the likelihood that the defendant's customary business activities might again involve him in such transactions;” (4) “the defendant's [pg. 2009-5506] recognition of his own culpability;” and (5) “the sincerity of his assurances against future violations.”” Abdo, 234 F. Supp. 2d at 565 (quoting Kaun , 827 F.2d at 1149–50). The court will address each of these factors in turn.

A. Gravity of Harm
Defendant's conduct has resulted in serious harm to the U.S. Treasury not only in the form of understatements of liability, but also the administrative burden on the IRS of auditing, investigating, and collecting taxes on the returns prepared by defendant. (Grimaldi Decl., ¶ 15; see generally Kutka Decl.; Knaff Decl” (DE #26-12)). The harm to CMI members and other customers is also significant. Many CMI customers were subjected to audits and were required to pay significant amounts in back taxes. (Fields Dep. at 16; S. Galley Decl. ¶¶ 23, 24).

B. Extent of Defendant's Participation and Degree of Scienter
As detailed above, defendant continued to promote CMI's programs with false and fraudulent advice to CMI members and other customers, and he did so knowingly. His involvement with the promotion of CMOI's programs was extensive and included traveling across the country to present seminars on CMI's programs as well as the tax benefits of these programs. Defendant's involvement went beyond mere presentation of CMI's materials and included actual development of materials. Defendant himself developed the workbook organizer distributed at these seminars. Further, the unreasonable tax positions that he promoted were applied in preparing tax returns for CMI members.

C. Defendant's Recognition of His Own Culpability
The record contains no indication that defendant has ever acknowledged that the tax schemes he promotes are false or fraudulent.

D. Likelihood of Recurrence and Assurances Against Future Violations
Defendant's involvement with CMI programs began as early as 1993 and, based on the record before this court, continued until at least until 25 February 2008 when he posted promotional materials in the federal building while attending a settlement conference in this case. Significantly, defendant's activities continued even after the criminal conviction of Aldridge and the injunction entered against Prescott. Defendant's continuation of his promotion of CMI's programs and his failure to acknowledge his culpability under these circumstances is a significant, if not immovable, barrier to any assurance that he will desist in this conduct.

For the foregoing reasons, the court concludes that an injunction against defendant is necessary to prevent future similar conduct of defendant. See Music Masters, 621 F. Supp. at 1057 (“Where there is no indication that an individual will attempt to comply with the law, injunctive relief has been determined to be appropriate.”).

CONCLUSION
For the foregoing reasons, it is RECOMMENDED that the Government's motion for summary judgment be ALLOWED and that the court issue an injunction (“Injunction”) permanently barring defendant, Ideal Tax Services, and First Class Limousine, and their agents, representatives, employees, successors, and all other persons or entities in active concert or participation with defendant, Ideal Tax Services, First Class Limousine, or any of them from:

(1.) Preparing, assisting in the preparation of, or directing the preparation or filing of federal tax returns or forms on behalf of any person or entity other than defendant;
(2.) Giving any tax advice to any other person or entity for pay;
(3.) Appearing as a representative of any person or entity before the IRS;
(4.) Engaging in conduct subject to penalty under I.R.C. § 6700, including preparing or assisting in the preparation of a document related to a matter material to the internal revenue laws that includes a position that defendant knows would, if used, result in an understatement of another person's tax liability;
(5.) Organizing, promoting, marketing, or selling any entity, plan or arrangement that advises or assists customers to attempt to violate the internal revenue laws or unlawfully evade the assessment or collection of their federal tax liabilities, including by means of complex trust programs;
(6.) Engaging in conduct subject to penalty under I.R.C. § 6700, including making, furnishing, or causing another person to make or furnish statements about the allowability of any deduction, credit, or the securing of any tax benefit by reason of participating in a tax shelter, entity, plan, or arrangement, that defendant knows or has reason to know is false or fraudulent;
(7.) Telling customers that they may continue to control and receive beneficial enjoyment from assets irrevocably transferred to a trust [pg. 2009-5507] without regard to the grantor trust rules of I.R.C. §§ 673 through 677;
(8.) Telling customers that personal residences can be transferred to a trust for the purpose of claiming tax deductions for personal expenses in order to reduce federal tax liability;
(9.) Telling customers that the purchase of American Silver Eagle coins is a deductible business expense;
(10.) Engaging in any other conduct subject to any penalty under the I.R.C. or any other conduct that interferes with the administration and/ or enforcement of the internal revenue laws; and
(11.) Engaging in any of the activities listed in Paragraphs 1 through 10 above through the use of any other individual or entity.
IT IS FURTHER RECOMMENDED that, pursuant to 26 U.S.C. § 7402, the court order in the Injunction, or by separate order issued contemporaneously with the Injunction, that:

(12.) Within 30 days after issuance of the Injunction, defendant must file with the court and provide to the Government's counsel a complete list of customers (including names, addresses, phone numbers, e-mail addresses, and social security numbers or employer identification numbers) for whom defendant has prepared individual or trust federal income tax returns, or whom defendant has assisted in the creation of any trust or other entity;
(13.) Within 30 days after issuance of the Injunction, defendant must, at his own expense, send a copy of the complaint and Injunction in this action to each of his customers, employees, and associates, both current and former;
(14.) Within 45 days after issuance of the Injunction, defendant must provide evidence of his compliance with the foregoing paragraph by filing a declaration with this court setting out a complete list of names and addresses of individuals or entities to whom he has mailed a copy of the complaint and Injunction in this action; and
(15.) The Government be permitted to engage in post-injunction discovery to monitor defendant's compliance with the Injunction.
IT IS FURTHER RECOMMENDED that, to facilitate compliance by defendant, the Injunction and the separate order, if any, issued contemporaneously with the Injunction advise defendant that failure to abide by such Injunction or order may be punished by criminal contempt under 18 U.S.C. § 401 and otherwise as provided by law.

The Clerk shall send copies of this Memorandum and Recommendation to counsel for the Government and to defendant, who have ten business days, or such other period as the District Judge specifies, to file written objections. Failure to file timely written objections bars an aggrieved party from receiving a de novo review by the District Judge on an issue covered in the Memorandum and Recommendation and, except upon grounds of plain error, from attacking on appeal the unobjected-to proposed factual findings and legal conclusions accepted by the District Judge.

This the 26th day of January, 2009.

James E. Gates

United States Magistrate Judge

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1

The year used in the Clerk's file stamp on the first page of this filing is 2007. Use of this year appears clearly to be an error. The document itself is dated the “Two Thousandth and Eighth year Anno Domini” (Abate. Pet. at 3) and the CM/ECF date stamp indicates filing in 2008 (id. at 1). In addition, the docket sheet for this case lists no filing on 11 April 2007.
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2

Page number references in citations to the RFA are to the numbers assigned by the CM/ECF electronic docketing system. The CM/ ECF-assigned page numbers are used in citations to other documents if the document is otherwise unnumbered.
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3

I.R.C. § 6700(a) reads:
((a)) Imposition of penalty.—Any person who—
((1))
((A)) organizes (or assists in the organization of)— (i) a partnership or other entity, (ii) any investment plan or arrangement, or (iii) any other plan or arrangement, or
((B)) participates (directly or indirectly) in the sale of any interest in an entity or plan or arrangement referred to in subparagraph (A), and
((2)) makes or furnishes or causes another person to make or furnish (in connection with such organization or sale)—
((A)) a statement with respect to the allowability of any deduction or credit, the excludability of any income, or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement which the person knows or has reason to know is false or fraudulent as to any material matter, or
((B)) a gross valuation overstatement as to any material matter
shall pay ... [specified penalties].

I.R.C. § 6700(a).

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4

This section provides, in pertinent part, as follows:
((a)) In general.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including--
((1)) a reasonable allowance for salaries or other compensation for personal services actually rendered;
((2)) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and
((3)) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.
I.R.C. § 162(a).

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5

In support of its argument, the Government cites to the version of I.R.C. § 6694 that was in effect at the time that it filed its motion for summary judgment. However, the version of the statute that was in effect for the returns prepared by defendant in tax years 2000 to 2003, which are relied upon by the Government in support of its argument, contains a different standard for “unreasonable position.” Compare I.R.C. § 6694, as amended by Pub. L. No. 110-28, § 8246(b), 121 Stat. 112, 203 (2007) (effective 25 May 2007) with I.R.C. § 6694, as amended by Pub. L. No. 101-239, §§ 7732(a), 7737(a), 103 Stat. 2106, 2402, 2404 (1989) (effective 31 Dec. 1989). The difference in these two standards has been explained by the IRS as follows:
First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits. Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.
IRS Notice 2007-54 (2007-27 I.R. Bull. 12 (2 July 2007)). All citations in this memorandum are to the 19 December 1989 version of the statute. However, were the court to apply the standard in the later version, the court would still conclude that defendant has prepared tax returns based on unreasonable positions.

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6

A position is “disclosed” for the purposes of this statute where “the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return.” I.R.C. § 6662(d)(2)(B)(ii).

Injunction against a return preparer

2010-02-17T15:51:00.001-05:00

U.S. v. STENLINE, Cite as 105 AFTR 2d 2010-XXXX, 02/05/2010

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UNITED STATES OF AMERICA, Plaintiff, v. TRAVIS NICHOLAS STENLINE, individually and d/b/a Nick Tax or Nick's Taxes, Defendant

Court Name: IN THE UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION,
Docket No.: Civil Action No. 3:09-CV-2122-L,

Date Decided: 02/05/2010.

Disposition:

OPINION
IN THE UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION,

MEMORANDUM OPINION AND ORDER
Judge: Sam A. Lindsay United States District Judge

Before the court is United States' Motion for Default Judgment and Permanent Injunction, filed January 25, 2010. After consideration of the motion, brief in support, record, and applicable law, the court hereby grants United States' Motion for Default Judgment and denies the motion for permanent injunction, but grants an injunction for fifteen years.

I. Background

This is an action brought by the government (“Plaintiff”) against Defendant Travis Nicholas Stenline, individually and d/b/a Nick Tax or Nick's Taxes (“Defendant” or “Stenline”), to enjoin Defendant from participating in filing tax returns for other persons or entities as well as from engaging in conduct subject to penalty under 26 U.S.C. Sections 6701, 6694, and 6695. Defendant is a tax return preparer, as defined by the Internal Revenue Code Section 7701(a)(36), who prepares other people's tax returns for compensation. At least 242 of those returns presumably contain false or fraudulent items and understate the income taxes of the taxpayers. Over fifty of the tax returns prepared by Stenline for the tax year 2006 have made bogus claims for the Telephone Excise Tax Refund, the number one fraudulent scheme among the IRS's “2007 “Dirty Dozen” Tax Scams.”

Stenline has also presumably prepared and filed twelve “zero” returns for his customers for tax year 2006, on which Stenline erroneously reported no wages and no taxable income for his customers. He has additionally misapplied “fuel tax credits” to fraudulently obtain tax reductions on his returns, as well as earned income tax credits, education credits, dependency exemptions, and other fraudulent expenses and deductions to reach the same end. Stenline has further declined to prepare and submit a list of persons to the IRS containing the names of all the customers that he prepared tax returns for the years 2005 through 2007.

Plaintiff states that the 242 false or fraudulent tax returns prepared by Stenline have resulted in erroneous claim refunds of over $800,000 and that Stenline's refund rate on those returns is 100%. His customers now face large income tax deficiencies and may be liable for sizeable penalties and interest. The government requests injunctive relief under Internal Revenue Code Sections 7407, 7408, and 7402.

Defendant was properly served on December 17, 2009, and to date has not filed an answer to Plaintiff's complaint, nor has he defended against the allegations in any other manner. Plaintiff requested an entry of default on January 13, 2010, which the clerk of the court entered on the same day. Plaintiff now requests a default judgment against Defendant to enjoin him permanently from further perpetuating his unlawful business practices.

II. Analysis
The court finds that because Defendant have neither filed an answer to Plaintiff's complaint nor otherwise defended in this lawsuit, and because Defendant is not an infant, an incompetent or in the military, Plaintiff is entitled to judgment against Defendant. The court therefore accepts as true the well-pleaded allegations stated by Plaintiff in its complaint, and those other facts in United States' Motion for Default Judgment and Permanent Injunction.

Plaintiff only requests injunctive relief against Defendant. Specifically, Plaintiff requests the court to permanently enjoin Defendant from further participating in the preparation or filing of tax returns pursuant to Internal Revenue Code Sections 7407, 7408, and 7402. The court may enjoin a person under Section 7407 from acting as an income tax return preparer if that person has engaged in conduct subject to penalty under Section 6694, which penalizes a return preparer who willfully attempts to understate the tax liability of another person or who does so with intentional or reckless disregard of rules and regulations resulting in a tax understatement; or if that person has engaged in conduct subject to penalty under Section 6695, which penalizes a return preparer who, inter alia, fails to provide a copy of his customer list upon request of the IRS.See I.R.C. § 7407(b)(1)(A). The court determines that Defendant should be enjoined pursuant to Section 7407 in light of the facts established in Plaintiff's complaint and motion.

The court has authority to grant injunctive relief under Section 7408 if the defendant engaged in conduct subject to penalty under Section 6701 and such relief is appropriate to prevent the recurrence of such conduct. Id. § 7408(b). Plaintiff's complaint establishes that Stenline has prepared and filed federal tax returns for customers knowing that the returns understate their correct tax liability; injunctive relief is therefore appropriate to prevent Stenline from continuing to engage in such activity.

Pursuant to Section 7402, the court can issue an injunction “as may be necessary or appropriate for the enforcement of the internal revenue laws.” Id. § 7402(a). In light of Plaintiff's complaint and motion, the court determines that Defendant has engaged in conduct that substantially interferes with the administration and enforcement of the internal revenue laws and is likely to continue engaging in such conduct unless enjoined.

That Plaintiff is entitled to injunctive relief cannot be reasonably disputed. The court, however, does not believe that the circumstances of this case justify the imposition of a “lifetime” or permanent injunction against Stenline. Plaintiff did not alert the court to any case authority in which a court imposed a lifetime ban on a person's ability to assist taxpayers in preparing their tax returns for compensation. * The court, however, has found authority that supports a lifetime ban under certain circumstances. Courts have imposed such bans on a person acting as a tax preparer when such person's actions qualify as extreme or egregious misconduct. See United States v. Gleason, 432 F.3d 678, 683–84 [96 AFTR 2d 2005-7538] (6th Cir. 2005);United States v. Nordbrock , 38 F.3d 440, 447 [74 AFTR 2d 94-6624] (9th Cir. 1994); United States v. Bailey, 789 F. Supp. 788, 818–19 [69 AFTR 2d 92-1237] (N.D. Tex. 1992).

An examination of these cases readily reveals that the misconduct took place repeatedly over several years and that hearings or trials were held in each case. In this case, Plaintiff produces evidence for only the 2006 tax year. Further, no hearings or trials have been held in this case, as it is being determined on a motion for entry of default judgment. In such instances, the court does not enjoy the ability to observe the demeanor and conduct of the defendant or to assess the full flavor of the testimony. Both of these factors (length of time and lack of hearing or trial) are quite significant with respect to the court's determination here. A lifetime ban is a draconian remedy and should not be undertaken lightly. The court accordingly determines that a lifetime injunction against Stenline is not warranted and that a fifteen-year injunction adequately addresses Stenline's misconduct and goes no further than necessary to accomplish the statutory objectives.

III. Conclusion
For the reasons stated, the court grants United States' Motion for Default Judgment but denies the request for a permanent injunction. The court does, however, grant an injunction against Stenline for a term of fifteen years. Accordingly, the court enjoins and restrains Defendant for fifteen years, as provided above, from preparing or filing, or assisting in the preparation or filing, of any federal tax returns or related documents and forms for others; and engaging in conduct subject to penalty under Code §§ 6694, 6695 and 6701. In accordance with Rule 58 of the Federal Rules of Civil Procedure, a judgment will issue by separate document.

It is so ordered this 5th day of February, 2010.

Sam A. Lindsay

United States District Judge

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*

A party seeking relief, unless such relief is universally known as the type of relief available, should always provide the court with authority that demonstrates the party is entitled to the relief requested.
© 2010 Thomson Reuters/RIA. All rights reserved.

2010-02-16T12:18:00.003-05:00

CCA 201005029

For bankruptcy cases filed on or after 10/17/2005, debts for withheld taxes, taxes for which return wasn't filed, taxes for which return was late-filed within 2 years of bankruptcy case, taxes for which debtor filed fraudulent return, and taxes that debtor attempted to evade or defeat aren't subject to Chap. 13 discharge.

FULL TEXT:
Office of Chief Counsel

Internal Revenue Service

memorandum

Number: 201005029

Release Date: 2/5/2010

CC:PA:Br5

POSTN-137568-09

UILC: 09.00.00-00

date: October 21, 2009

to: Michael Skeen, Associate Area Counsel

San Francisco, Group 3

(Small Business/Self-Employed)

CC:SB:7:3

from: G. William Beard

Senior Technical Reviewer, Br. 5

(Procedure & Administration)

CC:PA:Br5

subject: Dischargeable Taxes, Penalties, and Interest under Post-BAPCPA Chapter 13 Provisions

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

ISSUES

1. For Chapter 13 bankruptcy cases filed on or after October 17, 2005, in which the taxpayer properly completes the plan and receives a discharge, which tax claims are nondischargeable?
2. Is interest on nondischargeable tax claims also nondischargeble?
3. Are postpetition penalties relating to nondischargeable tax claims dischargeable?
CONCLUSIONS

1. For bankruptcy cases filed on or after October 17, 2005, debts for withheld taxes, taxes for which a return was not filed, taxes for which a return was late-filed within two years of the bankruptcy case, taxes for which the debtor filed a fraudulent return, and taxes that the debtor attempted to evade or defeat, are not subject to the Chapter 13 discharge.
2. If the tax debt is dischargeable in Chapter 13, then the associated prepetition and postpetition interest is dischargeable. If the underlying tax liability is not dischargeable, then the associated prepetition and postpetition interest liability is also not dischargeable.
3. All nonpecuniary tax penalties and the interest that accrues thereon are dischargeable.
DISCUSSION
Significant changes were made to the Bankruptcy Code by the Bankruptcy Abuse and Consumer Protection Act of 2005 (BAPCPA). Most of the changes were effective for bankruptcy cases filed on or after October 17, 2005. You requested advice because you will soon be required to decide whether a variety of federal tax debts are no longer collectible because the taxpayer successfully completed a Chapter 13 plan in a post-BAPCPA case and received a discharge. This memorandum identifies those tax claims that are not dischargeable under the regular Chapter 13 discharge in B.C. § 1328(a), as amended by BAPCPA. The effect of the discharge on interest and penalty claims is discussed thereafter. A note of caution, however, is required. The Ninth Circuit has held that a plan that was confirmed without objection to a provision purporting to discharge an otherwise nondischargeable claim was binding on the parties. The terms of the plan made a nondischargeable debt dischargeable. In re Pardee , 193 F.3d 1083 (9 Cir. 1999).

LAW AND ANALYSIS

A. Taxes Nondischargeable Under B.C. § 1328(a) as Amended by BAPCPA.

Prior to BAPCPA, a Chapter 13 debtor who completed his plan payments was entitled to what has been referred to as a “super discharge” of all taxes provided for by the plan or disallowed under section 502, including taxes stemming from fraudulent or unfiled returns. 11 U.S.C. § 1328(a) 11 U.S.C. § 1328(a). BAPCPA substantially narrowed the scope of the Chapter 13 discharge by excepting from the discharge a number of tax debts. B.C. § 1328(a) lists the debts excepted from the general discharge. In relevant part, §1328(a) provides:

“[A]s soon as practicable after completion by the debtor of all payments under the plan..., the court shall grant the debtor a discharge of all debts provided for by the plan or disallowed under section 502 of this title, except any debt ... of a kind specified in section 507(a)(8)(C) or in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523(a)...
Of the provisions referenced by section 1328(a), four are most likely to apply to tax debts at issue in a Chapter 13 proceeding; they are sections 507(a)(8)(C), 523(a)(1)(B), 523(a)(1)(C), and 523(a)(3). Each of these exceptions to the discharge under 1328(a) is discussed below.

1. B.C. § 507(a)(8)(C)

Subsection (C) of subparagraph 507(a)(8) refers to a tax required to be collected or withheld and for which the debtor is liable in whatever capacity. This exception encompasses the portion of employment taxes withheld from employees wages, and the Trust Fund Recovery Penalty under I.R.C. § 6672. While a claim for section 507(a)(8)(C) liabilities is entitled to priority status, and must paid in full under the terms of a Chapter 13 plan, the exception to discharge allows the Service to collect such liabilities even if was not able to identify the liability in time to file a claim, which was a problem before BAPCPA because the Service often could not identify the debtor as a responsible officer under section 6672 in time to file a claim. See IRM 5.9.10.5.3(6) Note and 5.9.17.15.1(1).

2. B.C. § 523(a)(1)(B)

This subsection excepts from the discharge any debt —

(1) for a tax...
(B) with respect to which a return ..., if required -
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report, or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition.
Stated more simply, taxes for which no return was filed, and taxes for which a return was late-filed within two years before the petition date, are nondischargeable. See IRM 5.9.17.15.1.

4. B.C. § 523(a)(1)(C)

This subsection makes nondischargeable any debt “for a tax with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.” See IRM 5.9.2.9.1(2)f and 5.17.8.22(6).

5. B.C. § 523(a)(3)(A)

This subsection makes nondischargeable debts that are neither listed nor scheduled under B.C. § 521(1) [re-designated by BAPCPA as subsection 521(a)(1)] with the name of the creditor to whom the debt is owed in time to permit a proof of claim to be timely filed, unless the creditor had notice or actual knowledge of the case in time to file a timely proof of claim. This exception applies where the debtor fails to list the Service on its schedule of liabilities or otherwise notify the Service of the bankruptcy case. However, if the Service learns of the bankruptcy proceeding in time to file a timely claim, this exception will not apply. Note that even in pre-BAPCPA cases, courts have held that a Chapter 13 debtor does not receive a discharge of a debt if the creditor did not have notice of the bankruptcy case in time to file a timely claim. See Ellet v. Stanislaus, 506 F.3d 774 (9 Cir. 2007) (refusing to discharge a tax debt where the taxing authority was not given adequate notice of the debtor's Chapter 13 proceeding in time to file a timely claim). See also United States v. Hairopoulos, 118 F.3d 1240 (8 Cir. 1997) (fundamental fairness requires that the tax debt was not provided for by the plan and could not be discharged where the Service did not file a claim due to inadequate notice).

B. The Status of Prepetition and Postpetition Interest
Prepetition interest (interest through the date the bankruptcy petition was filed) is nondischargeable if the underlying tax is nondischargeable. In re Larson, 862 F.2d 112, 119 (7th Cir.1988). Postpetition interest is generally not paid through a Chapter 13 plan and cannot be collected after the bankruptcy case if the debt is discharged. There are three important exceptions in Chapter 13 cases (the first two are not new to the Service in Chapter 13 cases). First, if a creditor's claim is over-secured - the value of the collateral exceeds the amount of the prepetition claim - then the creditor's claim includes postpetition interest until the value of the claim exceeds the value of he collateral. 11 U.S.C. § 506(b). Second, even an under-secured secured claim may be entitled to postconfirmation interest on its claim. See 11 U.S.C. § 1325(a)(5) 11 U.S.C. § 1325(a)(5). Third, if the debt is nondischargeable, the postpetition interest is not discharged and can be collected from the debtor after the bankruptcy case. See Bruning v. United States, 376 U.S. 358 (1964). Since BAPCPA created a number of tax debts that are now nondischargeable, debtors will owe postpetition interest on the nondischargeable tax obligations. Congress recognized this when drafting BAPCPA and also added B.C. § 1322(b)(10), which allows a Chapter 13 plan to provide for the payment of postpetition interest on nondischargeable claims, except that such interest may be paid only to the extent that the debtor has disposable income available to pay such interest after making provision for full payment of all allowed claims.

C. The Status of Prepetition and Postpetition Penalties
BAPCPA did not alter the dischargeability of penalties; prepetition penalties are still nonpriority claims that are subject to discharge. To the extent prepetition tax penalties (and their associated prepetition interest) are not paid pursuant to the Chapter 13 plan, they are dischargeable under B.C. § 1328(a)(2) because that subsection does not include subsection 523(a)(7) among its list of nondischargeable provisions. Also note that under I.R.C. § 6658, penalties under section 6651, 6654, and 6655 for failure to make timely payments of tax incurred by the debtor before the bankruptcy case do not accrue during the bankruptcy case.

Please call (202) 622-3620 if you have any further questions.

Section 6694 violation

2010-02-10T17:43:00.001-05:00

U.S. v. MADZIMA, Cite as 104 AFTR 2d 2009-6044, 08/21/2009 , Code Sec(s) 7407; 7408; 6694; 6695; 6701
________________________________________
UNITED STATES OF AMERICA, PLAINTIFF v. Lennon R. MADZIMA, DEFENDANT.
Case Information:
Code Sec(s): 7407; 7408; 6694; 6695; 6701
Court Name: U.S. District Court, Northern Dist. of Texas,
Docket No.: Civil Action No. 3:08-CV-1043-B,
Date Decided: 08/21/2009.
Disposition: Decision for Govt.
HEADNOTE
1. Return preparer penalties—injunctions. Return preparer and his business were permanently enjoined from acting as return preparers, representing individuals before IRS, understating clients' liabilities or engaging in other conduct subject to penalty under Code Sec. 6694 , et seq. or that substantially interfered with tax law enforcement, and promoting any false tax scheme. Also, preparer was ordered to provide govt. with client list.
Reference(s): ¶ 74,075 Code Sec. 7407 ; Code Sec. 7408 ; Code Sec. 6694 ; Code Sec. 6695 ; Code Sec. 6701
OPINION
UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION,
MEMORANDUM ORDER
Judge: JANE J. BOYLE UNITED STATES DISTRICT JUDGE
Before the Court is Plaintiff's Motion for Default Judgment of Permanent Injunction and Memorandum of Law in Support (doc. 13). Based on the following facts established and conclusions of law, the Court will GRANT Plaintiff's motion and enter this permanent injunction against the Defendant, Lennon R. Madzima, individually and doing business as Sameday Tax Services.
I.
BACKGROUND
The United States filed a Complaint for Permanent Injunction and Other Relief against Defendant Lennon R. Madzima, individually and doing business as Sameday Tax Services, on June 23, 2008. The Complaint alleged Madzima engaged in continued and repeated conduct subject to penalty under I.R.C. § 6694, § 6695 and § 6701. Subsequently, the United States submitted its Motion for Leave to Serve Lennon R. Madzima by Publication and To Extend the Period for Service which the Court granted on November 3, 2008. Lennon R. Madzima was served via publication in the Dallas Morning News on November 7, 21 and 28, 2008, and the United States filed an Affidavit of Publication with the Court on December 17, 2008.
Madzima failed to answer the complaint within twenty days of filing. Accordingly, the United States entered a Request for Entry of Default by the Clerk on January 9, 2009. Pursuant to Fed. R. Civ. P. 55(a), the Clerk entered a default against Madzima on January 12, 2009. The United States now moves the Court to enter an order of default judgment of permanent injunction.
II.
LEGAL STANDARD
Rule 55(b)(2) of the Federal Rules of Civil Procedure allows the court in its discretion to enter a judgment of default when the party entitled to the judgment applies to the court. Where, as here, a default has been entered pursuant to Fed. R. Civ. P. 55(a), the factual allegations of the complaint, except those relating to the amount of damages, are taken as true. 10A Charles Alan Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice & Procedure, § 2688 (3d ed. 1998). Moreover, the entry of default bars the defendant from contesting the truth of the facts alleged in the complaint, as those alleged facts are deemed admitted. T-Mobile USA, Inc. v. Shazia & Noushad Corp. , No. 3:08-CV-00341, 2009 WL 2003369, at 4 (N.D. Tex July 10, 2009)(noting that courts have acknowledged default against a defendant is tantamount to actual success on the merits); see also Au Bon Pain Corp. v. Artect, Inc., 653 F.2d 61, 65 (2d Cir. 1981); Geddes v. United Financial Group, 559 F.2d 557, 560 (9th Cir. 1977).
In this action, the United States is seeking injunctive relief under 26 U.S.C. (I.R.C.) §§ 7402, 7407 and 7408. Because I.R.C. §§ 7407 and 7408 set forth specific criteria for injunctive relief, the United States need only meet those statutory criteria, without reference to traditional equitable factors, for this Court to issue an injunction under those sections. United States v. Estate Pres. Servs., 202 F.3d 1093, 1098 [85 AFTR 2d 2000-603] (9th Cir. 2000); see also United States v. Buttorff , 761 F.2d 1056, 1063 [56 AFTR 2d 85-5247] (5th Cir. 1985).
To obtain an injunction under I.R.C. § 7407, the United States may show, among other things, that the defendant (1) engaged in conduct subject to penalty under I.R.C. §§ 6694 or 6695, or engaged in any other fraudulent or deceptive conduct that substantially interferes with the proper administration of the internal revenue laws, and (2) that injunctive relief is appropriate to prevent the recurrence of such conduct. To obtain an injunction under I.R.C. § 7407 preventing the defendant from acting as [pg. 2009-6045] an income tax return preparer, the United States must additionally show that the defendant engaged in this conduct continually or repeatedly and that a narrower injunction would be insufficient to prevent defendant from interfering with the proper administration of the internal revenue laws. United States v. Bailey, 789 F. Supp. 788, 816 [69 AFTR 2d 92-1237] (N.D. Tex. 1992). To obtain an injunction under I.R.C. § 7408, the United States may show, among other things, that the defendant engaged in conduct subject to penalty under I.R.C. § 6701 and that injunctive relief is appropriate to prevent the recurrence of such conduct. Finally, to obtain an injunction under I.R.C. § 7402(a), the United States must show that an injunction is necessary or appropriate to enforce the internal revenue laws.
III.
FACTS ESTABLISHED AS A MATTER OF LAW
In accordance with Federal Rule of Civil Procedure 55, if the Court determines the Defendant is in default, the factual allegations of the complaint, except those relating to the amount of damages, will be taken as true. 10A Charles Alan Wright, Arthur R. Miller, & Mary Kay Kane, Federal Practice & Procedure § 2688 (3d. ed. 1998); see also T-Mobile USA, Inc. v. Shazia & Noushad Corp., No. 3:08-CV-00341, 2009 WL 2003369, at 4 (N.D. Tex. July 10, 2009). Accordingly, Plaintiff's Complaint establishes the following facts as a matter of law:
(1.) Madzima does business as Sameday Tax Services in Dallas, Texas, and charges customers for the preparation of federal income tax returns.
(2.) Madzima repeatedly and continually engaged in conduct in violation of I.R.C. § 6694, as it applies to tax returns prepared on or before May 25, 2007, by understating his customers' income tax liabilities by negligently and willfully claiming frivolous and meritless federal fuel tax credits that had no realistic possibility of being sustained on the merits. The federal fuel tax credits Madzima claimed were based on business activities that were ineligible for federal fuel tax credit under I.R.C. § 6421, and the amounts claimed were so exaggerated that no reasonable person could conclude they were anything but deliberately fabricated.
(3.) Madzima prepared at least 1,100 returns from 2005 to 2007 that claimed a total of over $1,000,000 in false fuel tax credits. Madzima claimed the bogus fuel tax credits on 46 percent of the federal income tax returns that he prepared for customers for processing year 2007.
(4.) Madzima repeatedly and continually engaged in conduct in violation of I.R.C. § 6694, as it applies to returns prepared on or before May 25, 2007, by understating his customers' income tax liabilities by negligently and willfully inflating or fabricating telephone excise tax refund credits. The amounts claimed were so exaggerated that no reasonable person could conclude they were anything but fraudulently fabricated.
(5.) Madzima prepared federal income tax returns on behalf of customers for tax year 2006 that claimed inflated TETR credits, totaling in excess of $100,000.
(6.) Madzima engaged in conduct in violation of I.R.C. § 6695 by failing to provide the Internal Revenue Service with copies of the returns that he prepared from 2004 to 2006 or a list of returns that he has prepared during that time, as the IRS requested pursuant to I.R.C. § 6107(b).
(7.) Madzima filed in excess of 430 federal income tax returns on behalf of customers for tax years 2005 and 2006 on which Madzima listed his income tax return preparer identification number as the social security number of an individual who was unaware of Madzima's actions in violation of I.R.C. § 6109(a).
(8.) Madzima repeatedly and continually engaged in conduct in violation of I.R.C. § 6701 by preparing fraudulent returns that made false claims for the fuel tax credit and telephone excise tax credit and claimed other fraudulent deductions, knowing that such returns understated his customers' tax liabilities and that the returns would be used in connection with a material matter arising under the internal revenue laws.
(9.) Absent this permanent injunction, Madzima is likely to continue to defraud the United States Treasury by intentionally understating his customers' income tax liabilities.
(10.) Madzima's fraudulent activities are sufficiently broad and flexible that a narrow injunction prohibiting only certain enjoinable activities is unlikely to prevent continued interference by Madzima with the proper administration of the Internal Revenue laws.
IV.
CONCLUSIONS OF LAW
[1] The Court finds that Defendant has continually and repeatedly engaged in conduct subject to penalty under 26 U.S.C. §§ 6694 and 6695, and that injunctive relief is appropriate under 26 U.S.C. § 7407 to prevent Defendant, and any business or entity through [pg. 2009-6046] which he operates, and anyone acting in concert with him, from further engaging in such conduct. The Court further finds that because such conduct was continual and repeated, and because a narrower injunction would not be sufficient to prevent Defendant's interference with the proper administration of the internal revenue laws, that Defendant should be enjoined from further acting as a federal tax return preparer under § 7407. The Court further finds that Defendant engaged in conduct subject to penalty under 26 U.S.C. § 6701, and that injunctive relief is appropriate under 26 U.S.C. § 7408 to prevent Defendant, and any business or entity through which he operates, from further engaging in such conduct. The Court further finds that Defendant engaged in conduct that interferes with the enforcement of the internal revenue laws, and that injunctive relief is appropriate pursuant to the Court's inherent equity powers and 26 U.S.C. § 7402(a) to prevent recurrence of such conduct.
Based on the foregoing and the record in this case, and for good cause shown,
IT IS HEREBY ORDERED, ADJUDGED and DECREED that Defendant Lennon R. Madzima, individually and doing business as Sameday Tax Services, and those persons in active concert or participation with him, are enjoined from directly or indirectly:
((1).) acting as a federal income tax return preparer, or assisting in or directing the preparation or filing of federal tax returns for any person or entity other than himself, or appearing as a representative on behalf of any person or organization whose tax liabilities are under examination by the Internal Revenue Service;
((2).) understating customers' liabilities as prohibited by 26 U.S.C. § 6694;
((3).) engaging in any other activity subject to penalty under 26 U.S.C. §§ 6694, 6695, 6701, or any other penalty provision in the Internal Revenue Code; and
((4).) engaging in conduct that substantially interferes with the proper administration and enforcement of the internal revenue service laws and from promoting any false tax scheme.
IT IS FURTHER ORDERED that Lennon R. Madzima shall produce to counsel for the United States, within fifteen days of this Order, a list that identifies by name, social security number, address, e-mail address, and telephone number and tax period(s) all persons for whom he prepared federal tax returns or claims for a refund since December 31, 2004.
IT IS FURTHER ORDERED that the United States is permitted to conduct discovery to ensure compliance with the terms of this permanent injunction.
SO ORDERED.
DATED August 21, 2009
JANE J. BOYLE
UNITED STATES DISTRICT JUDGE

IRS OPR suspends a CPA

2010-02-09T08:45:00.001-05:00

News Release 2010-19, 02/05/2010, IRC Sec(s).

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Headnote:

Reference(s):

Full Text:

IRS Suspends Tax Practitioner for Preparing False Tax Returns
A Certified Public Accountant has been suspended for twelve months from practice before the Internal Revenue Service by the Office of Professional Responsibility for providing false or misleading information in connection with the preparation of his clients' tax returns.

“Practitioners have a duty both to their clients and to the system to insure taxpayers are complying with tax laws and filing complete and accurate tax returns,” Karen L. Hawkins, Director of the Office of Professional Responsibility said.

Robert A. Loeser, a certified public accountant from Houston, Texas, assisted his clients to lower their tax bills by claiming false business expenses on tax returns he prepared.

For no legitimate business purpose, Loeser's clients were advised to forward funds from their businesses to two corporations Loeser controlled. The corporations then rebated the funds to his clients. Loeser prepared the clients' books and business tax returns expensing and deducting the entire amounts that were paid to the corporations.

The IRS alleged Loeser violated Circular 230 by giving false or misleading information to the Department of Treasury and the IRS.

The settlement agreement included a disclosure authorization that allowed the Office of Professional Responsibility to issue this release.

The Office of Professional Responsibility (OPR) establishes and enforces standards of competence, integrity and conduct for tax professionals — enrolled agents, attorneys, CPAs, and other individuals and groups covered by Treasury Circular 230.

Proposed taxreturn preparer requilrements

2010-02-08T10:32:00.001-05:00

Proposed New Requirements for Tax Return Preparers: Frequently Asked Questions

Posted 2/2/2010

If an employee of a business prepares the business’ tax returns as part of their job responsibilities, will the recommendations affect them?

No. An employee who prepares his employer’s returns is not required to sign as a paid preparer. Accordingly, unless the employee prepares other federal tax returns for compensation, he or she will not be required to register and obtain a PTIN.

Will Accredited Council of Accountancy for Taxation (ACAT) credential holders have to pass the IRS return preparer examination and complete continuing professional education to prepare returns?

Yes, ACAT credential holders will need to pass the IRS exam unless they are also attorneys, certified public accountants, or enrolled agents. As for continuing professional education, they will be subject to the new requirements unless they are also attorneys, CPAs, enrolled agents, enrolled actuaries or enrolled retirement plan agents.

Only attorneys, certified public accountants and enrolled agents will be exempt from testing. Attorneys, certified public accountants, enrolled agents, enrolled actuaries and enrolled retirement plan agents are exempt from the return preparer continuing education requirements.

Will the competency test be available in any other languages such as Spanish?
At least initially, the test will only be available in English.

Because a Preparer Tax Identification Number (PTIN) is going to be mandatory in the future, can I go ahead and get one now?

Yes, you may obtain a PTIN if you do not already have one and begin using it now. However, once the new online preparer registration system becomes available, you will still need to register. The system will ask if you already have a PTIN and it will reassign you the same number.

To apply for a PTIN now, you can apply by using e-Services – Online Tools for Tax Professionals or by filing Form W-7P, Application for Preparer Tax Identification Number. Online applications are processed faster, and return preparers are encouraged to apply online.

Enrolled agents currently pay $125 for enrollment and renewal. Attorneys and certified public accountants pay similar fees to their oversight organizations. Will the new IRS registration fee be applicable to all enrolled agents, attorneys, and CPAs in addition to their other fees?

Yes. All signing paid tax return preparers will have to pay a fee to register (and renew) as return preparers and to obtain PTINs. This fee is in addition to any fee paid tax return preparers must pay for any other certifications or licenses they hold. Because they are exempt from testing, attorneys, CPAs, and enrolled agents would not be required to pay the separate testing fee.

Posted 1/22/2010
What is the best estimate for when the new regulations will be implemented?
Sept. 1, 2010, is the current target date for an on-line registration system and Jan. 1, 2011, is the current target date for requiring all paid signing preparers to be registered and to use a Preparer Tax Identification Number (PTIN). Final determination of these dates is dependent on many factors and will be widely publicized as soon as available.
Testing will not be implemented until after registration and mandatory PTIN usage are in place.
How will the new regulations affect registered or licensed public accountants? Would they have to test?
In many states, a registered or licensed public accountant (LPA) has the same rights and privileges as a certified public accountant. Thus, an LPA in those states is eligible to practice before the IRS by virtue of their public accountant’s license and these individuals will not be required to pass the IRS' return preparer examination or satisfy the CPE requirements for tax return preparers.
The following is a non-exclusive list of states where a LPA has the same rights and privileges as a CPA: Alabama, Alaska, Arkansas, California, Colorado, Connecticut, Hawaii, Idaho, Maine, Montana, New Hampshire, New Jersey, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Vermont, and West Virginia
LPAs in the following states do not have the same rights and privileges as a certified public accountant and, therefore, will be required to pass the IRS' return preparer examination and satisfy the CPE requirements for tax return preparers to prepare any federal tax return for compensation (unless the LPA is an attorney or enrolled agent): Delaware, Illinois, Iowa, Kansas, Michigan, Oregon, and South Carolina
LPAs in other states should review the laws of the state in which they are licensed to determine whether they have the same rights and privileges as a certified public accountant.
In Minnesota we have Registered Public Accountants. These individuals are governed by the Minnesota Board of Accountancy, must register with the Board, pay a fee, and have continuing education requirements and ethics requirements. Will they have to test?
In general, a registered (or licensed) public accountant may practice before the IRS if the registered (or licensed) public accountant has the same rights and privileges as a certified public accountant under state law. Although the IRS has reviewed the laws of 29 states to determine if the registered (or licensed) public accountants in those states have the same rights and privileges as a CPA, Minnesota is not one of those 29 states. Accordingly, the registered public accountants in Minnesota should review their own state laws to determine whether they have the same rights and privileges as a CPA. until the Office of Professional Responsibility has an opportunity to formally consider whether Minnesota’s registered public accountants are qualified to practice as CPAs.
Will there be a distinction between enrolled agents and the new category of preparers who will be required to take the new competency test?
Yes. The practice of enrolled agents before the IRS will not be limited. The practice of the new category of preparers will be limited to preparing tax returns for compensation and representing taxpayers in Examination when the return under examination was a return that they prepared.

How will the conditions to practice before the IRS be changed by the new regulations? Currently tax practitioners that are not attorneys, certified public accountants, or enrolled agents have limited practice before the IRS.

The new category of preparers who pass the competency test will have the same limited practice rights that an unenrolled preparer currently has.
Will there be a new designation for preparers who pass the competency test?
Yes, more information regarding this new designation will be made available at a future date.

Will the testing be done by the same firm that administers the enrolled agent exam? Or will IRS be doing the testing?
The testing likely will be done by an external vendor(s). The vendor(s) is unknown at this time.
Will a CPA who keeps his or her license current but is considered inactive be subject to testing?
Yes. Only attorneys, certified public accountants, or enrolled agents who are active and in good standing with their respective licensing agencies are exempt from competency testing.
Will the tests be open book or resource assisted?
This has not been determined. Stay tuned to the IRS.gov Tax Professionals page for information on this issue.
The two competency tests are described as covering: 1) Wage & non business 1040 and 2) Wage and Small Business 1040. What does small business include? And how would this impact those who prepare other business returns?
For competency testing purposes, small business will include Form 1040 Schedules C, E, and F and various other 1040 related forms. Appendix I of the Return Preparer Review report contains a detailed list.
Even if they do not prepare 1040 returns, preparers of business returns who are not attorneys, certified public accountants, or enrolled agents will be required to pass the Wage and Small Business 1040 test.
The IRS plans to add a third test with regard to business tax rules after the three-year implementation phase is completed.
Will the recommendations apply to individuals who only prepare payroll or other non-1040 series returns?
All paid signing tax return preparers will be required to register. If the preparer is not an attorney, certified public accountant, or enrolled agent, the preparer will need to satisfy the competency test and continuing education requirements. The preparer will need to pass the complex test if they prepare business returns.
What is the required percentage to pass the competency test?
This has not been determined. Stay tuned to the IRS.gov Tax Professionals page for information on this issue.
Attorneys and certified public accountants in some states are not subject to continuing education requirements. Will this impact the application of the proposed IRS rules for those individuals?
No. The lack of continuing education requirements for attorneys or certified public accountants in a specific state will not impact the exception. All attorneys and certified public accountants will be exempt from IRS CE requirements.
However, as stated in the Return Preparer Review report, the IRS believes that all tax return preparers have an obligation to stay current on the tax laws and continuing education serves to help individuals remain current and to expand their knowledge within their field of expertise. Such courses are important to tax administration given the complexity of the tax laws and the frequent changes made to the Internal Revenue Code and the rules and regulations implemented to assist in the administration of the Code.
The IRS will consider requiring continuing professional education from additional individuals if data is collected in the future that identifies such a need. Additionally, the IRS plans to reach out to licensing authorities to encourage them to support annual continuing professional education that includes federal tax law topics and updates and ethics for those individuals who are licensed by them and who prepare federal tax returns.
Will individuals who are active attorneys, certified public accountants, or enrolled agents be required to register if they do not prepare or sign any tax returns?
Not unless they prepare for compensation and sign one or more federal tax returns.

Will Electronic Return Originators (EROs) who only transmit tax returns and do not prepare returns be subject to the new review recommendations?

Although individuals who assist in the transmission of tax returns electronically are subject to other IRS rules and regulations currently, individuals who assist in the transmission of tax returns electronically, but do not prepare returns for compensation, are not the focus of the recommendations in the report.
Will preparers who are registered by the states of California or Oregon (California Tax Return Preparers and Oregon Licensed Tax Preparers/Consultants) be exempt from testing and continuing education requirements?
Only attorneys, certified public accountants, and enrolled agents will be exempt from testing and continuing education requirements.
Who will be included in the public database of return preparers?
At a minimum, it will include the preparers who have passed the competency exam. Other information about who would be included is not yet available. Stay tuned to the IRS.gov Tax Professionals page for information on this issue.

What will happen to an unenrolled return preparer who registers with the IRS as a part of the initial registration of return preparers but does not pass the competency test within three years from the implementation date?

The IRS will contact them proposing to deactivate their PTIN and remove them from the list of registered preparers, as well as, explaining the appeals process.
Check back frequently for additional questions and answers to be posted.

IRS Proposes New Registration, Testing and Continuing Education Requirements for Tax Return Preparers Not Already Subject to Oversight

Higher Standards to Boost Protections and Service for Taxpayers,
Increase Confidence in System, Yield Greater Compliance with Tax Laws
IR-2010-1, Jan. 4, 2010

WASHINGTON –– The Internal Revenue Service kicked off the 2010 tax filing season today by issuing the results of a landmark six-month study that proposes new registration, testing and continuing education of tax return preparers. With more than 80 percent of American households using a tax preparer or tax software to help them prepare and file their taxes, higher standards for the tax preparer community will significantly enhance protections and service for taxpayers, increase confidence in the tax system and result in greater compliance with tax laws over the long term.

To bring immediate help to taxpayers this filing season, the IRS also announced a sweeping new effort to reach tax return preparers with enforcement and education. As part of the outreach effort, the IRS is providing tips to taxpayers to ensure they are working with a reputable tax return preparer.

"As tax season begins, most Americans will turn to tax return preparers to help with one of their biggest financial transactions of the year. The decisions announced today represent a monumental shift in the way the IRS will oversee tax preparers," said IRS Commissioner Doug Shulman. "Our proposals will help ensure taxpayers receive competent, ethical service from qualified professionals and strengthen the integrity of the nation's tax system. In addition, we are taking immediate action to step up oversight of tax preparers this filing season.”

Based on the results of the Return Preparer Review released today, the IRS recommends a number of steps that it plans to implement for future filing seasons, including:
• Requiring all paid tax return preparers who must sign a federal tax return to register with the IRS and obtain a preparer tax identification number (PTIN). These preparers will be subject to a limited tax compliance check to ensure they have filed federal personal, employment and business tax returns and that the tax due on those returns has been paid.
• Requiring competency tests for all paid tax return preparers except attorneys, certified public accountants (CPAs) and enrolled agents who are active and in good standing with their respective licensing agencies.
• Requiring ongoing continuing professional education for all paid tax return preparers except attorneys, CPAs, enrolled agents and others who are already subject to continuing education requirements.
• Extending the ethical rules found in Treasury Department Circular 230 -- which currently only apply to attorneys, CPAs and enrolled agents who practice before the IRS -- to all paid preparers. This expansion would allow the IRS to suspend or otherwise discipline tax return preparers who engage in unethical or disreputable conduct.
Other measures the IRS anticipates taking are highlighted in the full report.

Currently, anyone may prepare a federal tax return for anyone else and charge a fee. While some preparers are currently licensed by their states or are enrolled to practice before the IRS, many do not have to meet any government or professionally mandated competency requirements before preparing a federal tax return for a fee.
First Step: Letters to 10,000 Preparers
The initiatives announced today will take several years to fully implement and will not be in effect for the current 2010 tax season. In the meantime, the IRS is taking immediate action to step up oversight of preparers for the 2010 filing season.

Beginning this week, the IRS is sending letters to approximately 10,000 paid tax return preparers nationwide. These preparers are among those with large volumes of specific tax returns where the IRS typically sees frequent errors. The letters are intended to remind preparers to be vigilant in areas where the errors are frequently found, including Schedule C income and expenses, Schedule A deductions, the Earned Income Tax Credit and the First Time Homebuyer Credit.

Thousands of the preparers who receive these letters will also be visited by IRS Revenue Agents in the coming weeks to discuss their obligations and responsibilities to prepare accurate tax returns. This is part of a broader initiative by the IRS to step up its efforts to ensure paid tax return preparers are assisting clients appropriately. Separately, the IRS will be conducting other compliance and education visits with return preparers on a variety of issues.

In addition, the IRS will more widely use investigative tools during this filing season aimed at determining tax return preparer non-compliance. One of those tools will include visits to return preparers by IRS agents posing as a taxpayer.

During this effort, the IRS will continue to work closely with the Department of Justice to pursue civil or criminal action as appropriate.

Steps Taxpayers Can Take Now to Find a Preparer
In addition to the stepped-up oversight of preparers, Shulman also announced a new outreach effort to help make sure taxpayers choose a reputable preparer this filing season. That’s particularly important because taxpayers are legally responsible for what is on their tax returns -- even if those returns are prepared by someone else.

“Taxpayers should protect themselves from unscrupulous preparers,” Shulman said. “There are some simple steps people can take to choose a reputable tax preparer.”

Most tax return preparers are professional, honest and provide excellent service to their clients. Shulman offered the following points for taxpayers to keep in mind when selecting a tax return preparer:
• Be wary of tax preparers who claim they can obtain larger refunds than others.
• Avoid tax preparers who base their fees on a percentage of the refund.
• Use a reputable tax professional who signs the tax return and provides a copy.
Consider whether the individual or firm will be around months or years after the return has been filed to answer questions about the preparation of the tax return.
• Check the person’s credentials. Only attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters, including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared.
• Find out if the return preparer is affiliated with a professional organization that provides its members with continuing education and other resources and holds them to a code of ethics.
More information about choosing a tax return preparer and avoiding fraud can be found in IRS Fact Sheet 2010-03, How to Choose a Tax Preparer and Avoid Tax Fraud.

Only a 12 month suspention? Very generous of the IRS

2010-02-05T11:49:00.000-05:00

IRS Suspends Tax Practitioner for Preparing False Tax Returns

WASHINGTON — A Certified Public Accountant has been suspended for twelve months from practice before the Internal Revenue Service by the Office of Professional Responsibility for providing false or misleading information in connection with the preparation of his clients’ tax returns.

“Practitioners have a duty both to their clients and to the system to insure taxpayers are complying with tax laws and filing complete and accurate tax returns,” Karen L. Hawkins, Director of the Office of Professional Responsibility said.

Robert A. Loeser, a certified public accountant from Houston, Texas, assisted his clients to lower their tax bills by claiming false business expenses on tax returns he prepared.

For no legitimate business purpose, Loeser’s clients were advised to forward funds from their businesses to two corporations Loeser controlled. The corporations then rebated the funds to his clients. Loeser prepared the clients’ books and business tax returns expensing and deducting the entire amounts that were paid to the corporations.

The IRS alleged Loeser violated Circular 230 by giving false or misleading information to the Department of Treasury and the IRS.

The settlement agreement included a disclosure authorization that allowed the Office of Professional Responsibility to issue this release.

The Office of Professional Responsibility (OPR) establishes and enforces standards of competence, integrity and conduct for tax professionals -- enrolled agents, attorneys, CPAs, and other individuals and groups covered by Treasury Circular 230.

Bipartisan jobs legislation

2010-02-04T08:02:00.000-05:00

SCHUMER, HATCH UNVEIL TARGETED JOB CREATION BILL

Senators Believe Payroll Tax Cut Most Effective, Affordable Way to Get America Back to Work

WASHINGTON – U.S. Senators Chuck Schumer (D‐New York) and Orrin Hatch (R‐Utah) unveiled targeted legislation today that they believe would be most effective at putting the American people back to work. The Hire Now Tax Cut Act of 2010 would grant any private‐sector employer that hires a worker who had been unemployed for at least 60 days to not have to pay the employer’s 6.2 percent share of the Social Security payroll tax on that employee for the remainder of 2010.

“This proposal shows how much we can do to help create jobs when politics is put aside. Our payroll tax cut is a simple, cost‐effective and bipartisan solution. It will help put more Americans to work right away,” Senator Schumer said.
“While Senator Schumer and I disagree on most issues, we’ve been able to come together on an affordable, effective and targeted proposal to get the American people back to work,” said Hatch. “As a conservative, this proposal isn’t about more and more government spending; it’s about tax relief to get employers hiring again, which is exactly what millions of unemployed Americans most desperately need.”
The Senators cite five reasons why the payroll tax holiday is the best means of spurring job creation:

• Simple. This proposal is not only easy to explain, but easy to administer –
avoiding waste, fraud and abuse.
• Focused. It is exclusively focused on hiring unemployed workers.
• Front‐loaded. It provides an incentive for businesses to hire workers earlier in
the year.
• Immediate. It puts money into a business to start hiring immediately.
• Affordable. It will cost substantially less than other proposals.
Unlike various other tax credit proposals, this payroll tax holiday would go immediately
to a business’ bottom line – there would be no waiting until 2011 to receive a tax credit.
As an additional incentive, for any qualifying worker hired under this initiative that the
employer keeps on payroll for a continuous 52 weeks, the employer is eligible for an
additional non‐refundable $1,000 tax credit after the 52‐week threshold is reached, to
be taken on their 2011 tax return. In order to be eligible, the employee’s pay in the
second 26‐week period must be at least 80 percent of the pay in the first 26‐week
period.
Workers hired after the date of introduction are eligible for the payroll tax forgiveness
and the retention bonus, but only wages paid after the date of enactment receive the
exemption from payroll taxes.
A document fully outlining the proposal is below.
###
Senators Charles E. Schumer and Orrin Hatch
“HIRE NOW TAX CUT ACT OF 2010”
February 3, 2010
BASIC CONCEPT: Starting immediately after enactment, any business that hires a
worker that had been without full‐time work for at least 60 days prior to employment
can avoid paying the employer’s share of Social Security taxes on that worker for the
duration of 2010. The more a business pays a worker (up to the maximum Social
Security wage of $106,800), and the longer a business has a worker on its payroll, the
greater the tax benefit – so there is an incentive to hire people sooner, and pay them
more.
Unlike various tax credit proposals, the benefits under the “Hire Now Tax Cut” go
immediately into a business’ bottom line – no waiting until 2011 to receive a tax credit.
And since the benefit starts immediately after enactment and does not have an
arbitrary cap, it will facilitate utilization because some of the past issues with payroll
software are avoided.
For any qualifying worker hired under this incentive that the employer keeps on payroll
for a continuous 52 weeks, that employer is eligible for an additional $1,000 tax credit
after the 52‐week threshold is reached, to be taken on their 2011 tax return. In order to
be eligible, the employee’s pay in the second 26‐week period must be at least 80
percent of the pay in the first 26‐week period.
Workers hired after the date of introduction (February 2) are eligible for the payroll tax
forgiveness and the retention bonus, but only wages paid after the date of enactment
receive the exemption from payroll taxes.
EXAMPLES OF TAX SAVINGS:
􀂾 Hire a $50,000 worker on March 1, save $2,583.
􀂾 Hire a $90,000 worker on April 1, save $4,185.
􀂾 Hire a $60,000 worker on May 1, save $2,480.
ADDITIONAL FEATURES:
The tax benefit applies only to private‐sector employment, including nonprofit
organizations – public sector jobs are not eligible for either benefit.
Employees who are immediate family members of the employer do not qualify.
There is no minimum weekly number of hours that the new employee must work for the
employer to be eligible, and there is no maximum on the dollar amount of payroll taxes
per employer that may be forgiven.
For workers that would otherwise be eligible for the Work Opportunity Tax Credit, the
employer must select one benefit or the other for 2010 – no double‐dipping.
A worker who replaces another employee who performed the same job for the
employer is not eligible for the benefit, unless the prior employee left the job voluntarily
or for cause.
For the retention bonus to be paid, the worker’s wages during the second 26‐week
period must be at least 80 percent of the wages during the first 26‐week period.
Lost Social Security Trust Fund revenues will be supplemented by the General Fund.
ADVANTAGES/BENEFITS:
• Simple. The Schumer‐Hatch idea is easy to explain and administer: “No
employer payroll taxes on unemployed workers hired in 2010.” Since the
proposal is for a complete elimination of the 6.2 percent payroll tax for eligible
workers, rather than a fixed or capped dollar amount, employers will know to
simply zero out the tax for eligible workers.
• Focused. Given our budgetary constraints and the nagging problem of long‐term
unemployment, any employment incentive should be focused on the hiring of
workers who are currently unemployed. Only by focusing on the unemployed
can we get people off the unemployment rolls at an affordable cost to
taxpayers. Plus, unlike some versions of a payroll tax holiday, this proposal is not
biased towards either low‐wage or high‐wage workers. Under the Schumer‐
Hatch plan, a business saves 6.2 percent on both a $40,000 worker and a
$90,000 worker.
• Front‐Loaded. The proposal provides an incentive for businesses to hire workers
earlier in the year, because the tax benefit will be greater. A $60,000 worker
hired on March 1 will save a business about $3,100 in taxes, while that same hire
delayed until May 1 will save about $2,500.
• Immediate. In the current environment, no business should have to wait until
2011 to receive tax relief for hiring. Our proposal puts money into a business'
cash flow immediately, since the tax is simply not collected in the first place.
• Affordable. Because this provision is targeted towards hiring the unemployed,
as opposed to providing a tax benefit for any increase in payroll, its cost should
be more affordable at a time of record budget deficits

2010-02-03T07:16:00.000-05:00

Notice 2010-19, 2010-7 IRB, 02/02/2010, IRC Sec(s).

Headnote:

Reference(s):

Full Text:

Purpose And Background

This notice alerts taxpayers that the Internal Revenue Service (IRS) intends to issue guidance under section 2511(c) of the Internal Revenue Code. Congress enacted this section in section 511(e) of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and amended it in section 411(g)(1) of the Job Creation and Worker Assistance Act of 2002. Public Laws 107-16, 115 Stat. 71, and 107-147, 116 Stat. 46. Section 2511(c) is effective for transfers made after December 31, 2009, and before January 1, 2011.

Section 2511(a) generally provides that the gift tax shall apply to transfers in trust or otherwise, whether direct or indirect. Under § 25.2511-2(b) of the Gift Tax Regulations, a gift is complete when the donor parts with sufficient dominion and control as to leave in the donor no power to change its disposition. Section 2511(c) provides that, notwithstanding any other provision of section 2511 and except as provided in regulations, a transfer in trust shall be treated as a transfer of property by gift unless the trust is treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1. The Joint Committee on Taxation's explanation of section 2511(c) provides that certain transfers in trust are treated as transfers of property by gift even though such transfers would have been regarded as incomplete gifts, or would not have been treated as transfers under the gift tax provisions in effect prior to 2010. Joint Committee on Taxation, Technical Explanation of the “Job Creation and Worker Assistance Act of 2002” (JCX-12-02), March 6, 2002.

Interim Provisions

Some taxpayers may have inaccurately interpreted section 2511(c) as excluding from the gift tax transfers to a trust treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1, even though those transfers would otherwise be taxable under Chapter 12. The provisions of Chapter 12 regarding the substantive law applicable to the gift tax were not amended by EGTRRA, and those provisions continue to apply to all transfers made by donors during 2010. Section 2511(c) is an addition to those substantive law provisions and is applicable to transfers made in 2010. Section 2511(c) broadens the types of transfers subject to the transfer tax under Chapter 12 to include certain transfers to trusts that, before 2010, would have been considered incomplete and, thus, not subject to the gift tax. Accordingly, each transfer made in 2010 to a trust that is not treated as wholly owned by the donor or the donor's spouse under subpart E of part I of subchapter J of chapter 1 is considered to be a transfer by gift of the entire interest in the property under section 2511(c). The provisions of Chapter 12 as in effect on December 31, 2009, continue to apply (both before and during 2010) to all transfers made to any other trust to determine whether the transfer is subject to gift tax.

Effective Date

This notice is applicable to transfers made in trust after December 31, 2009. The Treasury Department and the IRS intend to issue regulations to confirm the conclusions set forth in this notice.

DRAFTING INFORMATION

The principal author of this notice is Laura Urich Daly of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice contact Laura Urich Daly on (202) 622-3090 (not a toll-free call).

President's FY 2011 budget proposals include many tax changes for businesses and individuals

2010-02-02T08:26:00.001-05:00

On Feb. 1, the President issued his FY 2011 budget proposals, accompanied by the Treasury's release of its “General Explanations of the Administration's Fiscal Year 2011 Revenue Proposals” (colloquially referred to as the Green Book). The budget and the Green Book reveal that the Administration has a robust agenda of tax proposals it will push Congress to enact.

Tax proposals for business include:

• A tax credit of up to $5,000 for new workers added in 2010, plus a reimbursement for payroll taxes on wage increases.

• For 2010, permitting a maximum of $250,000 to be expensed under Code Sec. 179 , with the investment-based phaseout level set at $800,000.

• Extending bonus first-year depreciation to apply to property placed in service in 2010.
• Allotting an additional $5 billion in tax credits for investment in advanced energy manufacturing projects.
• A zero percent capital gains tax on qualified small business stock held for at least five years, effective for stock acquired after Feb. 17, 2009.
• Making permanent the research credit (which under current rules went off the books at the end of 2009).
• Making permanent the Build America Bonds program.
• Removing company provided cell phones from the listed property category, effective for tax years ending after the enactment date.
• Repealing the lower-of-cost-or-market inventory accounting method, effective for tax years beginning after twelve months from the enactment date.
• Repealing the LIFO accounting method for inventories. Those currently using the LIFO method would be required to write up their beginning LIFO inventory to its FIFO value in the first tax year beginning after 2011. However, this one-time increase in gross income would be taken into account ratably over ten years, beginning with the first tax year beginning after 2011.
• Eliminating tax preferences (e.g., expensing of intangible drilling costs, enhanced oil recovery credit, percentage depletion) for oil, gas and coal companies.
• Extending through Dec. 31, 2011 the Subpart F “active financing” and “look-through” exceptions, the exclusion from unrelated business income of certain payments to controlling exempt organizations, the modified recovery period for qualified leasehold improvements and qualified restaurant property, and incentives for empowerment and community renewal zones.
• Making permanent the 0.2% unemployment insurance surtax.
• Subjecting highly leveraged Wall Street firms to a Financial Crisis Responsibility Fee to cover TARP expenses (i.e., the cost of the federal government's financial institution bailout). The Fee would be levied on the liabilities, net of deposits and certain insurance policy reserves, of qualified firms with more than $50 billion in assets. It would remain in place for at least 10 years, or longer if necessary to fully pay back TARP. The Fee would be effective as of July 1, 2010, and would be reported on the annual federal income tax return.
• Requiring a corporation that enters into a forward contract to issue its stock to treat a portion of the payment on the forward issuance as a payment of interest, effective for forward contracts entered into after 2011.
• Requiring dealers in commodities, commodities derivatives dealers, dealers in securities, and dealers in options to treat the income from their day-to-day dealer activities in section 1256 contracts as ordinary in character, not capital, effective for tax years beginning after the enactment date.
• Amending the definition of “control” in Code Sec. 249(b)(2) to incorporate indirect control relationships of the nature described in Code Sec. 1563(a) , effective on the enactment date.
• A ten-year reinstatement of the three Superfund excise taxes, and the corporate environmental income tax, to begin after 2010.
International tax proposals include:
... Taxing in the U.S. excessive profits shifted offshore using transfers of intangibles, thus restricting the tax incentive to engage in transfer pricing abuses.
... Delaying the deduction for the costs of overseas investment.
... A package of provisions to reduce tax evasion through the use of offshore accounts and entities to hide income and assets from IRS.
“Loophole closers” include changing the rules that allow those facing estate and gift taxes to undervalue transferred property, denying a tax deduction for punitive damage claims, repealing preferential tax treatment for commodities dealers and day traders, taxing carried (profits) interests as ordinary income.
Tax proposals for individuals include:
... Extending the Making Work Pay Credit for one year (a tax cut of up to $400 per person ($800 per family)).
... Making permanent the American Opportunity Credit for higher education expenses.
... Extending through 2011 the optional deduction for state and local general sales taxes.
... Increasing the child and dependent care tax credit for families earning up to $113,000 a year.
... Reinstating after 2010 the 36% tax rate for those with taxable income above the following amounts: $250,000 less the standard deduction and two personal exemptions, indexed from 2009, for married taxpayers filing jointly; $200,000 less the standard deduction and one personal exemption, indexed for inflation from 2009, for single filers. Also, the 28% bracket would be expanded so that taxpayers earning less than the $250,000/$200,000 amounts would not see their taxes rise as a result of the increased tax rate brackets.
... Reinstating beginning in 2011 the 39.6% tax rate (it would apply to those with taxable incomes over $373,650 before inflation adjustment).
... Beginning in 2011, reinstating for higher income taxpayers the reduction of itemized deductions and the personal exemption phaseout.
... Extending the COBRA premium subsidy to cover workers involuntarily terminated before 2011.
Tax proposals for retirement savings include:
• Simplifying and expanding the Saver's Credit to match 50% of a contribution up to $500 per individual ($1,000 per couple) for families earning up to $65,000 (with smaller credits for those earning up to $85,000). Additionally, the saver's credit would become a refundable credit.
• Creation of a system of automatic workplace IRAs to expand access to tax-favored retirement savings. Employers automatically enrolling their employees in IRAs would receive tax credits of up to $250 a year for two years.
• Doubling the maximum credit for small employers that establish new retirement plans to $1,000 per year for three years.
Proposals to help reduce the tax gap include requiring information reporting for payments to corporations, requiring electronic filing for more returns, clarifying when employee leasing companies can be held liable for their clients' federal employment taxes, codification of the economic substance doctrine, and clarified standards for classification of workers as employees or independent contractors

Earned Income Tax Credit

2010-02-01T07:19:00.001-05:00

News Release 2010-14, 01/29/2010, IRC Sec(s).

Headnote:

Full Text:

An expanded Earned Income Tax Credit (EITC) means larger families will qualify for a larger credit, offering greater relief for people who struggled through difficult financial times last year, the Internal Revenue Service said today.

The IRS and the Treasury Department marked EITC Awareness Day as their partners nationwide worked to highlight the availability of this important tax credit. EITC, which is in its thirty-fifth year, is one of the federal government's largest benefit programs for working families and individuals. Last year, nearly 24 million people received $50 Billion in benefits. The average credit was more than $2,000.

“As part of the economic recovery efforts, there have been important changes to expand EITC to benefit taxpayers,” said IRS Commissioner Doug Shulman. “Today, more than ever, hard-working individuals and families can use a little extra help. EITC can make the lives of working people a little easier.”

Eligibility for EITC depends on earned income and family size, among other tests. However, single people and childless workers also are eligible, although for smaller amounts. For tax years 2009 and 2010, the American Recovery and Reinvestment Act created a new category for families with three or more children and expanded the maximum benefit for this category.

To qualify for the EITC, earned income and adjusted gross income (AGI) for individuals must each be less than:

$43,279 ($48,279 married filing jointly) with three or more qualifying children
$40,295 ($45,295 married filing jointly) with two qualifying children
$35,463 ($40,463 married filing jointly) with one qualifying child
$13,440 ($18,440 married filing jointly) with no qualifying children
The maximum credit for tax year 2009 is:

$5,657 with three or more qualifying children
$5,028 with two qualifying children
$3,043 with one qualifying child
$457 with no qualifying children
The maximum amount of investment income is $3,100 for tax year 2009. For families, there are also certain requirements for child residency and relationship that must be met. Additional eligibility information is available in FS-2010-11 and on the Web at IRS.gov/EITC.

Another new provision adds to the definition of a “qualifying child:” The child must be younger than the person claiming the child unless the child is totally and permanently disabled any time during the year. The child cannot have filed a joint return other than to claim a refund. Also new for 2009, if a qualifying child can be claimed by either a parent or another person, the other person must have an AGI higher than the parent in order to claim the child for EITC purposes.

Historically, one in four eligible taxpayers fails to claim the EITC, which is why the IRS and its free tax preparation partners host an annual EITC Awareness Day. This year, there are 68 news conferences being held around the country. Community coalitions and IRS partners nationwide also are also issuing 128 news releases, writing letters to the editor and using social media tools to spread the word about EITC.

Typically, people who fail to claim the EITC include workers without qualifying children, people whose earned income falls below the threshold required to file a tax return, farmers, rural residents, people with disabilities and nontraditional families such as grandparents raising grandchildren. People must file a tax return to claim the EITC.

Free help is available to EITC-eligible taxpayers. There are nearly 12,000 free tax preparation sites nationwide. People who want to prepare their own tax returns can visit Free File on IRS.gov. This free tax software and free electronic filing program will walk taxpayers through a question and answer format and help them claim the tax credits and deductions for which they are eligible.

EITC-eligible taxpayers also can seek assistance at the 400 IRS Taxpayer Assistance Centers nationwide. To assist EITC taxpayers, 167 IRS assistance centers will offer Saturday service on Jan. 30, Feb. 6 and Feb. 20. A list is attached.

There is an online EITC Assistant also available on IRS.gov which can help taxpayers and tax preparers determine eligibility. And, for tax preparers and IRS partners, there is EITC Central which has links to toolkits that include marketing products.

More than 65 percent of EITC returns are prepared by a third party. The IRS urges taxpayers to choose a reputable tax preparer to avoid problems that come with an inaccurate tax return. The agency also urges tax preparers to follow due diligence requirements when preparing an EITC tax return. More information is available at www.irs.gov/eitc.

Earned income - dependency case

2010-01-28T06:01:00.001-05:00

T.C. Summary Opinion 2010-11
PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b), THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.

RUBEN ROBERTO FLORES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
UNITED STATES TAX COURT. Docket No. 7507-08S. Filed January 27, 2010.

Ruben Roberto Flores, pro se.
Deborah Mackay , for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b) , the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent 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.

Respondent determined a deficiency of $5,046 in petitioner's 2005 Federal income tax. The issues for decision are whether petitioner is entitled to: (1) Dependency exemption deductions for two of his children; (2) head of household filing status; (3) the refundable portion of the child tax credit; and (4) an earned income credit.
Background
Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time petitioner filed his petition, he resided in Illinois.
Petitioner has a son, R.F., 1 from a relationship with Lisa Cervantes (Ms. Cervantes). R.F. reached age 4 in 2005. Petitioner also has a daughter, Dulce Flores (Ms. Flores), from a relationship with Rosa Gonzalez (Ms. Gonzalez). Ms. Flores reached age 18 in 2005. In the fall of 2005 Ms. Flores entered her senior year of high school. Petitioner did not marry Ms. Gonzales or Ms. Cervantes.
From January 2005 through March 2005 petitioner and his two children, Ms. Flores and R.F., lived with petitioner's sister in her residence. During these 3 months petitioner was unemployed and had full-time custody of R.F. and Ms. Flores. Petitioner was receiving unemployment benefits and used the benefits to support his children and himself.

Upon securing employment with a contract landscaper for the City of Chicago, petitioner entered into a lease agreement effective April 1, 2005, for a one-bedroom apartment. The agreement listed petitioner, Ms. Flores, and R.F. as occupants, required a security deposit of $475, and provided for monthly rent of $475.
In April 2005, because petitioner was working during the weekdays, R.F. began living with Ms. Cervantes. At that time Ms. Cervantes was unemployed and was receiving welfare benefits and government-subsidized housing. In addition, Ms. Cervantes received child support payments of approximately $50 per week from petitioner, which were automatically withheld from his unemployment benefits and from his salary when employed. Even though Ms. Cervantes had physical custody of R.F. during the weekdays, R.F. would stay with petitioner during the weekends. Once petitioner's employment ended in October, R.F. resumed living with petitioner full time.
In contrast, Ms. Flores lived with petitioner throughout the year. Petitioner paid for Ms. Flores' housing, food, clothing, transportation to and from school, and other necessities. The Court received into evidence a notarized statement from Ms. Gonzalez stating that Ms. Flores lived with petitioner throughout 2005. Respondent conceded that petitioner had primary custody of Ms. Flores for 2005. On occasion Ms. Gonzalez would take Ms. Flores shopping and would give her nominal spending money.
During the summer Ms. Flores secured a job working part time as a teller or teller-in-training at a local bank. In the fall she continued working at the bank on an even more abbreviated schedule after classes. Ms. Flores' earnings were not large, and petitioner encouraged her to save what she earned. Ms. Flores used her savings to help pay for college, which she began in 2006, studying to become a nurse.
Petitioner did not keep records of the actual expenses he paid to maintain his household. During the preparation of the case for trial, in response to respondent's request, petitioner submitted a “Worksheet to Determine Support and Cost of Maintaining a Household 2005” dated September 17, 2008, detailing his household expenses for 2005. Respondent did not challenge the accuracy of the worksheet, which showed the following household expenses:
Rent $4,975
Utilities 540
Telephone 590
Food 1,400
Clothing 1,200
Entertainment 600
Transportation 1,200
Other 360
Total 10,865
Petitioner calculated on the worksheet that the above expenses totaled $11,535. Nothing in the record explains the difference of $670 ($11,535 − $10,865). Petitioner also wrote on the worksheet that other persons paid $300 of the $360 in other household expenses. Thus, petitioner paid total expenses of $10,565 ($10,865 − $300) during 2005 to maintain a household for himself and his two children.
Petitioner has another, older, daughter, Vanessa Rivera, living independently and not involved here, who prepared petitioner's 2005 Federal income tax return. Petitioner filed his 2005 return as head of household, reported total income of $12,735, and claimed two dependency exemption deductions, an earned income credit, and an additional child tax credit, which is the refundable portion of the child tax credit. The result was an overpayment of $4,146, for which petitioner requested direct deposit of the refund into his checking account.
Petitioner reported two items of income on his 2005 Federal income tax return: Wages of $8,735 and business income of $4,000. The wages are not at issue. However, with respect to the business income, petitioner attached to the return a Schedule C-EZ, Net Profit From Business, reporting that his business was daycare and listing his sister's address as his business address. Petitioner reported receipts of $4,000, no expenses, and self-employment tax of $565 related to the business. Nothing in the record shows that petitioner was in the daycare business. We infer that the $4,000 is actually petitioner's unemployment income that he did not report elsewhere on the return.
Respondent issued a notice of deficiency changing petitioner's filing status to single and disallowing the dependency exemption deductions, the earned income credit, and the additional child tax credit.

Discussion

In general, the Commissioner's determination set forth in a notice of deficiency is presumed correct, and the taxpayer bears the burden of showing that the determination is in error. Rule 142(a)(1); Welch v. Helvering , 290 U.S. 111, 115 (1933). Pursuant to section 7491(a) , the burden of proof as to factual matters shifts to the Commissioner under certain circumstances. Petitioner has neither alleged that section 7491(a) applies nor established his compliance with its requirements. Therefore, petitioner bears the burden of proof.
Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving his entitlement to a deduction. Rule 142(a)(1); INDOPCO, Inc. v. Commissioner , 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering , 292 U.S. 435, 440 (1934). A taxpayer is required to maintain records sufficient to establish the amounts of his or her income and deductions. Sec. 6001 ; sec. 1.6001-1(a) , (e), Income Tax Regs.

With respect to support, the law does not require a taxpayer to provide precise amounts, but the taxpayer must provide competent, convincing, or credible evidence to prove the total amount of support for each dependent. Blanco v. Commissioner , 56 T.C. 512, 514 (1971); Seraydar v. Commissioner , 50 T.C. 756, 760 (1968). Credible evidence means evidence that a court would find sufficient to make a decision if the record did not contain contrary evidence and if the evidence did not include implausible factual assertions or frivolous claims; thus, the evidence must be worthy of the Court's belief. Higbee v. Commissioner , 116 T.C. 438, 442 (2001).
I. Dependency Exemption Deductions

A taxpayer may be entitled to a dependency exemption deduction for each of his or her dependents. Sec. 151(a) , (c). A dependent includes a “qualifying child” of the taxpayer. Sec. 152(a) . In relevant part a qualifying child is an individual: (1) Who bears a relationship to the taxpayer as described in section 152(c)(2) ; (2) who has the same principal place of abode as the taxpayer for more than one-half of the year; (3) who meets the age requirements described in section 152(c)(3)specifying an individual under the age of 19; and (4) who has not provided over one-half of his or her own support for the year. Sec. 152(c)(1) . We now apply the law to the facts to decide whether R.F. and Ms. Flores are petitioner's qualifying children for 2005.
A. Whether R.F. Is a Qualifying Child
R.F. is petitioner's son, he reached age 4 in 2005, and because of his age, he clearly did not provide more than one-half (or any) of his own support. Therefore, the sole remaining question with respect to R.F. is whether he shared the same principal place of abode as petitioner for more than one-half of 2005.
Regarding this matter, we find petitioner's testimony highly credible. He offered to have his son testify (which the Court declined because of the boy's young age) that for 6 months of 2005 (the first 3 months and the final 3 months), while petitioner was at home and unemployed, R.F. lived with petitioner. During the other 6 months, April through October 2005, while petitioner was working as a landscaper, R.F. lived with Ms. Cervantes during the weekdays and with petitioner during the weekends. Thus, in aggregate, R.F. resided with petitioner full time for 6 months, and for 2 days of every week during the other 6 months. Hence, R.F. resided with petitioner for more than one-half of the year.

For the foregoing reasons, R.F. satisfies the requirements of section 152(c) to be petitioner's qualifying child for 2005, and therefore petitioner is entitled to a dependency exemption deduction for R.F.

B. Whether Ms. Flores Is a Qualifying Child

Ms. Flores is petitioner's daughter, she became age 18 in 2005 and was therefore under age 19 at the close of the year, and she resided with petitioner for more than one-half (namely all) of 2005 as confirmed by the notarized letter from her mother, Ms. Gonzalez, and as conceded by respondent. The sole remaining issue then is whether because of her alleged earnings from her job at the bank Ms. Flores provided more than one-half of her own support. See sec. 152(c)(1)(D) . We will now therefore apply the support test to Ms. Flores' situation.
With respect to the amount that Ms. Flores spent for her own support in 2005, we begin by noting that the record does not establish the amount Ms. Flores earned from her job at the bank or the amount she spent for her own support in 2005. Petitioner acknowledged that Ms. Flores worked for the bank; however, he also testified that he provided almost all of Ms. Flores' support for 2005 and that he encouraged her to save her earnings. We find petitioner's testimony credible.
Ms. Flores' situation bolsters petitioner's testimony. Ms. Flores was a senior in high school and needed to save money for college, which she began in 2006. She worked for a bank, making it convenient for her to save her wages. Petitioner paid for Ms. Flores' main needs: Housing, utilities, food, clothing, entertainment, and transportation to and from school. Ms. Gonzalez also provided her some minimal support, occasionally taking her shopping and giving her some spending money.
Respondent has not offered any evidence to refute petitioner's testimony. Respondent in his pretrial memorandum stated that Ms. Flores filed a 2005 Federal income tax return reporting wages of $4,374. Respondent later at trial conceded that Ms. Flores did not file a 2005 Federal income tax return. Respondent did not provide a transcript of account for Ms. Flores and did not produce a copy of a 2005 Form W-2, Wage and Tax Statement, for Ms. Flores from the bank where she worked during 2005.
Therefore, petitioner has met his burden, and respondent has not proved or even attempted to prove otherwise. Accordingly, the weight of the evidence clearly favors petitioner's contention that Ms. Flores did not provide over one-half of her own support for 2005.
Consequently, because Ms. Flores meets all of the relevant requirements of a qualifying child under section 152(c) , petitioner is entitled to claim her as a dependent for 2005.

II. Filing Status

As pertinent here, head of household filing status requires that the taxpayer maintain a home that was the principal place of abode of a qualifying child for more than one-half of the year. Sec. 2(b)(1)(A) . Additionally, head of household filing status is available only if the taxpayer furnished more than one-half of the cost of maintaining that residence. Sec. 2(b) .
Applying these requirements, we have already found that Ms. Flores was petitioner's qualifying child for 2005, she lived in petitioner's apartment for 9 months (April through December 2005), and petitioner furnished far more than one-half of the cost of maintaining his household. Therefore, petitioner is entitled to head of household filing status for 2005.

III. Refundable Child Tax Credit

Subject to adjusted gross income ceilings, not at issue here, a taxpayer is entitled to a $1,000 credit against tax for each qualifying child of the taxpayer. Sec. 24(a) . For purposes of this section, a qualifying child means an individual under age 17 who is a qualifying child of the taxpayer as defined in section 152(c) . Sec. 24(c)(1) . The age restriction disqualifies Ms. Flores. However, R.F. was age 4 in 2005 and satisfies the other requirements of a qualifying child under section 152(c) .
Generally, a taxpayer may not claim the child tax credit if the taxpayer does not have a “regular tax liability”. Sec. 24(b)(3)(A) ; Richmond v. Commissioner , T.C. Memo. 2009-207. Petitioner's regular tax liability for 2005 was zero because his income was less than the combination of his standard deduction plus his deduction for three exemptions (himself and his two qualifying children).

Despite the above restriction, a separate provision allows a taxpayer to receive a refund of a portion of the child tax credit equaling 15 percent of the taxpayer's earned income that exceeds a certain floor. Sec. 24(d) (referring to section 32 for the definition of earned income). For 2005, the inflation adjusted floor was $11,000. Rev. Proc. 2004-71 , sec. 3.04 , 2004-2 C.B. 970, 972.

Petitioner's earned income in 2005 was solely from his wages of $8,735 because unemployment compensation, $4,000 in this case, is not earned income. See sec. 1.32-2(c)(2) , Income Tax Regs. Accordingly, although petitioner did have one qualifying child, R.F., that satisfied the requirements of the child tax credit, petitioner did not have a regular tax liability to make him eligible for the credit and he did not have sufficient earned income to make him eligible for any part of the refundable portion of the child care tax credit. We sustain respondent on this issue.

IV. Earned Income Credit

Individuals may be eligible for an earned income credit, calculated as a percentage of earned income, if they meet certain criteria. Sec. 32(a)(1) . For purposes of qualifying for the earned income credit, an “eligible individual” is an individual who has a “qualifying child” for the taxable year. Sec. 32(c)(1)(A) . In pertinent part, a “qualifying child” is a child of the taxpayer that satisfies the requirements of section 152(c) . Sec. 32(c)(3) . As discussed above, Ms. Flores and R.F. are petitioner's qualifying children for 2005 under section 152(c) . Therefore, petitioner is entitled to an earned income credit for 2005 calculated with two qualifying children. However, for purposes of the earned income credit, petitioner's earned income for 2005 was $8,735, not the $12,735 he reported, because $4,000 of petitioner's income was from unemployment compensation, which is not earned income. See Jones v. Commissioner , T.C. Memo. 1993-358; sec. 1.32-2(c)(2) , Income Tax Regs.
To reflect our disposition of the issues,
Decision will be entered under Rule 155 .

Footnotes

1
The Court redacts the names of minor children. See Rule 27(a)(3).

Reporting requirement - FASB Interpretation No. 48

2010-01-27T09:50:00.003-05:00

Announcement 2010-9,Internal Revenue Service, (Jan. 27, 2010)

2010FED ¶46,266

Code Sec. 6011

Part III - Administrative, Procedural, and Miscellaneous
Uncertain Tax Positions - Policy of Restraint

Announcement 2010-9

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 (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).

Footnotes

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.

6694 - negligence

2010-01-26T06:09:00.002-05:00

Without question, 6694 penalties would apply under the facts of this case because the return preparer did not follow a published IRS position.

MAGUIRE PARTNERS - MASTER INVESTMENTS, LLC, MAGUIRE PARTNERS, INC., TAX MATTERS PARTNERS, et al., Plaintiffs v. UNITED STATES OF AMERICA, Defendant.

UNITED STATES DISTRICT COURT CENTRAL DISTRICT OF CALIFORNIA. Case No. CV 06-07371-JFW(RZx) ✓. Related Case Nos.: CV 06-7374-JFW (RZx). CV 06-7376-JFW (RZx). CV 06-7377-JFW (RZx). CV 06-7380-JFW (RZx). Dated: December 11, 2009.

AMENDED FINDINGS OF FACT AND CONCLUSIONS OF LAW

WALTER, United States District Judge: This action came on for a court trial on August 12, 13, and 14, 2008. Steven R. Mather and Lydia Turanchik of Kajan Mather and Barish appeared for Plaintiffs Maguire Partners - Master Investments LLC, Maguire Partners Inc., Thomas Master Investments LP, Thomas Partners Inc., Tax Matters Partner, Huntington/Fox Investments LP, Edward D. Fox, Jr., Thomas Division Partnership LP, Thomas Investment Partners Ltd., (collectively “Plaintiffs”). Andrew Pribe, Rick Watson, and Jonathan Sloat of the Office of the United States Attorney appeared for Defendant United States of America (“Defendant”). On September 22, 2008, the parties filed their proposed Post-Trial Findings of Fact and Conclusions of Law. On October 6, 2008, the parties each filed their Post-Trial Briefs and their marked copies of the opposing parties' proposed Post-Trial Findings of Fact and Conclusions of Law. After considering the evidence, briefs and argument of counsel, the Court makes the following findings of fact and conclusions of law: 1

Findings of Fact 2

I. Factual and Procedural Background

A. The Principals and Their Entities

1. James Thomas

James Thomas, a real-estate investor and developer, is the trustee of the Lumbee Clan Trust, which is a partner in Thomas Investment Partners Ltd. (“TIP”), which, in turn, is a partner in Thomas Division Partnership LP (“TDP”). In 2001 through 2002, these various partnerships owned an interest in: the Library Tower in Los Angeles; the Gas Company Tower in Los Angeles; the Wells Fargo Center in Los Angeles; the MGM Plaza in Santa Monica; the Solana project in Dallas; and Commerce Square in Philadelphia. These investments were highly leveraged with debt in the range of eighty to ninety percent of the value of the property. Thomas's net worth in 2001 was approximately $200 million, with approximately twenty to thirty percent in cash or marketable securities/cash equivalents and the remainder in real estate holdings, including those identified above.

2. Edward Fox

Edward Fox, a real-estate investor and developer, is the trustee of The Edward D. Fox, Jr. Family Trust dated February 14, 1990 (the “Fox Trust”), which is a partner in Huntington/Fox Investments LP (“HFI”), which, in turn, is a partner in both Maguire Partners - Master Investments LLC (“MP-MI”) and Thomas Master Investments LP (“TMI”). In 2001 through 2002, these various partnerships owned an interest in: the Library Tower in Los Angeles; the Gas Company Tower in Los Angeles; the Wells Fargo Center in Los Angeles; the MGM Plaza in Santa Monica; the Solana project in Dallas; and Commerce Square in Philadelphia. These investments were highly leveraged with the debt in the range of eighty to ninety percent of the value of the property.

In 2001, Fox also was a major investor in the publicly-held Center Trust REIT where he served as chairman of the board and chief executive officer. The Media Center Shopping Mall in Burbank, California was one of the key assets owned by the Center Trust REIT. In 2001, Fox also was a founder and owner of Commonwealth Partners, which was assembling a portfolio of commercial real estate projects in partnership with various California state pension funds. Fox's net worth in 2001 was approximately $50 million.

B. The Transactions At Issue

1. The Lumbee Clan Trust Transaction

On December 20, 2001, the Lumbee Clan Trust and AIG entered into a transaction in which the Lumbee Clan Trust paid $1.5 million to AIG. The source of the funds used to pay AIG was a distribution from TIP. Thomas contends that the purpose of the transaction was to serve as a hedge against potential loss in the value of his real-estate interests arising from the risk of terrorism after September 11, 2001. Thomas also contends that the Lumbee Clan Trust paid $1.5 million for an opportunity to receive a net maximum of $38.4 million. The potential payout from the transaction was tied to the value of a portfolio of twenty REIT stocks (the “REIT basket”).

a. The Structure of the Transaction

In general, the transaction between the Lumbee Clan Trust and AIG consisted of a short option, a long option, and a promissory note. On December 20, 2001, the Lumbee Clan Trust and AIG in order to implement the transaction did the following: (1) the Lumbee Clan Trust sold a short option to AIG for $100 million; (2) the Lumbee Clan Trust purchased a long option from AIG for $61,683,169; (3) the Lumbee Clan Trust purchased a promissory note from AIG for $39,816,831; and (4) the Lumbee Clan Trust pledged the proceeds from the long option and the promissory note to secure the short option. The Lumbee Clan Trust's transaction costs amounted to $1.5 million. The long and short options were Asian-style European options. 3 The promissory note eliminated AIG's obligation to transfer funds to the Lumbee Clan Trust in the amount representing the difference between the price of the short option and the price of the long option. The strike price of the short option was fifty percent of the value of the REIT basket, or $100,021,176. The strike price of the long option was seventy percent of the value of the REIT basket, or $140,029,647.

b. The Terms of the Transaction

The terms of the transaction provided that any payoff depended on the average value of the REIT basket between December 20, 2001, and March 19, 2002, as compared to the value as of December 19, 2001. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, did not fall by greater than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Lumbee Clan Trust would receive no payout. If the average value of the REIT basket between December 20, 2001, and March 19,2002, fell more than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Lumbee Clan Trust would receive a cash payment that would increase dollar-for-dollar with the reduction in the average value of the REIT basket below seventy percent of the value of the REIT basket on December 19, 2001, until a maximum payout of $40,008,471 was reached. This maximum payout would be reached if the average value of the REIT portfolio fell by fifty percent or more from its value of December 19, 2001. However, the Lumbee Clan Trust would never be obligated to pay out-of-pocket anything other than the $1.5 million transaction costs paid to AIG on December 20, 2001, for the transaction.

c. The Contributions to the Partnerships

On December 27, 2001, the Lumbee Clan Trust contributed the transaction to TIP. Specifically, the Lumbee Clan Trust contributed the long option and the promissory note, and TIP assumed the short option. On December 27, 2001, TIP contributed the transaction to TDP. Specifically, TIP contributed the long option and the promissory note, and TDP assumed the short option. These contributions of the assets and assumptions of the short option were with the approval of AIG. After the contributions to the partnerships, AIG's position in the short option remained secured by the pledge of the long option and the promissory note.

d. The Performance of the REIT Basket and the Transaction

The value of the REIT basket did not decline by an average of thirty percent for the period between December 20, 2001, and March 19, 2002, as compared to its value on December 19, 2001. Therefore, the transaction did not yield a net payment to TDP.

e. The Tax Reporting by the Partnerships and the IRS Adjustments Related to the Transaction

(i.) Thomas Investment Partners

TIP reported on its 2001 Form 1065 that $101,500,000 had been contributed in capital during the year and that this amount constituted an asset of TIP. TIP also reported on its 2001 Form 1065 that the Lumbee Clan Trust had increased its capital in TIP by $101,500,000. TIP also issued a K-1 (partner's share of income, credits, deductions, etc.) to the Lumbee Clan Trust for 2001 that reflected an increase in the Lumbee Clan Trust's capital account of $101,500,000 due to the contribution of the transaction. TIP reported on its 2002 Form 1065 that it had interest income of $191,640 and it claimed deductions of $1,691,640. TIP did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued a notice of Final Partnership Adjustment (“FPAA”) which adjusted downward the capital contributed to and assets of TIP by $101,500,000 and sought to adjust the outside basis of LCT by $101,500,000. For 2002, the FPAA adjusted downward income by $191,640 and disallowed the deduction of $1,691,640.

(ii.) Thomas Division Partnership

TDP reported on its 2001 Form 1065 that $101,500,000 had been contributed in capital during the year and that this amount constituted an asset of TDP. TDP also reported on its 2001 Form 1065 that TIP had increased its capital in TDP by $101,500,000. TDP also issued a K-1 to TIP for 2001 that reflected an increase in TIP's capital account of $101,500,000 due to the contribution of the transaction. TDP reported on its 2002 Form 1065 that it had interest income of $191,640, and it claimed deductions of $1,691,640. TDP did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of TDP by $101,500,000, and sought to adjust the outside basis of TIP by $101,500,000. For 2002, the FPAA adjusted downward income by $191,640, and disallowed the deduction of $1,691,640.

2. The Fox Trust Transaction

On December 20, 2001, the Fox Trust and AIG entered into a transaction in which the Fox Trust paid $675,000 to AIG. Fox contends that the purpose of the transaction was to serve as a hedge against potential loss in the value of his real-estate interests arising from the risk of terrorism after September 11, 2001. Fox also contends that the Fox Trust paid $675,000 for an opportunity to receive up to a net maximum of $17,242,574. The potential payout from the transaction was tied to the value of a portfolio of twenty REIT stocks (the “REIT basket”). This was the identical basket that the Lumbee Clan Trust transaction used.

a. The Structure of the Transaction

In general, the transaction between the Fox Trust and AIG consisted of a short option, a long option, and a promissory note. On December 20, 2001, the Fox Trust and AIG in order to implement the transaction did the following: (1) the Fox Trust sold a short option to AIG for $45 million; (2) the Fox Trust purchased a long option from AIG for $27,757,426; (3) the Fox Trust purchased a promissory note from AIG for $17,917,574; and (4) the Fox Trust pledged the proceeds from the long option and the promissory note to secure the short option. The Fox Trust's transaction costs amounted to $675,000. The options were Asian-style European options. The promissory note eliminated AIG's obligation to transfer funds to the Fox trust in an amount representing the difference between the price of the short option and the price of the long option. The strike price of the short option was fifty percent of the value of the REIT basket, or $45,009,529. The strike price of the long option was seventy percent of the value of the REIT basket, or $63,013,341.

b. The Terms of the Transaction

The terms of the transaction provided that any payoff depended on the average value of the REIT basket between December 20, 2001, and March 19, 2002, as compared to the value as of December 19, 2001. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, did not fall by greater than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Fox Trust would receive no payout. If the average value of the REIT basket between December 20, 2001, and March 19, 2002, fell by more than thirty percent as compared to the value of the REIT basket on December 19, 2001, then the Fox Trust would receive a cash payment that would increase dollar-for-dollar with the reduction in the average value of the REIT basket below seventy percent of the value of the REIT basket on December 19, 2001, until a maximum payout of $18,003,812 was reached. This maximum payout would be reached if the average value of the REIT portfolio fell by fifty percent or more from its value on December 19, 2001. However, the Fox Trust would never be obligated to pay out-of-pocket anything other than the $675,000 transaction costs paid to AIG on December 20, 2001.

c. The Contributions to the Partnerships

On December 27, 2001, the Fox Trust contributed the transaction to HFI. Specifically, the Fox Trust contributed the long option and the promissory note, and HFI assumed the short option. On December 27, 2001, HFI contributed $34,749,083 of the transaction to MP-MI. Specifically, HFI contributed seventy-six percent of the long option and the promissory note, and MP-MI assumed seventy-six percent of the short option. HFI had no prior investment in MP-MI. On December 27, 2001, HFI contributed $7,682,535 of the transaction to TMI. Specifically, HFI contributed seventeen percent of the long option and the promissory note, and TMI assumed seventeen percent of the short option. HFI had no prior investment in TMI. On December 27, 2001, HFI contributed the remaining seven percent of the transaction to Manhattan Properties, LP 4 , which assumed the remaining seven percent of the short option. These contributions of the assets and assumptions of the short option were with the approval of AIG. After the contributions to the partnerships, AIG's position in the short option remained secured by the pledge of the long option and the note.

d. The Performance of the REIT Basket and the Transaction

The value of the REIT basket did not decline by an average of thirty percent for the period between December 20, 2001, and March 19, 2002, as compared to its value on December 19, 2001. Therefore, the transaction did not yield a net payment to Fox.

e. The Tax Reporting by the Partnerships and the IRS Adjustments Related to the Transaction

(i.) Huntington/Fox Investments

HFI reported its investment in MP-MI on its 2001 Form 1065 in the amount of $513,515. HFI reported its investment in TMI on its 2001 Form 1065 in the amount of $113,519. HFI reported on its 2002 Form 1065 deductions of $707,183 and income of $80,114 pertaining to the transaction. HFI did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of HFI by $42,431,618, and sought to adjust outside basis of the Fox Trust by $42,431,618. For 2002, the FPAA adjusted income downward by $80,114, and disallowed the deduction of $707,183.

(ii.) Maguire Partners-Master Investments

MP-MI reported on its 2001 Form 1065 that it had made a capital contribution of $34,749,083 during the year and that this amount constituted an asset of the partnership. MP-MI also reported on its 2001 Form 1065 that HFI had increased its capital in MP-MI by $34,749,083. MP-MI also issued a K-1 to HFI for 2001 that reflected an increase in the HFI's capital account of $34,749,083 due to the contribution of the transaction. MP-MI reported on its 2002 Form 1065 that it had interest income of $65,609 and it claimed deductions of $579,143 pertaining to the transaction. It also reported other investments of $34,235,549. MP-MI did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of MP-MI by $34,749,083, and sought to adjust the outside basis of HFI by $34,749,083. For 2002, the FPAA adjusted downward income by $65,609, and disallowed the deduction of $579,143. The IRS also adjusted the other investments downward by $34,235,549.

(iii.) Thomas Master Investments

TMI reported on its 2001 Form 1065 that it had made a capital contribution of $7,682,535 during the year and that this amount constituted an asset of TMI. TMI also reported on its 2001 From 1065 that HFI had increased its capital in TMI by $7,682,535. TMI also issued a K-1 to HFI for 2001 that reflected an increase in HFI's capital account of $7,682,535 due to the contribution of the transaction. TMI reported on its 2002 Form 1065 that it had interest income of $14,505, and it claimed deductions of $128,040 pertaining to the transaction. It also reported other investments of $7,569,000. TMI did not account for the short option on either the Form 1065 or the K-1s for 2001 and 2002. For 2001, the IRS issued an FPAA that adjusted downward the capital contributed to and assets of TMI by $7,682,535, and sought to adjust the outside basis of HFI by $7,682,535. For 2002, the FPAA adjusted downward income by $14,505, and disallowed the deduction of $128,040. The IRS also adjusted the other investments downward by $7,569,000.

C. Background Regarding the Transactions at Issue

1. The Arthur Andersen Call-Option Spread

The transactions that were entered into by the Lumbee Clan Trust and AIG and the Fox Trust and AIG were designed by Arthur Andersen and referred to internally by various names, such as the “call-option spread”, the “synthetic put” and “asset-hedging.” The call-option spread consisted of two call options - one long and one short - and a promissory note. 5 By using the call-option spread, a taxpayer would be able to create a basis in an amount substantially greater than the amount of money actually paid for the call-option spread by taking the position that the transaction created a “contingent” liability for purposes of I.R.C. § 752 . In order to create basis and obtain the tax benefit, the taxpayer was required to contribute the call-option to a partnership.

The call-option spread was viewed by Arthur Andersen tax partners as one of many-tax-avoidance techniques marketed by Arthur Andersen. In fact, from 1999 to 2001, Arthur Andersen arranged approximately ten call-option spread transactions, and in all but one of these transactions AIG was the counterparty. The call-option spread was considered a “proven solution” by Arthur Andersen, which included techniques offered by Arthur Andersen to minimize taxes. It is estimated that the call-option spread transactions generated about $14.7 million in fees for Arthur Andersen in fiscal years 2000 and 2001.

2. Thomas and Fox Learn About the Call-Option Spread

In 2001, Martin Griffiths, a tax partner in the Los Angeles office of Arthur Andersen, was the engagement partner and the main point of contact for Thomas and Fox. In fact, Thomas, Fox, and another real estate investor, Robert Maguire, represented approximately one hundred percent of Griffiths's business. Because Griffiths was familiar with the investment portfolios and tax needs of Thomas and Fox, he considered it his duty to investigate and determine if any of the “interesting planning ideas” presented to him by Arthur Andersen had any applicability to Thomas or Fox. He testified that it was his job to bring Arthur Andersen's “industry expertise” to bear on Thomas and Fox's interests.

Sometime before September 11, 2001, Griffiths became aware of the call-option spread, and decided to investigate it for Thomas, Fox, and Maguire. Before September 11, 2001, Griffiths contacted his fellow tax partner Mandel to learn more about the call-option spread. After discussing the call-option spread with Mandel, Griffiths and Mandel met with Thomas and, separately, with Fox on September 27, 2001. During these meetings, Mandel explained to Thomas, a former trial attorney with the I.R.S., and Fox the increased basis that could result from the call-option spread, which Mandel described as a hedge, if the options and note were contributed to a partnership. In the weeks after the September 27, 2001 meetings, Griffiths continued to discuss the call-option spread with Thomas and Fox, including detailed discussions regarding the structure of the transaction.

In December 2001, Paul Rutter, outside transactional counsel to Thomas and Fox, met with Mandel to discuss the transaction. He also reviewed the transactional documents prepared by Sullivan & Cromwell, counsel to AIG. Rutter was not an expert on options or hedging, and did not provide business advice to Thomas or Fox regarding the transaction. Instead, Rutter's representation was limited to reviewing the documents prepared by AIG's counsel, which included the contribution agreements by which the transaction would be contributed to the partnerships. Rutter testified that it was his understanding “that they [AIG] were doing this transaction with other people and had a pre-existing set of documents they used[.]”

Rutter also testified that the decision to contribute the transactions to Thomas and Fox's respective partnerships had already been made by the time he became involved in the transaction. In fact, Thomas and Fox admitted that it was always their intention to contribute the transactions to their respective partnerships. The partnership contributions were always viewed by Thomas, Fox, Griffiths, and Rutter as integral to the entire transaction.

On December 20, 2001, Thomas and Fox entered into the call-option spread transactions, described above, with AIG.

II. Discussion

A. The Lumbee Clan Trust Transaction And The Fox Trust Transaction Lack Economic Substance.

A taxpayer is not permitted to reap tax benefits from a transaction that lacks economic substance. 6 Coltec Industries, Inc. v. United States , 454 F.3d 1340, 1352-55 (Fed. Cir. 2006) (discussing Supreme Court precedent invoking economic substance since 1935). As the Federal Circuit explained in Coltec , the economic substance doctrine requires “disregarding, for tax purposes, transactions that comply with the literal terms of the tax code but lack economic reality,” and, thus, “prevent[s] taxpayers from subverting the legislative purpose of the tax code by engaging in transactions that are fictitious or lack economic reality simply to reap a tax benefit.” Id. at 1352-54.

1. Legal Standard for Economic Substance Analysis

To determine whether a transaction is merely an economic sham, the court must determine whether the transaction had any practical economic effect other than the creation of tax benefits. Casebeer v. Commissioner , 909 F.2d 1360, 1363 (9th Cir. 1990); Sochin v. Commissioner , 843 F.2d 351, 354 (9th Cir. 1988). Therefore, the court must exam the objective economic substance of the transaction and the subjective business motivation of the taxpayer. Sochin , 843 F.2d at 354; Casebeer , 909 F.2d at 1363. However, the objective and subjective inquiries are not “discrete prongs of a rigid twostep analysis,” but “are simply more precise factors to consider in the application of [the Ninth Circuit's] traditional sham analysis; that is, whether the transaction had any practical economic effects other than the creation of income tax losses.” Id.

a. The Objective Economic Substance Inquiry

Under the objective economic substance inquiry, the Court must determine “whether the transaction ha[s] economic substance beyond the creation of tax benefits.” Casebeer , 909 F.2d at 1365 ( citing Bail Bonds by Marvin Nelson, Inc. v. Commissioner , 820 F.2d 1543, 1549 (9th Cir. 1987). To do so, the court must analyze whether the “substance of the transaction reflects its form” and whether, objectively, “the transaction was likely to produce economic benefits aside from a tax deduction.” Id.

A transaction lacks objective economic substance where it does not appreciably affect a taxpayer's beneficial interest except to reduce his taxes. Knetsch v. United States , 364 U.S. 361, 366 (1960); ACM Partnership v. Commissioner , 157 F.3d 231 248 (3d Cir. 1998). For example, de minimis economic effect - such as the accumulation of small amounts of cash value in an annuity contract or the assumption of marginal risks in a partnership arrangement - are insufficient to create economic substance. Knetsch , 364 U.S. 361, 365-66 (finding transaction involving leveraged annuities to be economic sham because possible $1,000 cash value of annuities at maturity was “relative pittance” compared to purported value of annuities); ASA Investerings Partnership v. Commissioner , 201 F.3d 505, 514 (D.C. Cir. 2000); ACM , 157 F.3d at 251-52.

b. The Subjective Business Purpose Inquiry

The Court analyzes a taxpayer's subjective business purpose by determining “whether the taxpayers have shown that they had a business purpose for engaging in the transaction other than tax avoidance.” Casebeer , 909 F.2d 1363-64. This analysis “often involves an examination of the subjective factors that motivated a taxpayer to make the transaction at issue,” such as the experience of the taxpayer, the extent of the taxpayer's investigation into a transaction, the extent of any advisor's investigation into the deal, and the taxpayer's trial testimony regarding their motivation for entering into the transaction.” Bail Bonds , 820 F.2d at 1549; see, also, Casebeer , 909 F.2d at 1364.

One factor that can be considered in analyzing a taxpayer's subjective business purpose is whether the taxpayer was acting like a prudent economic actor or contrary to rational business interests in the transaction. See, e.g., Gilman v. Comm'r , 933 F.2d 143, 146-47 (2d Cir.1991) (requiring taxpayer to demonstrate that prudent investor could have concluded that “realistic potential for economic profit” existed) (internal quotation marks omitted); Rice's Toyota World, Inc. v. Comm'r , 752 F.2d 89, 91 (4th Cir.1985) (equating lack of economic substance with finding that “no reasonable possibility of a profit exists”); Long Term Capital , 330 F.Supp.2d at 172 (finding that transaction lacked economic substance because, “at the time the transaction was entered into, a prudent investor would have concluded that there was no chance to earn a non-tax based profit return in excess of the costs of the transaction”); Estate of Strober v. Comm'r , 63 T.C.M. (CCH) 3158, 3160 (1992) (“We conclude that … a prudent investor, relying upon independently obtained appraisals and research, would not have concluded that [the] transaction offered a reasonable opportunity for economic gain exclusive of tax benefits.”). Thus, as the Federal Circuit found in Coltec, there must be an objective inquiry into economic reality that would ask “‘whether a reasonable possibility of profit from the transaction existed,’” Coltec , 454 F.3d at 1356 (quoting Black & Decker , 436 F.3d at 441), and “whether the transaction has ‘realistic financial benefit.’” Id . at 1356 n. 16 (quoting Rothschild , 407 F.2d at 411); see, also, Jade Trading, 80 Fed. Cl. At 47-48 (“The inquiry is not whether the [taxpayers] believed the Jade transaction was a real investment capable of making a profit, but whether the Jade transaction in fact objectively was a real investment capable of making a profit and altering their financial positions.”). In addition, where a taxpayer is sophisticated in economics and/or taxation, entering a bad deal may shed light on the taxpayer's true tax-avoidance motivation. Id. (“the absence of reasonableness sheds light on Long Term's subjective motivation, particularly given the high level of sophistication possessed by Long Term's principals in matters economic.”). Similarly, a conspicuous lack of concern over the particulars of the transaction by the taxpayer may be evidence that the transaction is a sham. See, Mahoney v. Commissioner , 808 F.2d 1219, 1220 (6th Cir. 1987).

2. The Transactions At Issue Lack Economic Substance

The presence or lack of economic substance for federal tax purposes is determined by a fact-specific inquiry on a case-by-case basis. Frank Lyon , 435 U.S. at 584. In this case, the Court finds that the evidence demonstrates that the transactions at issue do not have economic substance because Thomas and Fox received no economic benefit, other than the increase in basis, from the transactions. In addition, the Court finds that the evidence demonstrates that Thomas and Fox were motivated by this increased basis and not by any purported “hedging” benefit.

Plaintiffs argue that factual differences between this case and the recent economic substance cases of Stobie Creek and Jade Trading mean that the transactions at issue in this case do, in fact, have economic substance. However, an examination of how the economic substance analysis was applied in Stobie Creek and Jade Trading demonstrate that the transaction at issue in this case, like the transactions in those cases, do not have economic substance.

a. Under the Economic Substance Analysis as Applied in Stobie Creek , The Transactions At Issue in This Case Lack Economic Substance

Stobie Creek involved the contribution of offsetting long and short foreign-currency options to single-member LLCs. The plaintiffs in Stobie Creek alleged that the principal involved was a “reasonable investor” who “made a reasonable assessment regarding profitability.” Id . at 693. In evaluating this claim, the court stated that it could not “ignore the functional and historical reality that the [offsetting option pairs] were part of the prepackaged J&G strategy marketed to shelter taxable gains.” Id. In addition, the Court in Stobie Creek relied heavily on the expert testimony offered by the Government in concluding that “plaintiffs' attempts to establish a legitimate profit motive wither against the devastating, much more credible expert testimony that established the objective economic reality that the [offsetting option pairs] were severely over-priced, had a negative expected-rate-of-return, and consequently had a scant profit potential.” Stobie Creek , 823 Fed. Cl. At 696. The Government's expert concluded that the transaction “was priced at levels that far exceeded [the components'] theoretical value[,]” where those values were computed using an adaptation of the Black-Scholes model. Id. At 685.

The court dismissed the plaintiffs' expert's criticism of the Government's expert's reliance on the Black-Scholes model. While the court recognized the validity of the criticism that “the model involves assumptions of perfect and static markets[,]” it found that the plaintiffs' expert “could not offer a more appropriate substitute.” Id. at 689-90. The court concluded that the expert testimony “suggests that no reasonable and prudent investor would have expected a possibility of a profit on these transactions.” Id. at 693.

In evaluating the subjective business purpose prong of the economic substance analysis, the court rejected the testimony of the principal that he “believed a 30% chance of doubling his investment existed” because the court found that “the [offsetting option pairs] had no objectively reasonable possibility of returning a profit and therefore lacked an objective business purpose.” Id. at 698. The court found that the transactions were “integral to a ‘preconceived’ tax shelter scheme that was not structured to create a viable profit-producing investment, but, rather, to inflate the basis in an unrelated asset that would yield large capital gains upon sale.” Id. Moreover, the court found that while there was “limited evidence” of an investment motive, the evidence was “not sufficient to overcome the evidence that the [offsetting option pairs] were economic nullities beyond producing the claimed tax benefits.” Id.

Similarly, in this case, Defendant's expert, Professor Grendier, used recognized option-pricing-modeling techniques to conclude that the value of the Thomas transaction was $574, and the value of the Fox transaction was $259. 7 Therefore, based on a thirty-five percent volatility, Thomas and Fox paid approximately 2,700 and 2,600 times the value of the transactions they purchased.

Although Plaintiffs' experts, Professors Manaster and Edelstein, criticized Professor Grendier's Black-Scholes method, Professor Manaster testified that, in the absence of comparative prices, he would have performed the same analysis while Professor Edelstein offered no acceptable alternative to Professor Grenadier's analysis.

Moreover, like the transaction in Stobie Creek , the call option spread was a prepackaged deal offered by Arthur Andersen that focused on the creation of basis. Arthur Andersen did not offer any advice on whether the transaction was a hedge, and Mandel, who offered the call option spread to Thomas and Fox, had no expertise on hedging or options.

Finally, there is no credible evidence that the transactions performed as hedges. First, there is no credible evidence that a close correlation exists between the value of the broad-based REIT basket and the value of any of Thomas's and Fox's real estate investments. Second, even if the transactions served as hedges, the price paid by Thomas and Fox vastly exceeded any benefit they could have received. In addition, despite claiming to follow the REIT market closely, Fox did not know the difference between the average drop required to produce a return of one dollar on his transaction, and the historical drop that occurred in 1974. Therefore, as in Stobie Creek , the Court does not find that the self-serving testimony of the principals, Thomas and Fox, sufficient to overcome the substantial and objective evidence that the transactions at issue are economic nullities entered into for the purpose of fabricating tax basis in amounts that are vastly disproportionate to the actual cost.

b. Under the Economic Substance Analysis as Applied in Jade Trading , The Transactions At Issue in This Case Lack Economic Substance

Jade Trading , another recent case involving economic substance analysis, involved the contribution of a long option and a short option to a partnership. Jade Trading , 80 Fed. Cl. at 11-13. The three taxpayers each paid $150,002, and each obtained an increased basis of $15 million. Id. The court disallowed the claimed tax benefits and determined that the transaction was an economic sham. Id. at 14. The court reached its conclusion based on five reasons. First, the claimed losses “were purely fictional” because the taxpayers “did not invest $15 million in the spread and did not lose $15 million when exiting Jade without exercising either option.” Second, the plaintiffs contentions that the transaction had a profit potential was contradicted by the large limitation on the maximum net profit that could be earned and the “large and unusual” fees that the plaintiffs paid. Third, the transaction was “devised and marketed by a tax accounting group …as a tax product, not by an investment advisor as a vehicle to earn a profit,” and, thus, the court found it “was developed as a tax avoidance mechanism and not an investment strategy.” Fourth, the initiation of the transaction outside the partnership followed by the contribution to the partnership “had no effect whatsoever on the investment's value, quality, or profitability, except to add cost and burden,” but “packaging the investment in the partnership vehicle was an absolute necessity for securing the tax benefits.” Fifth, there was a “highly disproportionate tax advantage to the underlying monetary outlay - the tax loss per [taxpayer], $14.9 million, was roughly 65 times greater than each LLC's $225,002 financial commitment to Jade, almost 100 times each LLC's $150,002 investment in the spread transaction which generated the loss, and approximately 100 times the $140,000 potential net profit each LLC could have earned.”

Similarly, the Court finds that consideration of these same five reasons in this case leads to the same result - that the transactions at issue in this case lack economic substance. First, the claimed basis is fictional, because Thomas and Fox paid only $1.5 million and $675,000, respectively for the integrated transactions they purchased, but gained an increased basis of $101,500,000 and $45,675,000, respectively. The increase in basis is approximately sixty-seven times what they paid for the transactions. Second, as Professor Grenadier explained, there is virtually no likelihood of a thirty percent average drop over ninety days - the drop required to yield a one dollar return - much less the average fifty percent drop required to yield the maximum payout possible. 8 Third, the design of the call option spread demonstrates that it was designed for the creation of tax benefits. Mandel, who was intimately familiar with the call option spread transaction format and was integral in selling these transactions to Thomas and Fox, was a tax expert specializing in “leading edge tax solutions,” not an options or risk-management expert. Moreover, there is no evidence that the call option spread was designed as a hedge generally, or that it operated as a hedge with respect to the transactions at issue in this case. Fourth, there is no evidence that the contribution to the partnerships, which was part of the design of the prepackaged transactions, had any effect “on the investment's value, quality, or profitability.” However, the contribution was required for the creation of an increased basis. In addition, in the weeks after Mandel first discussed the call option spread with Thomas and Fox, Griffiths provided tax advice to them about the increased basis they would achieve if they purchased the transactions. Fifth, the tax benefit is highly disproportional - sixty-seven times - to the actual economic outlay. As a result the Court finds that the transactions at issue lack economic substance.

c. The Transactions At Issue In This Case Are Economic Shams.

In this case, it is clear that Plaintiffs are not taxpayers “who structured their transactions and ordered their affairs in a way so as to reduce their liability for taxes or to achieve the greatest tax benefits; rather, the tax benefits shaped the structure of the investment in order to achieve the goal of tax avoidance.” Stobie Creek , 82 Fed. Cl. at 698; see, also, Coltec , 454 F.3d at 1357 (“there is a material difference between structuring a real transaction in a particular way to provide a tax benefit (which is legitimate), and creating a transaction, without a business purpose, in order to create a tax benefit (which is illegitimate).”). Because of the mismatch between the purported purpose of “hedging” and the inability of the Asian-style options to satisfy that purpose, the dramatic overpayment by Thomas and Fox for the de minimis value they received in return, and the virtual impossibility of receiving even one dollar in return versus the certain increase in basis by $101,500,000 Thomas and 445,675,000 by Fox, the Court finds that the only appreciable benefit gained by the transactions at issue was an increased basis. This conclusion is supported by the fact that Thomas and Fox were sophisticated economic actors. In fact, Thomas was a former trial attorney with the IRS. Thomas and Fox, along with Griffiths, their tax advisor, obviously recognized the value that would result from the increased basis, such as shielding distributions of cash and property from their partnerships by characterizing that property as a return on capital, or reducing the obligation to restore a negative capital account on termination of their partnerships.

The Court finds that the weight of evidence, including the persuasive expert testimony by Professor Grenadier, established that the transactions at issue did not appreciably improve the economic position of Thomas and Fox beyond the creation of an increased basis. Any subjective belief by Thomas and Fox that the transaction constituted a hedge was not objectively supported by the evidence, and any subjective belief that there was an economic benefit is not objectively reasonable. No prudent business person, such as Thomas or Fox, would pay between 2,600 and 2,700 times the value of the transactions in this case for this type of a hedge. Because the transactions do not provide any appreciable economic benefit to Thomas or Fox, the Court finds that the transactions at issue are economic shams, and any evidence of a non-tax avoidance subjective motivation is not sufficient to give the transactions economic substance. Therefore, the transactions must be disregarded under the prevailing economic substance doctrine, and are without effect for purposes of federal taxation.

B. Application of the Step Transaction Doctrine Yields a Cost-Basis of $1.5 Million for Thomas and $675,000 for Fox.

As an alternative to the economic substance doctrine, Defendant also seeks to invalidate the tax effects claimed by Plaintiffs under the step transaction doctrine. “The Supreme Court has expressly sanctioned the step transaction doctrine, noting that ‘interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction.’” The Falconwood Corp. v. United States , 422 F.3d 1339, 1349 (2005) (quoting Comm'r v. Clark , 489 U.S. 726, 738 (1989)). “[T]he objective of the doctrine is to ‘give tax effect to the substance, as opposed to the form of a transaction, by ignoring for tax purposes, steps of an integrated transaction that separately are without substance.’” Id . (quoting Dietzsch v. United States , 204 Ct.Cl. 535, 498 F.2d 1344, 1346 (1974)).

Courts principally rely on two tests to determine whether to apply the step-transaction doctrine: the interdependence test and the end result test. See, Kornfield v. Commissioner , 137 F.3d 1231, 1235 (10th Cir. 1998); Brown v. United States , 782 F.2d 559, 563-64 (6th Cir. 1986); Security Indus. Ins. Co. v. United States , 702 F.2d 1234, 1244 (5th Cir. 1983); McDonald's Rests. v. Commissioner , 688 F.2d 520, 524-25 (7th Cir. 1982). While the two tests have different formulations, both tests have as their central purpose the implementation of “the central purpose of the step transaction doctrine; that is, to assure that tax consequences turn on the substance of a transaction rather than on its form.” King , 418 F.2d at 517.

1. The End-Result Test

The end-result test applies when “a series of separate transactions were prearranged parts of what was a single transaction, cast from the outset to achieve the ultimate result.” Greene v. United States , 13 F.3d 577, 583 (2d Cir. 1994)( citing Penrod v. Commissioner , 88 T.C. 1415, 1429 (T.C. 1987). “[p]urportedly separate transactions will be amalgamated into a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result.” Brown , 782 F.2d at 564 ( quoting King , 418 F.2d at 516). While the taxpayer's intent is relevant under the end-result test, it is not the intent to avoid taxes; instead, it is whether the taxpayer intended to achieve a particular end-result, legitimate or not, through a series of interrelated steps. True , 190 F.3d at 1175. Thus, if a taxpayer structures a single transaction in a certain way that involves multiple steps, “he cannot request independent tax recognition of the individual steps unless he shows that at the time he engaged in the individual step, its result was the intended end result in and of itself.” Id. at 1175 fn. 9.

In this case, both Thomas and Fox contend that the reason they engaged in the transactions at issue was to “hedge” against a catastrophic collapse in the real-estate market. Thus, as they described it, Thomas and Fox essentially placed a “bet” that they now contend amounted to a hedge. Therefore, the long option, the short option, and the promissory note are simply the “interrelated steps” through which Thomas and Fox accomplish this “bet” or “hedge.” Under the end results test, these interrelated steps of the transaction should be collapsed into a unified whole and the tax consequences determined accordingly.

In addition, any attempt by Plaintiffs to argue that they had a valid business purposes, such as the plaintiff in the Falconwood case, in engaging in the transactions at issue does not “immunize” these transactions from the step transaction doctrine. See, Stobie Creek , 82 Fed. Cl. at 701. While the court in Falconwood held that the step transaction doctrine did not apply to the series of transactions at issue, it did so because the taxpayer had an independent business purpose for the initial step, and then was bound by regulation to follow the remaining steps that the Government had sought to collapse. Falconwood , 422 F.2d at 1351-52 (“Upon completing a downstream merger for independent business reasons, Falconwood therefore had little choice in the face of quasi-legislative mandates but to file a final consolidated tax return for the group that covered Falconwood's operations for its entire taxable year.”). However, as in Stobie Creek, Plaintiffs “cannot align themselves with the factual circumstances presented in Falconwood ” because they “were not bound by any legislative or regulatory mandate to proceed along the tortuous steps that resulted in the claimed basis enhancement.” Stobie Creek , 82 Fed. Cl. at 702.

2. The Interdependence Test

“The interdependence formulation of the step transaction doctrine requires an inquiry into whether the individual transactions in the series would be “fruitless” without completion of the series.” Id. at 699 ( quoting Falconwood , 422 F.3d at 1349). Under this test, courts analyze whether or not one part of the overall transaction would have occurred without another part. Kornfield , 137 F.3d at 1235; Security Indus. Ins. , 702 F.2d at 1247. If not, the transaction is then integrated and the step transaction applies. Id. Thus, under this test, courts “disregard the tax effects of individual transactional steps if “it is unlikely that any one step would have been undertaken except in contemplation of the other integrating acts.” True , 190 F.3d at 1175 ( citing Kuper v. Commissioner , 533 F.2d 152, 156 (5th Cir. 1976)).

In this case, the components of the transactions at issue were interdependent because each component was required to accomplish the desired economic result, which was, as Plaintiffs describe it a “bet” or “hedge” against a collapse in the real estate market. This is best demonstrated by the fact that the documents executed as part of the transactions created interlocking contractual obligations. For example, the Certificate re: Consent and Authorization discusses a “Master Transaction.” The Master Transaction “would be effectuated through the execution and delivery by the Trust of the following agreements: (a) Master Agreement to be entered into by … the Trust and [AIG] …; (b) Note …, to be entered into by and between the Trust and [AIG]…; (c) Pledge Agreement by and between Trust and [AIG]; (d) Option and Equity Derivative Account Agreement by and between Trust and [AIG], and (e) Confirmation Letter Agreements re: share option transaction I and re: share option transaction II to Trust from [AIG].” Moreover, the Master Agreement specifies that all transactions and confirmations constitute a single agreement.

The creation of these interlocking obligations with respect to the long option, the short option, and the note accomplished the goal of creating the “bet” sought by Thomas and Fox. Neither the long or short option independently could have created the required “bet.” For example, Thomas and Fox would have only benefitted from an independent purchase of the long option if prices of the stocks in the REIT basket increased, which is the opposite of what they were trying to accomplish in “hedging” against a drastic downturn in the real estate market. In addition, an independent purchase of the short option would have exposed Thomas and Fox to unlimited losses if the price of the stocks in the REIT basket increased. Thus, the purchase of the long option, the short option, and the AIG note were required to accomplish the desired “hedge.” Therefore, the transactions making up the steps of the “hedge” strategy pursued by the Plaintiffs “are interdependent and have no independent functional justification outside of the series.” Stobie Creek, 82 Fed. Cl. at 700. “Under the interdependence test, the individual steps must be disregarded and collapsed into a single transaction.” Id.

The Court finds that, under either the interdependence test or the end result test, the step transaction doctrine applies to Plaintiffs' transactions. Id. Accordingly, the tax consequences should be determined on the substance of the transactions at issue, and not on the form used by Plaintiffs. Id.

C. Application of the Substance Over Form Doctrine Yields a Cost-Basis of $1.5 Million for Thomas and $675,000 for Fox.

In 1945, the Supreme Court stated: “The incident of taxation depends on substance rather than form of the transaction.” Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945); see, also, True v. United States , 190 F.3d at 1174 (10th Cir. 1999); Allen v. Commissioner , 925 F.2d 348, 352 (9th Cir. 1991). In applying this principle, a court “must look beyond the taxpayers' characterization of isolated, individual transaction steps, and also review the substance of each series of transactions in its entirety.” True , 190 F.3d at 1174. Thus, taxpayers may not characterize a transaction solely based on the labels they have used, because such an approach “would completely thwart the Congressional policy to tax transactional realities rather than verbal labels.” Crenshaw v. United States , 450 F.2d 472, 477-78 (5 th Cir. 1971). Therefore, it is the “true nature” of the transaction, not its “mere formalisms” that control. Court Holding , 324 U.S. at 334; see, also, Allen , 925 F.3d at 352; True , 190 F.3d at 1174.

The countervailing consideration to application of the substance over form doctrine is the principle that taxpayers may generally structure their transactions as they wish. Brown v. United States , 329 F.3d 664, 671 (9 th Cir. 2003). Thus, courts do not invalidate claimed tax benefits if the form of the transaction yields tax benefits which are consistent with Congressional intent as to the particular Internal Revenue Code provisions at issue. Id. at 672. Therefore, courts must make a fact-specific inquiry to determine if the facts fall within the intended scope of the applicable statute. Stewart v. Commissioner , 714 F.2d 977, 988 (9 th Cir. 1983).

In this case, Thomas and Fox entered into the transactions at issue, which they described as “bets” or “hedges” against a collapse in the real estate market. Thomas contends that he “paid approximately $1,500,000 to take a chance that he could receive up to $38,400,000.” According to Thomas, “[t]he $1.5 million is, in effect, the TDP transaction cost, the cost of inducing Banque AIG to make a bet on real estate values. Similarly, Fox contends he “paid approximately $675,000 to take a chance that he could receive up to $17,242,574.” According to Fox, “[t]he $675,000 is, in effect, the Fox transaction cost, the cost of inducing Banque AIG to make a bet on real estate values.”

Once these initial payments of $1.5 million and $675,000 were made, Thomas and Fox had no downside exposure from their “bets,” and only an extremely remote possibility of receiving a return. These contractually interlocking transactions were carefully structured so that the amount payable under the short option would never exceed the amounts to be received from the long option and the AIG note. The assets - the long option and the note - were pledged to AIG to secure the liability created by the short option.

For purposes of the application of the form over substance doctrine, the substance of the transaction is clearly a net payment of $1.5 million by Thomas and $675,000 by Fox for a possible payout with no downside exposure. Therefore, Thomas's true economic cost is $1.5 million, not $101.5 million. Similarly, Fox's true economic cost is $675,000, not $45,675,000.

Because the basis of property is its cost per I.R.C. § 1012 , and because Thomas's economic cost for the entire transaction was $1.5 million, his basis was $1.5 million. Thomas's partnerships succeeded to that basis. Similarly, because Fox's economic cost for the entire transaction was $675,000, his basis was $675,000. HFI succeeded to that basis, while MP-MI and TMI succeeded to their proportional share of that basis. The partnerships' characterization of the contribution at more than sixty times what Thomas and Fox actually paid for their unified position is plainly inconsistent with the fundamental principle that basis equals cost as expressed by Congress in I.R.C. § 1012 . Accordingly, under the substance over form doctrine, the tax consequences should be determined on the substance of the transactions at issue, and not on the form used by Plaintiffs.

D. Even if the Transactions At Issue Have Economic Substance and the Step-Transaction and Form Over Substance Doctrines Do Not Apply, the Obligation Created by the Short Option is a Liability for Purposes of I.R.C. § 752.

When a partner contributes property to a partnership, the partnership succeeds to the contributing partner's basis in the property under I.R.C. § 723 . In addition, the contributing partner increases his basis in the partnership by his cost basis in the property under I.R.C. § 722 .

On the other hand, when a partnership assumes a liability of a partner, the partner's basis in his partnership interest is: (1) decreased by the amount of the liability; and (2) increased by the partner's share of the partnership liability resulting from the assumption of the liability. I.R.C. §§ 722 , 733(1), and 752(a) and (b). Once the liability is satisfied, the partner's basis in his partnership interest is decreased by the amount of the liability. I.R.C. §§ 733(1) and 752(b).

In this case, Plaintiffs argue that the short option was not a liability for purposes of Section 752 . Therefore, for example, Thomas argues that the $101.5 million increase in basis that he received when he contributed the long option and the AIG note should not be reduced to account for the offsetting $100 million short option. However, as explained above, when the liability is satisfied, Thomas's basis should be reduced by $100 million pursuant to Section 752 . Therefore, the increase in Thomas's basis would be merely $1.5 million, or the equivalent of Thomas's net payment for the transaction. Thus, the characterization of the partnership's short option as a liability for purposes of Section 752 is consistent with the cost basis - and the economic reality - of Thomas's contribution. See , I.R.C. § 1012 .

The above interpretation of Section 752 is consistent with Revenue Ruling 88-77 , where the I.R.S. determined that when an obligation creates or increases the basis of the obligor's assets, the obligation is a “liability” for the purposes of Section 752 . In Revenue Ruling 88-77 , the I.R.S. defined liability for purposes of Section 752 to “include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings).”

In this case, the short option, the long option, and the AIG note were contractually interlocked, and the acquisition of the obligation (the short option) clearly created basis (via the long option and the note) and should be recognized as a liability for purposes of Section 752 . In fact, the long option and the AIG note were purchased with the proceeds of the sale of the short option.

The above interpretation of Revenue Ruling 88-77 is consistent with the Fifth Circuit's interpretation in Korman & Associates, Inc., v. United States , 527 F.3d 443 (5th Cir. 2008), and the Court of Federal Claim's recent interpretation in Marriott International Resorts, L.P., v. United States , 83 Fed. Cl. 291 (2008). 9 At the time of the transactions at issue in this case and prior to the Fifth Circuit's decision in Korman , the Helmer line of cases found that certain liabilities assumed by partnerships should not be recognized for basis purposes because they were too indefinable or “contingent.” See, Helmer v. Commissioner , T.C. Memo. 1975-160 (1975); see, also, Long v. Commissioner , 71 T.C. 1 (1978), and La Rue v. Commissioner , 90 T.C. 465 (1988).

For example, in Helmer , a corporation held a purchase option on real estate owned by a partnership, and made periodic payments to maintain the option. T.C. Memo. 1975-160 (1975). Because the partnership was obligated to apply the option payments to the purchase price if the corporation exercised its option, the partners argued that its receipt of these payments created a partnership liability that increased their basis in the partnership. Id. However, the Tax Court found that the payments “created no liability on the part of the partnership to repay the funds paid nor to perform any services in the future.” 10 Id.

However, in Korman , the Fifth Circuit addressed the question whether the assumption of a liability from a short sale of Treasury notes is a liability under Section 752 , and determined that it was a Section 752 liability because the assumption was accompanied by the contribution of the proceeds from the short sale. In Korman, the taxpayer borrowed $100 million in Treasury bills and sold them for $102.5 million. The taxpayer then contributed the $102.5 million to a partnership, and the partnership assumed the liability for covering the short sale. The taxpayer then conveyed the partnership interest to another partnership, which sold the interest for $1.8 million. The taxpayer claimed a loss of $100 million, and ignored the liability created by the obligation to cover the short sale because it was “contingent.” 11

The Fifth Circuit noted that the taxpayer acknowledged “only suffer[ing] a $200,000 economic loss” but “claim[ing] a $102.6 [m]illion tax loss on its return.” Id. at 456. The Fifth Circuit found the taxpayer was making a “premeditated attempt to transform this wash transaction (for economic purposes) into a windfall (for tax purposes)” that was “reminiscent of an alchemist's attempt to transmute lead into gold.” Id.

In this case, as in Kornman , Plaintiffs are seeking to “treat[] [their] contingent assets and … contingent liabilities asymmetrically.” Id. at 460 (internal citation omitted). Moreover, the proceeds from the initial short sale and the subsequent covering transaction in this case are “inextricably intertwined.” Id . at 460-61. Therefore, to apply the Helmer line of cases to this case would, as the Korman court found, “fl[y] in the face of reality” and result in an “unwarranted aberration.” Id. at 461.

E. Even if the Short Option is Not an I.R.C. § 752 Liability, the Obligation Created by the Short Option Must Still be Taken into Account under Treasury Regulation § 1.752-6.

Section 1.752-6 of the Treasury Regulations applies to a partnership's assumption of liability occurring after October 18, 1999, and before June 24, 2003, if I.R.C. § 752(a) and (b) do not apply to that liability. 12 26 C.F.R. 1.752-6. On June 24, 2003, the Treasury Department proposed regulations, including temporary Treasury Regulation § 1.752-6 , that would define “liability” in the partnership context under I.R.C. § 752 , and which relied on the interpretation of “liability” found in I.R.C. § 358(h)(3) 13 and Revenue Ruling 88-77 . See, Assumption of Partner Liabilities , 68 Fed.Reg. 37,434 (June 24, 2003) (Prop. Treas. Reg. §§ 1.752-0 to -7). These temporary regulations became final on May 26, 2005, and the Treasury Department specified that Treasury Regulation § 1.752-6 would apply retroactively. See, 70 Fed.Reg. 30,334, 30,335 (May 26, 2005). Treasury Regulation § 1.752-6 was adopted by Congressional directive pursuant to Section 309 of the Community Renewal Tax Relief Act of 2000 (“2000 Act”), which added Section 358(h) to the I.R.C., and which defines “liability” as including contingent obligations for purposes of certain corporate stock exchanges. Section 309(c)(1) of the 2000 Act required the Secretary of the Treasury to adopt comparable rules for transactions involving partnerships, and expressly authorized retroactivity of those rules by stating that the Treasury Regulations adopted under Section 309(c) “shall apply to assumption of liabilities after October 18, 1999, or such later date as may be prescribed in such rules.”

If Treasury Regulation § 1.752-6 is applied retroactively in this case, the short options at issue would constitute liabilities for purposes of I.R.C. § 752 , and, thus, would require a reduction in the partnership basis claimed by Plaintiffs.

Plaintiffs argue that, as the court in Stobie Creek recently found, the requirement under Section 1.752-6 that a partner's basis in a partnership interest must be reduced by the value of the contingent liabilities assumed by the partnership is “contrary to the then existing policy to exclude contingent liabilities from the computation of partnership basis.” Stobie Creek Investments, LLC v. United States , 82 Fed. Cl. 636, 668 (2008) (citing Helmer , 34 T.C.M. (CCH) 727 (1975)). Both Plaintiffs and the court in Stobie Creek base the conclusion that Section 1.752-6 represented a change from previous policy on the Treasury Department's statement that “[t]he definition of a liability contained in these proposed regulations [including Section 1.752-6 ] does not follow Helmer. ” Stobie Creek, 82 Fed. Cl. At 668 (citing 68 Fed.Reg. at 37,436).

However, other courts have found that Treasury Regulation § 1.752-6 does apply retroactively. For example, in Cemco the United States Court of Appeals for the Seventh Circuit observed that Treasury Regulation § 1.752-6 was “explicit” in stating that it applied retroactively to assumptions of liabilities occurring before its enactment. Cemco Investors, LLC v. U.S. , 515 F.3d 749, 752 (7th Cir. 2008). The Cemco court relied on I.R.C. § 7805(b)(6) which specifically allows retroactivity. 14 Cemco , 515 F.3d at 752. The Cemco court found that the effect of Treasury Regulation § 1.752-6 was to “instantiate the pre-existing norm that transactions with no economic substance don't reduce people's taxes.” Cemco , 515 F.3d at 752.

This Court agrees with the Cemco court that Treasury Regulation § 1.752-6 should be applied retroactively. The Court finds that the rationale of the First Circuit in Stobie Creek and Plaintiffs with respect to Treasury Regulation § 1.752-6 “misrepresents the state of prior law” by interpreting the statement that “[t]he definition of a liability contained in these proposed regulations does not follow Helmer v. Commissioner ” as an indication that Helmer represented the prevailing prior law. Burke, Karen C. and McCough, Gayson, M.P., Cobra Strikes Back: Anatomy of a Tax Shelter (June 19, 2008), at 33 and 39 n. 121. In addition, the Treasury Department also stated that “following the principles set forth in § 1.752-1T(g) and Rev. Rul. 88-77 , the proposed regulations provide that an obligation is a liability if and to the extent that incurring the obligation: (A) Creates or increases the basis of any of the obligor's assets (including cash).” 68 Fed. Reg. 37434, 37437 (2003).

Recognizing that “[t]here is no statutory or regulatory definition of liabilities for purposes of section 752 ” (68 Fed. Reg. 37434, 37435 (2003)), the Treasury Department relied upon Revenue Ruling 88-77 and Salina Partnership v. Commissioner , T.C. Memo 2000-352 (T.C. 2000), and concluded that “[c]ase law and revenue rulings, however have established that, as under section 357(c)(3) , the terms liabilities for this purpose does not include liabilities the payment of which would give rise to a deduction, unless the incurrence of the liability resulted in the creation of, or increase in, the basis of property.” 68 Fed. Reg. 37334, 37435 (2003). Thus, the Treasury Department found that “[t]he question of what constitutes a liability for purposes of section 752 was addressed in Revenue Ruling 88-77 ,” and that the definition of liability in Revenue Ruling 88-77 was consistent with the Internal Revenue's position in Revenue Ruling 95-26 . Id. at 37436. Therefore, the Treasury Department simply applied the pre-existing rule contained in Revenue Ruling 88-77 to address the possibility of abuse caused by contingent liabilities not being recognized under I.R.C. § 752 . 15

Moreover, Notice 2000-44 placed Plaintiffs on notice that the transactions it described would be scrutinized and penalized. Because Notice 2000-44 was issued in August 2000, and notified taxpayers that the contribution of paired long and short options to partnerships in order to artificially increase outside basis were abusive, and would not be allowed, the Secretary's exclusion of these transactions from the exceptions in Treas. Reg. § 1.752-6(b) should not have been a surprise to sophisticated taxpayers such as Thomas and Fox, and their advisor, Arthur Andersen tax partner Griffiths. Moreover, while Plaintiffs argue that Notice 2000-44 did not give them notice because the transactions at issue are not identical to those described in Notice 2000-44 , Plaintiffs conveniently ignore the “substantially similar” language contained in the Notice. Accordingly, the Court finds that even if the short options at issue in this case are not liabilities under I.R.C. § 752 , the obligations created by the short options still must be taken into account under Treasury Regulation § 1.752-6 .

F. The Accuracy-Related Penalties on the Ground of Negligence or Disregarding the Rules or Regulations is Appropriate Under I.R.C. § 6662.

Section 6662 of the Internal Revenue Code governs accuracy-related penalties. The purpose of penalties is “to deter taxpayers from playing the ‘audit lottery,’ that is, taking undisclosed questionable reporting positions and gambling that they [will] not be audited. Caulfield v. Commissioner , 33 F.3d 991, 994 (8th Cir. 1994). As Plaintiffs have argued, Thomas and Fox have not yet used any of the tax benefits associated with the transactions at issue in this case. Because this case is a partnership-level proceeding, the Court must determine “the applicability of any penalty … which relates to an adjustment to a partnership item.” I.R.C. § 6221 . However, the actual computation of the penalty in not done at the partnership level.

One of the accuracy-related penalties provided for in Section 6662 of the Internal Revenue Code is for negligence or disregard of rules or regulations. I.R.C. § 6662(a) and (b)(1). The Code defines negligence as “any failure to make a reasonable attempt to comply with the provisions” of the Code. I.R.C. § 6662(c) . This is an objective standard requiring that the taxpayer exercise “due care.” Hansen v. Commissioner , 471 F.3d 1021, 1028 (9th Cir. 2006) ( citing Collins v. Commissioner , 857 F.2d 1383, 1386 (9th Cir. 1988)). Due care exists where the taxpayer “acted as a reasonable and prudent person would act under similar circumstances.” Id. Under the Treasury Regulations, negligence is “strongly indicated” where “a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit, or exclusion on a return which would seem to a reasonable and prudent person to be ‘too good to be true’ under the circumstances.” Treas. Reg. § 1.6662-3(b)(1)(ii) (2002); see also Hansen , 471 F.3d at 1029. In the Ninth Circuit, negligence is determined by an analysis of “both the underlying investment and the taxpayer's position taken on the tax return.” Hansen , 471 F.3d at 1029; see also Neonatology Associates, P.A. v. Commissioner , 299 F.3d 221, 234 (3d Cir. 2002) (finding that a taxpayer “proceeds at his own peril” when “presented with what would appear to be a fabulous opportunity to avoid tax obligations.”); Pasternak v. Commissioner , 990 F.2d 893, 902 (6th Cir. 1993) (upholding negligence penalty where the “Tax Court found that petitioners were aware that they were buying a program primarily of ‘window dressings’ for tax benefits and either negligently or intentionally disregarded the law.”).

In this case, the Court finds that the facts support the imposition of an accuracy-based penalty on the grounds of negligence or disregard of the rules and regulations. Specifically, the transactions were entered into over one year after the IRS issued IRS Notice 2000-44 entitled “Tax avoidance using artificially high basis,” which alerted taxpayers and their representatives that purported losses arising from certain transactions designed to create artificially high bases in partnership interests would be disallowed. In addition, the partnerships failed to demonstrate any attempt to determine whether the transactions would potentially be covered by Revenue Ruling 88-77 . Moreover, the partnerships failed to demonstrate that they attempted to determine whether the transactions had any economic substance. Furthermore, the partnerships failed to demonstrate that they sought and received disinterested and objective tax advice because the tax advice that they did receive came from Arthur Anderson, which also arranged the transactions. Based on these facts, the Court concludes that any objective view of the transactions results in the conclusion that they had no non-tax economic benefit.

In addition, the partnership returns reported the valuation of the transaction at sixty-seven times their proper value under either I.R.C. § 752 or the substance over form or step-transaction analysis. In that regard, the Thomas partnerships reported an increase in its capital account of $101,500,000, which is sixty-seven times the actual economic outlay of $1.5 million that Thomas paid for the transaction. Any reasonable and prudent taxpayer would consider the transaction “too good to be true.” Treas. Reg. 1.6662-3(b)(1)(ii) (2002). Therefore, the Court finds that the partnerships were negligent and disregarded the rules and regulations for purposes of I.R.C. § 6662 . Id.

The reasonable cause and good faith defense is a fact and circumstance test that focuses on the taxpayer's affirmative actions to determine its correct tax liability: “[g]enerally, the most important factor is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability.” Treas. Reg. § 1.6662-4(b) . The taxpayer's “experience, knowledge, and education” may be taken into account. Id. Reliance on a tax advisor “does not necessarily demonstrate reasonable cause and good faith.” Id.

In this case, the partnerships did not have reasonable cause to disregard the liabilities created by the short options in valuing the Arthur Andersen call option spreads contributed to the partnerships. The transactions were entered into over one year after the IRS issued IRS Notice 2000-44 entitled “Tax avoidance using artificially high basis.” This notice alerted taxpayers and their representatives that purported losses arising from certain transactions designed to create artificially high basis in partnership interests would be disallowed. In addition, the partnerships have failed to provide evidence that they diligently attempted to properly assess their proper tax reporting. The partnerships also have failed to demonstrate any attempt to determine whether the transactions would potentially be covered by Revenue Ruling 88-77 . Furthermore, the partnerships have failed to demonstrate that they attempted to determine whether the transactions had any economic substance. Finally, the partnerships have failed to demonstrate that they sought and received disinterested and objective tax advice because the tax advice that they did receive came from Arthur Andersen, which also arranged the transactions resulting in the increased basis that is at issue in this case. Therefore, the partnerships have failed to demonstrate that they acted in good faith as required by the reasonable cause exception of I.R.C. § 6664(c)(1) .

Conclusions of Law

1. The Court has original jurisdiction over the federal claims asserted in this action pursuant to Section 6226 of the Internal Revenue Code. The Court's jurisdiction extends to all items of the partnership for the period at issue. I.R.C. § 6226(f) . Contributions to partnerships and distributions from partnerships are partnership items. Treas. Reg. § 301.6231(a)(3)-1(a)(4)(I) and (ii). The characterization of offsetting options when contributed to partnerships is a partnership item. See, Jade Trading, LLC v. United States , 80 Fed. Cl. 11, 41-43 (Fed. Cl. 2007); Nussdorf v. Comm'r , 129 T.C. 30, 43-44 and n. 16 (2007). 16

2. Venue is proper in the United States District Court for the Central District of California under 28 U.S.C. § 1391(b) because the alleged acts complained of occurred and are occurring in this district.

3. In applying the economic substance analysis to the transactions at issue in this case, the Court concludes that the transactions at issue are economic shams for tax purposes.

4. Application of the step-transaction doctrine, through either the end result test or interdependence test, yields a cost basis of $1.5 million for Thomas and $675,000 for Fox.

5. Application of the substance over form doctrine yields a cost basis of $1.5 million for Thomas and $675,000 for Fox.

6. The obligations created by the short options in the transactions at issue are liabilities for purposes of I.R.C. § 752 .

7. The obligations created by the short options in the transactions at issue are liabilities for purposes of Treasury Regulation § 1.752-6 .

8. I.R.C. § 6221 requires that “the tax treatment of any partnership item (and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item) shall be determined at the partnership level.” I.R.C. § 6226(e) authorizes this Court to conduct partnership-level proceedings and determine “the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item,” I.R.C. § 6226(f) . In this case, the Court concludes that the partnerships were negligent for purposes of IRC § 6662 , and, therefore, accuracy-related penalties are applicable in this case.

Footnotes

1
The Court deferred ruling on the admissibility of deposition testimony of Messrs. Mandel, Varellas and Nelson offered by the government as well as certain trial exhibits objected to by the parties in the Final Pre-Trial Exhibit Stipulation filed August 5, 2008, pending further post-trial submissions by the parties. On October 6, 2008, the parties filed Notices of Designated Deposition Testimony of Kenneth Mandel, Lawrence Varellas, and Kurt Nelson, Plaintiffs' Objections and Defendant's Response to Objections.

The Court has reviewed the objections to the proffered deposition testimony and the objections to certain trial exhibits in the Final Pre-Trial Stipulation filed August 5, 2008, and rules as follows: The Court overrules the objections to Exhibits 45, 52, 53, 54, 74, 81, 82, 85, 86, 88, 89, 90, 94, 95, 97, 100, 101, 102, 103, 105, 130, 131, 140, 141, 142, 143, 144, 145, 146, 151, 260 (a) - (v) and those exhibits will be received into evidence as of the last day of trial, which was August 14, 2008. As to the objections to the deposition testimony of Mr. Mandel, all of the Plaintiffs' objections are overruled except for the following objections which are sustained: (1) p. 35, lines 2 - 4. As to the objections to the deposition testimony of Mr. Varellas, all of Plaintiffs' objections are overruled except the following which are sustained: (1) p. 47, lines 1- 10 and 15 - 25; (2) p. 48, lines 1 - 25; (3) p. 54, lines 1 - 25; (4) p. 55, lines 1 - 8; and (5) p. 87, lines 15 - 25. As to the objections to the deposition testimony of Mr. Nelson, all of Plaintiffs' objections are overruled. Plaintiffs' objections to Defendant's attempt to introduce documents through deposition excerpts which were not marked by Defendant as trial exhibits are sustained. Those documents are inadmissible and will not be received into evidence and have not been considered by the Court.

2
The Court has elected to issue its findings in narrative form. Any finding of fact that constitutes a conclusion of law is also hereby adopted as a conclusion of law, and any conclusion of law that constitutes a finding of fact is also hereby adopted as a finding of fact.

3
An Asian-style option is an option whose payoff depends on the average value of the underlying security or commodity over a specified period of time. In this case, the Asian-style feature meant that the payout was dependent on the average value of the REIT basket from December 20, 2001, to March 19, 2002, as compared to the value of the REIT basket on December 19, 2001. A European option is one that can only be exercised on a particular date. In this case, the date was March 19, 2002.

4
The Manhattan Properties, L.P., transaction is not a part of this litigation.

5
Ken Mandel was a tax partner at Arthur Andersen who worked on "leading edge tax solutions for both high-net-worth clients and large public corporations." Defendant contends that Mandel developed the call-option spread, which is an allegation that Plaintiffs deny. In any case, it is clear from the evidence in this case that Mandel is familiar with the Arthur Andersen technique referred to as the call-option spread. In fact, Mandel described the call-option spread as suitable "for a handful of very large dollar, trust-client transactions, where we excluded the participation from outside attorneys and other non Firm professionals."

6
Defendant argues that Plaintiffs are not entitled to the increased basis created by the transactions at issue under the economic substance doctrine, the substance-overform doctrine, or the step-transaction doctrine. As the Stobie Creek court noted, "[t]hese doctrines vary in origin and somewhat in application, yet apply to the same analysis." (citing King Enters., Inc. v. United States , 418 F.2d 511, 516 n. 6 (1969) ( "[C]ourts have enunciated a variety of doctrines, such as step transaction, business purpose, and substance over form. Although the various doctrines overlap and it is not always clear in a particular case which one is most appropriate, their common premise is that the substantive realities of a transaction determine its tax consequences." ); and H.J. Heinz Co. & Subsidiaries v. United States , 76 Fed.Cl. 570, 583-85 (2007) (discussing multiple formulations employed by courts to consider whether transaction has economic substance or whether it is a "sham" )).

7
Professor Grenadier used a thirty-five percent implied volatility, which is validated by the implied volatility of the Bank of America and JP Morgan quotes Plaintiffs received for similar transactions.

8
In post-trial filings in January 2009, Plaintiffs ask the Court to take judicial notice of the fact that had options with identical terms been purchased on October 1, 2008, there would have been a payoff. In fact, Plaintiffs allege that the actual drop in the REIT basket for the ninety-day period from October 1, 2008 to December 29, 2008, using Asian-style options was 43.47 percent. Defendant does not dispute that this information is accurate, but asserts that it is irrelevant because Defendant did not argue that a payoff from the transactions as issue was "impossible" , but merely "extremely low" and, thus, any economic substance from the transactions at issue was de minimis . The Court agrees with Defendant that the fact that Plaintiffs are able to demonstrate one instance of an Asian-style European option drop in the nearly fifty-year history of REITs occurring seven years after the transactions in question does not change the Court's conclusion that a payoff from the transactions at issue was, at best, highly unlikely. In addition, the Court's conclusion that the transaction at issue lack economic substance is based on, as explained above, a variety of other factors.

9
The recent Court of Federal Claims case of Marriott International Resorts , relied on Revenue Ruling 88-77 to determine that the obligation created by a short sale was a liability for purposes of I.R.C. § 752 . Marriott International Resorts, L.P. v. United States , 83 Fed. Cl. 291 (2008) (finding that, in light of the promulgation of Revenue Ruling 88-77 , symmetrical treatment that "would call for recognition of the corresponding obligation to replace the borrowed securities" was required under Section 752 ).

10
That the option holder in Helmer was able to exercise his option or not is a key distinction between Helmer , and its progeny, and this case where the funds received from the sale of the short option are used to purchase the long option and the AIG note, and the proceeds of which are pledged to secure the liability created by the short option. Helmer and its progeny also are distinguishable from this case because they did not involve the assumption of a payment obligation by a partnership from a partner.

11
However, as the Fifth Circuit found, "[t]he Internal Revenue Code deals with dollars, and the basis adjustment provisions of section 752 presume that the value of the liability is ascertainable." Korman, 527 F.3d at 452.

12
Section 1.752-7 applies to assumptions of liability occurring after June 24, 2003, and taxpayers could elect to apply it to assumptions of liability occurring between October 18, 1999, and June 24, 2003. Treas. Reg. § 1.752-7(k) .

13
Section 358(h)(3) , which defines "liability" in the context of determining basis on corporate transactions as including "any fixed or contingent obligation to make payment."

14
Retroactivity is also permitted to prevent abuse pursuant to I.R.C. § 7805(b)(3) .

15
Treasury Regulation § 1.752-6 also incorporates the definition of liability contained in I.R.C. § 358(h)(3) , which defines "liability" to include contingent liabilities.

16
The parties do not dispute the facts requisite to federal jurisdiction.