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Coordinated Issues Paper - Insurance

ab@irstaxattorney.com (Return Preparer Tax Law) — Sat, 20 Mar 2010 12:48:00 +0000

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

* * *

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

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

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

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

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

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

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

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

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

DISCUSSION

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

§ 1.832-4 Gross income

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

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

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

Several conclusions follow from these general principles:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Estimates of unpaid losses must represent actual unpaid losses.

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

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

Page Last Reviewed or Updated: November 19, 2009
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Provisions of HIRE Act effective 3..18..2010

ab@irstaxattorney.com (Return Preparer Tax Law) — Fri, 19 Mar 2010 13:31:00 +0000

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

Red Flag audit issues - IRS dirty dozen

ab@irstaxattorney.com (Return Preparer Tax Law) — Thu, 18 Mar 2010 13:41:00 +0000

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

IRS dirty dozen: Tax scams: Tax fraud

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

Dirty Dozen : English

Message for Tax Preparers : English

Choosing a Return Preparer : English/Spanish/ASL

For this and other videos: YouTube/IRSVideos

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

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

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

The IRS urges taxpayers to avoid these common schemes:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

new liberal rules on computing future income

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 17 Mar 2010 20:00:00 +0000

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

If… Then…

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

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

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

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

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

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

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

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

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

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Tue, 16 Mar 2010 21:27:00 +0000

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

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

If… Then…

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

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

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

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

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

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

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

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

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

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

What are your chances of being audited?

ab@irstaxattorney.com (Return Preparer Tax Law) — Mon, 15 Mar 2010 13:06:00 +0000

What are your chances for being audited?

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

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

What are the chances of being audited?

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

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

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

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

trust fund penalty - willfulness - section 6672

ab@irstaxattorney.com (Return Preparer Tax Law) — Fri, 12 Mar 2010 13:27:00 +0000

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

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

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

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

no levy or proceeding in court for the collection of the remainder of such penalty shall be made, begun, or prosecuted until a final resolution of a proceeding begun as provided in paragraph (2) . Notwithstanding the provisions of section 7421(a) , the beginning of such proceeding or levy during the time such prohibition is in force may be enjoined by a proceeding in the proper court. Nothing in this paragraph shall be construed to prohibit any counterclaim for the remainder of such penalty in a proceeding begun as provided in paragraph (2) .
(2) Suit must be brought to determine liability for penalty.
If, within 30 days after the day on which his claim for refund with respect to any penalty under subsection (a) is denied, the person described in paragraph (1) fails to begin a proceeding in the appropriate United States district court (or in the Court of Claims) for the determination of his liability for such penalty, paragraph (1) shall cease to apply with respect to such penalty, effective on the day following the close of the 30-day period referred to in this paragraph .
(3) Bond.
The bond referred to in paragraph (1) shall be in such form and with such sureties as the Secretary may by regulations prescribe and shall be in an amount equal to 11/2 times the amount of excess of the penalty assessed over the payment described in paragraph (1) .
(4) Suspension of running of period of limitations on collection.
The running of the period of limitations provided in section 6502 on the collection by levy or by a proceeding in court in respect of any penalty described in paragraph (1) shall be suspended for the period during which the Secretary is prohibited from collecting by levy or a proceeding in court.
(5) Jeopardy collection.
If the Secretary makes a finding that the collection of the penalty is in jeopardy, nothing in this subsection shall prevent the immediate collection of such penalty.
(d) Right of contribution where more than 1 person liable for penalty.
If more than 1 person is liable for the penalty under subsection (a) with respect to any tax, each person who paid such penalty shall be entitled to recover from other persons who are liable for such penalty an amount equal to the excess of the amount paid by such person over such person's proportionate share of the penalty. Any claim for such a recovery may be made only in a proceeding which is separate from, and is not joined or consolidated with—
(1) an action for collection of such penalty brought by the United States, or
(2) a proceeding in which the United States files a counterclaim or third-party complaint for the collection of such penalty.
(e) Exception for voluntary board members of tax-exempt organizations.
No penalty shall be imposed by subsection (a) on any unpaid, volunteer member of any board of trustees or directors of an organization exempt from tax under subtitle A if such member—
(1) is solely serving in an honorary capacity,
(2) does not participate in the day-to-day or financial operations of the organization, and
(3) does not have actual knowledge of the failure on which such penalty is imposed.

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Thu, 11 Mar 2010 19:02:00 +0000

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

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

HEADNOTE
XX.

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

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

Opinion by COHEN

MEMORANDUM OPINION
Respondent determined a deficiency of $56,471 and an accuracy-related penalty of $11,294 under section 6662(a) in relation to petitioners' 2006 Federal income tax. After a concession by petitioners, the issues for decision are (1) whether Thomas Rosato (petitioner) was an independent contractor, statutory employee, or common law employee and (2) whether petitioners are subject to the section 6662(a) penalty. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Background
This case was submitted fully stipulated under Rule 122, and the stipulated facts are incorporated as our findings by this reference. Petitioners resided in New York at the time the petition was filed.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Whether an individual is an employee must be determined on the basis of the specific facts and circumstances involved. Profl. & Executive Leasing, Inc. v. Commissioner, 89 T.C. 225, 232 (1987), affd. 862 F.2d 751 [63 AFTR 2d 89-427] (9th Cir. 1988); Simpson v. Commissioner, 64 T.C. 974, 984 (1975). Relevant factors include: (1) The degree of control exercised by the principal; (2) which party invests in the work facilities used by the worker; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; (7) the relationship the parties believed they were creating; and (8) the provision of employee benefits. See Avis Rent A Car Sys., Inc. v. United States, 503 F.2d 423, 429 [34 AFTR 2d 74-5882] (2d Cir. 1974); Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387. We consider all of the facts and circumstances of each case, and no single factor is determinative. Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Decision will be entered for respondent.

Reporting uncertain positions

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 10 Mar 2010 02:26:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Fri, 05 Mar 2010 18:03:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Thu, 04 Mar 2010 13:57:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 03 Mar 2010 14:08:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Tue, 02 Mar 2010 18:06:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Sun, 28 Feb 2010 18:01:00 +0000

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.
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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.
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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).
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8
“Income or Losses from Partnerships, Estates or Trusts, or Small Business Corporations.” S.A. at 47.
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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

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 24 Feb 2010 14:16:00 +0000

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.
________________________________________
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

ab@irstaxattorney.com (Return Preparer Tax Law) — Tue, 23 Feb 2010 17:05:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Thu, 18 Feb 2010 13:51:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 17 Feb 2010 20:51:00 +0000

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.

ab@irstaxattorney.com (Return Preparer Tax Law) — Tue, 16 Feb 2010 17:18:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Wed, 10 Feb 2010 22:43:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Tue, 09 Feb 2010 13:45:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Mon, 08 Feb 2010 15:32:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Fri, 05 Feb 2010 16:49:00 +0000

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

ab@irstaxattorney.com (Return Preparer Tax Law) — Thu, 04 Feb 2010 13:02:00 +0000

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