Thursday, March 19, 2009

Settling with IRS - Make Sure Procedure Is Followed

In Burton v. Commissioner, T.C. Memo. 2009-60, March 18, 2009, the issue was whether the taxpayers had entered into a binding settlement agreement with the IRS Appeals Office relating to taxpayers’joint income tax liability for 2000.

Taxpayers asserted a final binding settlement was entered into under which they were to pay a single lump sum of $60,000 without any further liability to pay statutory interest. The IRS asserted, among other things, that no final binding agreement was ever reached-particularly with regard to tapayers’ statutory interest.

In the letter the IRS Appeals officer explained that the tax due under the proposed settlement would be $60,000 and that interest would "continue to accrue" thereon until paid. The taxpayers’ attorney notified the Appeals officer that he agreed on behalf of taxpayers to the revised closing agreement, and the Appeals officer sent to the attorney the closing agreement along with the Form 870-AD for signature.

Taxpayers and the attorney signed the closing agreement and the Form 870-AD and mailed them, along with a check for $60,000, back to the Appeals officer. On taxpayers’ $60,000 check the words "paid in full" were written in the lower left corner.

The Appeals officer mailed a letter to taxpayers’ attorney acknowledging receipt of the closing agreement, the Form 870-AD and the $60,000 check. The Appeals officer explained that he could not process taxpayers’ $60,000 check because the check and payment did not include an additional $23,684 in statutory interest.

Not having received a response from taxpayers, the Appeals officer returned taxpayers’ $60,000 check, and the IRS issued a notice of deficiency. No one on behalf of the IRS ever signed the closing agreement that taxpayers had signed.

The Court in the case of Dormer v. Commissioner, T.C. Memo. 2004-167, explained the law applicable to administrative settlement offers involving Federal income taxes is well established. Regulations establish the procedures for closing agreements and compromises under sections 7121 and 7122. Secs. 301.7121-1, 301.7122-1, Proced. & Admin. Regs. These procedures are exclusive and must be satisfied in order to effect an administrative compromise or settlement which will be binding on both a taxpayer and IRS. The regulations and procedures under section 7122 provide the exclusive method of effectuating a compromise. Regulations under sections 7121 and 7122 require that any closing agreement or offer-in-compromise be submitted and/or executed on or in the specific form prescribed by the IRS. Secs. 301.71211(d), 301.7122-1(d), Proced. & Admin. Regs.

The Court in this case found that no final closing agreement was signed by an individual authorized to bind the IRS. This is not an issolated situation. We have seen other cases where the taxpayer's representive has not made sure the settlement was completed.

Wednesday, March 18, 2009

Joint Committee Releases Explanation

Strategic Concessions - Government Outmaneuvered

The Code imposes:

1. A 20% penalty for tax due that is attributable to return reporting positions based on negligence or substantial understatement.

2. a 40% penalty applies to tax due that is attributable to return reporting positions based on gross valuation or basis misstatements. Gross valuation or basis misstatements are those that exceed 200%.

A split among the courts has developed as to whether, if the tax is disallowed in a judicial proceeding for some threshold reason (such as lack of economic substance or simply failing to meet some other requirement of the code), the 40% gross valuation or basis misstatement penalty can apply. In holding that the 40% penalty cannot apply, courts reason that the tax due is attributable to the threshold disqualifier and not to the gross valuation or basis misstatement. See e.g., Keller v. Commissioner, ___ F.3d ___ (9th Cir. 2009). Other courts reject that if the gross valuation or basis misstatement was an essential ingredient of the originally claimed reporting position. See e.g., Long Term Capital Holdings, Inc. v. United States, 338 F.Supp.2d 122 (D. Conn. 2004), aff’d by unpublished order (2nd Cir. 9/27/05).

A decision reported just yesterday shows how a taxpayer skillfully exploited this split in authority. Alpha I, L.P., v. United States, ___ Fed. Cl. ___ (3/16/2009), denying the Government's motion for reconsideration in Alpha I, L.P., v. United States, 84 Fed. Cl. 622, 634 (2008). Basically, in this TEFRA proceeding, the partnership conceded a threshold legal disqualifier to the tax benefits in issue and then moved for summary judgment on the gross valuation misstatement issue because the valuation was no longer relevant and hence the tax due (conceded for other reasons) was not attributable to the gross valuation misstatement. The Government opposed the motion. The Court granted the motion. Alpha I, L.P., v. United States, 84 Fed. Cl. 622, 634 (2008). The Government then moved for reconsideration. The Court rejected the motion for reconsideration essentially because it did not raise any matters not previously considered as to the proper interpretation and application of the penalty. The Court reasoned (such as it is) in this regard (which I quote in its entirety because I don't understand it),

According to plaintiffs, however, "Defendant has lost sight of the different policy underlying the valuation misstatement penalty from other penalties designed to punish and deter taxpayers from taking negligent, aggressive, or fraudulent positions." Pls.' Resp. to Def.'s Mot. for Recons. 16. The court addressed the policy behind the § 6662(e) penalties in its Opinion of November 25, 2008. See Alpha I, 84 Fed. Cl. at 632-33. The court concluded that "forcing a 'trial on alternative grounds for adjustments plaintiffs have already conceded violates the purpose and policy behind the valuation misstatement penalties and is simply a waste of the Court's and the parties' resources.'" Id. at 632 (quoting Plaintiffs' Reply in Support of Plaintiffs' Motion for Partial Summary Judgment 5).
Apparently, the Court thought that was the end of it from a legal analysis perspective.

But the Court proceeded to dispatch a Government policy consideration not relevant to the interpretation and application of the penalty. This policy related to how the Government induces taxpayers into settlement without trial by holding out the prospects of a worse result at trial. The Government argues that the partners of the Alpha I partnership making this strategic maneuver would be better off than other similarly situated taxpayers who settled. Adopting Alpha I's position on this matter, the Court held that whether or not the taxpayer partners in Alpha I were better off is not relevant and in any event not certain. And that was the end of that.

The bottom line takeaway for practitioners whose clients may be subject to the gross valuation misstatement penalty in an overly aggressive shelter or other return reporting position is to find some threshold disqualifier and go to a jurisdiction (such as the Fifth, Ninth, or Court of Federal Claims) and concede the tax on the basis of the disqualifier.

Monday, March 16, 2009

American Recovery & Reinvestment Act (ARRA) of 2009

The new American Recovery and Reinvestment Act of 2009 is the subject of many conversations and is generating many questions. Many of these questions center on how this will affect taxpayers this filing season and next. IRS has placed information to help answer that question and others, on a special website. Click here.

Judge / Professor Lynch on the Blue Book

The New York Times reports that Judge / Professor Gerard Lynch is slotted for elevation to the Second Circuit Court of Appeals. Judge Lynch has written more than a few memorable opinions, but the one that comes immediately to my mind is his pronouncement on the relevance of the Blue Book to interpretation of a tax statute. Those in the plain meaning school of statutory interpretation (e.g., Justice Scalia) do not like such aids to interpretation, but this is what Judge Lynch had to say (Sequa Corp. v. United States, 350 F.Supp.2d 447, 454 (S.D. N.Y. 2004)):

However, as other federal courts around the country have noted, the Blue Book, as an interpretation of the statute by experts involved in the drafting process and very familiar with the problems being addressed, plainly has some value, particularly where the statute is ambiguous and the only available legislative history is limited to expressing broad policy goals. See Estate of Wallace v. Commissioner, 965 F.2d 1038, 1050 n.15 (11th Cir. 1992) (Blue Book is "a valuable aid to understanding"); McDonald v. Commissioner, 764 F.2d 322, 336 n.25 (5th Cir. 1985) (Blue Book is "entitled to great respect"); Hutchinson, 765 F.2d at 669 (although not legislative history, Blue Book can be "highly indicative" of Congressional intent); Ravenswood Group v. Fairmont Assoc., 736 F. Supp. 1285, 1287 (S.D.N.Y. 1990) (citing to Blue Book explanation). Where, as here, the explanation offered by the Blue Book accords both with the explicit statements of broad Congressional intent and with the most logical and consistent reading of somewhat ambiguous statutory provisions, that explanation is entitled to some weight. That weight simply tips the scales further in the direction of the Government's position. n6
- - - - - - - - - - - - - - - - - -Footnotes- - - - - - - - - - - - - - - - - -
n6 Sequa argues on reply that the Blue Book is no more than a treatise, equivalent to any other academic commentary. (P. Rep. 10.) As part of its efforts to discredit the Blue Book's interpretation and advance its own, Sequa cites three academic commentaries that it claims support its view of the statutory language. (P. Mem. 22-24, citing Daniel J. Lathrope, The Alternative Minimum Tax P 6.11[3][f] (1994); Robert M. Brown, "Corporate Alternative Minimum Tax" § 28.04[4], 50 N.Y.U. Institute on Fed. Tax'n (1992); Robert M. Brown and Donald J. Massoglia, "Corporate Alternative Minimum Tax" § 7.07, 45 N.Y.U. Institute on Fed. Tax'n (1987).) First, two of the three are authored by the same person, so it is misleading to suggest that "three [separate] analyses ... amply negate[]" the Blue Book. (P. Rep. 10.) Second, Sequa selectively quotes from Professor Lathrope's treatise to make his analysis appear more favorable. (P. Mem. 23.) Lathrope does note that the Blue Book's approach "has been criticized," and offers some additional bases for questioning the position. However, Lathrope follows the quoted section with the following: "On the other hand, the transition rules do permit a corporation's pre-1987 net operating losses to carry over, with modifications, to post-1987 taxable years as AT NOLS. Perhaps offset of AT NOL carrybacks can be justified as a balanced approach." He then footnotes to the academic and practitioner commentary both for and against the Blue Book's interpretation. See Lathrope, 6-94 n.431 (citing Brown, supra, and Brown & Massoglia, supra, as critical of the Blue Book; and Hriszko, Schott & Stevens, "Reduction of Corporate AMT NOL Due to Regular Tax NOL Carrybacks," 19 Tax Adviser 778, 779 (1988), as in accord with the Blue Book.) The only reasonable conclusion to be drawn from the academic writing on this issue is that all observers agree that the statute is ambiguous. Beyond this unremarkable observation, the treatises offer little additional insight.

Now, I suspect that Judge Lynch would probably not rank this brief discussion among his more important judicial pronouncements but this one does resonate with tax procedure afficionados. And, moving to the broader issue of finding context for words to assist in meaning, I am reminded of the following article of faith that I learned as a first year law student from a tax opinion by Justice Oliver Wendell Holmes that is a good guide in the law and in life (Towne v. Eisner, 245 U.S. 418, 425 (1918)):

A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used.