Relief from Joint and Several Liability - Two Year Rule Does Not Apply to Sec. 6015(f)

IRM 25.15.3.4.4(1) has added a note before the other note: Effective 6-8-09, until further notice, the Service will not disallow claims as being untimely under IRC § 6015(f). The Request for Innocent Spouse Relief will be reviewed based on the other factors under IRC § 6015(f). The Request for Innocent Spouse Relief under IRC § 6015(b) and IRC § 6015(c) will continue to be disallowed if not timely filed. This follows the recent Tax Court Case, Lantz V. Commissioner, 132 T.C. No. 8 (April 7, 2009). The Tax Court has ruled that the two year rule does not apply to IRC § 6015(f).

IRS Launches Tax Return Preparer Review

IRS Commissioner Doug Shulman has announced that by the end of 2009, he will propose a comprehensive set of recommendations to help the Internal Revenue Service better leverage the tax return preparer community with the twin goals of increasing taxpayer compliance and ensuring uniform and high ethical standards of conduct for tax preparers. For more see News Release IR-2009-57.

Interim Guidance On Return Preparer Penalty Procedures For Estate & Gift Preparer Penalty Cases

The IRS has issued Interim Guidance On Return Preparer Penalty Procedures For Estate & Gift Preparer Penalty Cases. The guidance advises that during every examination, estate tax attorneys should determine if further consideration of return preparer penalties is necessary. This determination will be made based on oral testimony and/or written evidence during the examination process. For more detailed information see SBSE-04-0509-009.

Materials on Offshore Account and Entity Voluntary Disclosure (Including FBARs)

Readers are reminded that the Voluntary Disclosure program for offshore accounts and entities must be implemented by September 23, 2009. Because of the time it takes to receive account documents and other information from offshore sources, persons desiring to enter the program must move promptly. For further information on the initiative, see the blogs on our sister site, the Federal Tax Crimes Blog here. This link will automatically update for blog items added in the future.

Persons having the required signatory or other authority over an offshore account anytime in 2008 must file the 2008 FBAR by 6/30/2009. For further information on this filing see here.

Tax Court Training Video

The Tax Prof Blog has posted here the links to the Tax Court's new training video series. The series is particularly useful for taxpayers representing themselves in the Tax Court (referred to in the jargon as pro se taxpayers), but some tax professionals who do not practice regularly in the Tax Court may also find the videos useful.

Xilinx & Section 482's Arm's Length Standard

On May 27, 2009, The Court of Appeals for the Ninth Circuit rendered the long-awaited opinion in Xilinx, Inc. v. Commissioner, ___ F.3d ___ (9th Cir. 2009). The Court concluded that the "arm's length" test for the application of § 482 is not the ubiquitous standard that most of us thought it was. I think the court was wrong. Let me explain.

I, like most who have played around in this field, think that the arm's length standard was always the ultimate guide and that any specific rules as to methodology in the 482 regulations were simply ways of administering the arm's length standard in specific contexts. After all, the Regulations specifically state that "the standard to be applied in every case" is the arm's length standard. § 1.482-1(a)(b)(1). Yet, the Xilinx Court held that, although the arm's length standard may be the general benchmark for valid 482 adjustments, the IRS can by regulation change that benchmark even if it achieves a demonstrably non-arm's length result.

I do not doubt that the IRS has a great deal of authority to promulgate regulations that, under Chevron (not mentioned by the majority opinion but clearly in the background), will be the law so long as reasonable even when not commanded by the plain meaning of the statute being interpreted. So, you might ask, does the statute as interpreted not require the arm's length standard? The statute itself does no mention the arm's length standard. The statute merely says that the IRS may make the adjustment when it is "necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." Evasion of taxes is a term of art in the tax area, generally meaning the willful intent to violate a known legal duty applicable in order to convict under Section 7201. But, evasion as a separate concept has no discernible meaning in § 482, so the courts have focused on the "clearly reflect income" standard in the text. What does clearly reflect income mean? It too is not self defining in this context, but the overwhelming body of law, including the IRS's own regulations, says it means the income that would be reflected in a transaction between parties dealing at arm's length -- the arm's length standard.

You might ask about the legislative history. It is sparse and unhelpful given that it was enacted in 1928 with early revenue statute predicates, a time when Congress was less wordy. I cover the sparse legislative history in my earlier article John A. Townsend, Reconciling Section 482 and the Nonrecognition Provisions, 50 Tax Lawyer 701, 702-705 (1997). Until Xilinx, the arm's length standard has become the standard for resolving transfer pricing issues where it really matters -- in cross-border contexts where our treaties uniformly adopt some variation of language that is interpreted to mean that the arm's length standard applies. (The Court discusses the treaty context, and I have discussed in more detail in John A. Townsend, Tax Treaty Interpretation, 55 Tax Law. 219 (2001).)

Readers will forgive me if I digress for a moment on the arm's length standard. Back in the old (real old) days while I was with DOJ Tax Appellate I briefed and argued Liberty Loan Corp. v. United States, 498 F.2d 225 (8th Cir. 1973). In that case, the taxpayer was a parent corporation with numerous consumer finance subsidiaries. The parent-taxpayer borrowed at 5.55% and re-lent to its subsidiaries much, if not most, of the cash the subsidiaries needed to lend in their consumer finance businesses. Each of the loans to the subsidiaries was reflected in separate lending documents. The taxpayer lent its profitable subsidiaries at a 5.75% rate and its unprofitable subsidiaries at a 0% rate. These two rate structures produced overall interest income to the parent-taxpayer at its cost of borrowing rate -- 5.5%, so the parent-taxpayer had neither income or loss at its level. The parties stipulated that, had the subsidiaries borrowed from a third party unrelated lender, they would each have paid a rate exceeding 5.75%. Exercising its authority under § 482 to adjust the 0% interest rate loans to 5% (a safe harbor rate) without adjusting the 5.75% interest rate loans. The 5.75% interest rate loans were not adjusted because they were within the "safe harbor" provided in the regulations. The parent-taxpayer objected, paid the tax and sued for refund. the parent-taxpayer won at the trial level. The district court treated the subsidiaries as a group borrower who, as a group but not as individual corporations, could borrow at the 5.5% rate, thus in effect making the transaction between the parent-taxpayer and the "group" at arm's length. The Government appealed to the Eight Circuit. The Government argued, that the no-interest loans could be adjusted to the safe harbor rate because that was an adjustment toward the actual arm's length rate (exceeding 5.75%) but could not adjust the 5.75% rate downward to mitigate the effect of the first adjustment because a downward adjustment of the 5.75% rate would impermissibly move the interest rate away from the arm's length rate stipulated to exceed 5.75%. The Government won the appeal. The Court of Appeals in Liberty Loan held:

Thus, it would have been contrary to the regulations for the Commissioner to balance out the transactions at 5% (or 5.55%) when the stipulated arm's length rate was in excess of 5.75%. This limitation on the offset provision logically follows when one remembers that the purpose of a § 482 adjustment is to more clearly reflect income. The upward adjustments to the no-interest loans do just that. Downward adjustments to the 5.75% loans, however, would have the effect of moving those loans even further away from the actual arm's length rate. In adjusting the no-interest loans upwards to 5%, the Commissioner therefore made the only adjustment he could.

In Xilinx, the court did exactly what the Government argued was impermissible in Liberty Loan -- i.e. it forced the taxpayer under the guise of the regulations to move the stipulated arm's length transfer price away from the arm's length standard. It is true that the court did that under what it perceived as authority of the IRS to require § 482 adjustments by regulation under Chevron-type notions (although the court does not refer to Chevron).

I think the dissent got this right.

Predicting Appellate Results from Quantity (Not Quality) of Questions

The New York times today here has a very interesting article (here) addressing the thesis that: “The bottom line, as simple as it sounds, * * * is that the party that gets the most questions is likely to lose.” It is a short article and I recommend the reader link to it and read it in its entirety.

I decided to make a few brief comments based on my appellate experience while with the DOJ Tax Division Appellate Section in the early 1970s. My experience was before 3 judge panels that, in oral argument, functioned similarly to the way the Supreme Court works in oral argument. Hence, I observed the dynamics of oral argument and, even in some cases, understood them and applied them to my client's perceived advantage. My brief comments are:

1. To state the obvious, the quantity of questioning is not a perfect predictor (hence "likely" in an important qualifier). But quantity is more than just slightly statiscally significant (86% is quite good). Most of us would like odds that good in placing any type of bet (or just living life). See Leonard Mlodinow, The Drunkard's Walk: How Randomness Rules Our Lives (2008) and Mlodinow's recent comment on the New Times Happy Days Blog.

2. The article suggests that justices often ask questions for which they already know the answer and are just using the question and answer to convince one or more other justices. Often, it does not matter whether the responsive answer is consistent with the questioning justice's perception of the right result. Even wrong answers can be an important teaching tool, as many of us learned as we participated in the Socratic method of teaching in law school.

3. While serving as an appellate attorney, I was aware of the dynamic in a general sense. By way of background, judges who read the briefs or have been briefed by their clerks, in most cases, have an idea of what they will hold before oral argument. Their minds can be changed (and I experienced one known such significant instance), but usually they go out as they came in. This comment is directed to the odds of changing a panel's mind, and is a different, but related, issue to predictability from the quantity of questions asked.

4. My personal experience is that, across the board, counsel for the party appealing (appellant) usually get more questions than counsel for the party not appealing (appellee). Keep in mind that the party appealing has to change the status quo and given the dynamics of systemic deference to the result below (whether to the jury or to the judge) (perhaps, heaven forbid, a form of inertia), I think that the party appealing is statistically more likely to lose, wholly independent of how many questions the panel asks. (This observation is consistent with the following observation in the article that, "If the two sides receive the same number of questions, the likelihood of reversal is 64 percent, which is in line with the usual probabilities; the court reverses more often than it affirms.") But the judge's perception of need to test whether that party should really lose, perhaps drive the dynamic of a larger quantity of questions.

5. Further dynamics are at issue in tax cases. The Government wins more far more times in taxpayer appeals in tax cases than it loses. In tax cases, taxpayers do not generally exercise the same restraint that the Government does in taking appeals which must be authorized by the Solicitor General; hence, the universe of taxpayer appeals present statistically more ill-advised -- unpersuasive -- appeals than the universe of Government appeals. Focusing on the opposite circumstance -- a Government appeal -- Government appeals are generally more meritorious because, in part, they are preceded by fairly rigorous review before the Solicitor General is persuaded to even authorize the appeal. I don't know the statistic, but I would be stunned if, statistically, the Government did not win significantly more of its appeals than the taxpayers win of their appeals. But, the Government on its appeal faces the same dynamic of trying to change the status quo, and thus the Government is bound to lose a number of its appeals, regardless of the rigorousness of the internal DOJ review process. The dynamic noted previously of deference will inevitably give some tilt to Court of Appeals' results in favor of affirmance rather than reversal.

6. I now provide some anecdotal experience based on the some of the preceding observations. On some taxpayer appeals where I perceived from the dynamics of the opening appellant argument the panel understood the issues and the Government would win, my appellee argument was simply to invite questions if the panel had any but otherwise to present no argument at all when the panel had no questions. (I usually flattered or pandered the panel by saying that I perceived from the panel's questions that they understood the issues in the case (just a euphemistic way of saying I thought the Government would win).) Almost invariably, the panel asked no questions and the Government won. Sometimes I varied this approach if the dynamics of the opening argument were generally favorable but I felt that only one or two points needed clarification. I would make those one or two points (once less than 30 seconds with no panel questions after a 25 minute appellant opening argument) and sit down. I developed the strategy to do this type of limited appellee oral argument after my first case with the Government -- a taxpayer appeal to the Second Circuit. After the taxpayer's counsel used all his time, I got up with my canned argument (that I had rehearsed with a panel from the Appellate Section and went, as canned, for about 15-18 minutes), but realized within three minutes that each member of the panel was (i) not paying a lot of attention to what I said and (ii) indeed was reading something that I quickly surmised or guessed or speculated was related to the next argument. I already knew from the court's questions on the opening argument that the Government would win, so I quickly (but not abruptly) closed my argument out, covering only the major outline. Perhaps 5 minutes out of a total permitted of 30 minutes. I speculate that the panel really appreciated that I did not further occupy their and our time (but I could be wrong if the panel had anticipated having that time to further prepare for the next argument). I don't think this approach would work in the Supreme Court, although I could imagine it working if the opening argument isolated some single limited issue that was concerning the justices and then only addressing that issue (provided of court that the issue for which the Supreme Court accepted certiorari was clearly understood).

7. On Government appeals, I approached it differently. I did not perceive a bias in the quantity of questions asked. Since the Government had the burden to persuade the court to change the status quo, I felt that I wanted questions from the court. I felt that, as attorney for the Government appellant, fewer questions meant loss. Of course, the Government lost some, perhaps most of the Government appeals I argued (I really did not keep count), and in those cases, overall, I am certain that I got more questions than counsel for the appellee. And, as I now recall it, in those successful Government appeals, the taxpayer's counsel got more questions from the panel than I did. So this observation is consistent with the statistic.

8. I offer one more observation in trying to use such statistics at the Supreme Court level to extrapolate conclusions about the dynamics of Courts of Appeals. Appeals to the Courts of Appeals are of right. The Courts of Appeals must hear and decide them. Appeals to the Supreme Court through the certiorari process are not appeals of right. The Supreme Court must affirmatively decide to hear the case and determine which issues it will hear. I perceive that the Courts of Appeals now are much more stringent in determining which cases justify oral argument than they were in the days I was doing appellate work on a daily basis. This can be a process with a dynamic not dissimilar to the Supreme Court's determining which cases it will hear. Presumably, Courts of Appeals are much more likely to hear oral argument in cases which, in the review process for determining which cases will be scheduled for oral argument, are identified as involving important issues (important in their own right or involving some potential conflict with other circuits or even the own circuit) for which oral argument can be useful in understanding the bases and ramifications of whatever action the Court of Appeals ultimately takes. In this sense, the designation for oral argument in the Court of Appeals suggests some statistical correlation with the likelihood for some form of reversal or some type of revision to the result or reasoning below (i.e., if the lower court action were clearly correct, oral argument is not needed), just as the Supreme Court's acceptance of certiorari suggests a more than random statistical possibility of reversal or revision of the result or reasoning below (as noted in the article, "the [Supreme] [C]ourt reverses more often than it affirms."). The Supreme Court's rigorous selection process makes it much more likely that the Court perceive an importance in correcting errors in result or reasoning below than it just pronouncing that the lower courts got it right in result and reasoning. That dynamic in the Courts of Appeals in assigning cases for oral argument is, I suspect, much less pronounced, simply because I don't think that the selection process is nearly so rigorous. But, having said that, there might be some positive correlation that would be shown with empirical analysis.

TEFRA Partnership Rules -- IRS Protective Position at Partner Level

In Bausch & Lomb Inc. v. Commissioner, T.C. Memo 2009-112, decided yesterday, at the IRS's request, the Tax Court held that the notice of deficiency issued by the Tax Court was invalid which meant that the Tax Court had no jurisdiction since a notice of deficiency is a jurisdictional prerequest in cases where the taxpayer petitions for redetermination. What's the deal? Why would the IRS urge the invalidity of its own notice of deficiency?

The reason is that the TEFRA partnership provisions, enacted in 1982, leave many issues undecided and the courts have been working through them ever since. In the meantime, as to at least some of these undecided issues, parties must take protective positions -- going through some formal steps even when they believe the steps should not apply given the purpose of the TEFRA patnership provisions. Although the Court's background discussion is somewhat cryptic as to the precise reasons for the protective position, that appears to be what happened in Bausch & Lomb and is certianly what happened in other cases where the unnecessary steps are less visible.

Extrapolating from the decision,. the following is probably the type of fact background for the IRS issuing a notice of deficiency. As readers will recall, the TEFRA provisions mandate unified audit and litigation for partnership items and affected items and then creates a special statute of limitations independent of the partners' statutes of limitations so that the unified result can be imposed on the parters. In lay terms, this requires the IRS to conduct a single partnership level audit and litigation of partnership items affecting a partnership and then, in a relatively summary assessment action, impose the results on the partners without concern for the individual partners' statutes of limitations.

The system is commendable in its purpose and most of the times serves that purpose of having a single proceeding rather than multiple and potentially inconsistent partner level proceedings as to the same items or items arising from the partnership. One of the rubs was likely presented in Bausch & Lomb. What should the IRS do when the IRS's position is that the partnership is a sham? One way of viewing a sham is that the partnership is to be disregarded altogether so that the TEFRA partnership proceedings simply never apply. This would mean that, if the IRS wants to actually collect related tax from the partners for items on their returns related to the sham partnership, the IRS must move against the partners via the notice of deficiency procedure rather than through the TEFRA rules. On the other hand, if the partnership even though a sham, is subject to the TEFRA partnership rules (administratively a good position given the purpose of the TEFRA partnership rules, even if not necessarily commanded by the explicit text of the statutory provisions) the IRS must proceed under the TEFRA provisions to issue a FPAA and then, failing litigation that would change the result, impose the results on the partners via a direct assessment. Notwithstanding logic that suggests that the latter -- proceeding under TEFRA -- is the right result, the statute does not literally foreclose a taxpayer argument that proceeding under TEFRA is the wrong result. The IRS in such cases might protectively proceed under both potential avenues -- i.e., (1) issue a notice of deficiency directly to the taxpayer even while the partnership level audit is going on and (ii) proceed under TEFRA to issue the FPAA and, upon final resolution fo the FPAA, impose the results on the partners as allowed the the TEFRA provisions.

That type of protective position appears to be what happened in Baush & Lomb. The IRS thinks the second avenue -- use of the TEFRA provisions -- is correct and thus that its protective notice of deficiency is not correct. The taxpayer for some reason wanted to litigate via the notice of deficiency rather than via the TEFRA procedures. The Tax Court accepted the IRS's position. That is the right result although we cannot provide a statutory analysis that necessarily commands that result. Let's just say that it is the only one that makes sense. Maybe Justice Scalia would decry it because the statute does not expressly command it, but he would be the only one that would have such qualms.

Hat tip to the Tax Professor List Serv.

IRS Reminds Small Tax-Exempt Organizations to File e-Postcards

In certain cases small tax exempt organizations are required to file Form 990-N with the IRS. The IRS has issued a notice reminding these tax exempt organizations to file the form. The form was due by May 15. See the notice.

Interim Guidance from OPR for Sanctions

See the interim guidance published by OPR with respect to sanctions of tax representatives. Click here for the guidance.