House Committee Approves Health Bill

The House Committee on Ways and Means approves America’s Affordable Health Choices Act. For more click. See the Bill.

Taxpayers Held Liable for the Accuracy-Related Penalty

The Court of Appeals for the Fifth Circuit has held a couple liable for the accuracy-related penalty under Section 6662 of the Internal Revenue Code. In Prudhomme v. Commissioner, the Court found that the Prudhommes could not avoid the penalty because they did not act in “good faith” and with “reasonable cause,” as required by Section 6664(c)(1). Generally, good faith and reasonable cause may exist when relying on an accountant to prepare a tax return. The Tax Court held that the Prudhommes did not meet this standard because they provided their accountants with insufficient information to prepare their tax return accurately and did not make a reasonable effort to assess their proper tax liability. The Fifth Circuit affirmed the decision of the Tax Court.

The Tax Court found the Prudhommes’ reliance on their accountant was not reasonable, because they did not fully inform the accountant of all facets of their finances.

If a taxpayer relies on an expert, all facts and circumstances regarding whether that reliance was reasonable and in good faith, including the taxpayer’s education, sophistication and business experience, must be taken into account.

IRS Issues Highlights of 2008 Tax Changes

The IRS has issued Publication 553, Highlights of 2008 Tax Changes. This publication highlights major tax law changes that take effect in 2008 and 2009. The seven chapters cover the following: (1) Tax Changes for Individuals; (2) Tax Changes for Businesses; (3) IRAs and Other Retirement Plans; (4) Estate and Gift Taxes; (5) Excise Taxes: (6) Foreign Issues; and (7) How To Get Tax Help.

Tax Court Again Disallows Unsubstantiated Expenses

In Kyne v. Commissioner, T.C. Summ. Op. 2009-98 (June 25, 2009), the Tax Court has ruled in favor of the IRS disallowing unsubstantiated expenses. We are seeing more and more cases from audit to appeals to the courts where taxpayers are losing, if expenses taken as a deduction cannot be substantiated. It is a good time to remind clients to improve record keeping and make sure documentation exists to prove deductions.

National Taxpayer Advocate Submits Mid-Year Report to Congress

National Taxpayer Advocate Nina E. Olson today delivered a report to Congress that identifies the priority issues the Office of the Taxpayer Advocate will address in the coming fiscal year. Among the key areas of focus will be working with the IRS to improve taxpayer services, enhancing IRS oversight of federal tax return preparers, improving the accessibility of the offer in compromise program, and working with the IRS to improve its ability to administer refundable tax credits effectively. See News Release IR-2009-63.

Among the key areas of focus for the Taxpayer Advocate will be working with the IRS (1) to improve taxpayer services, (2) enhancing IRS oversight of federal tax return preparers, (3) improving the accessibility of the offer in compromise program, and (4) working with the IRS to improve its ability to administer refundable tax credits effectively.

TIGTA Issues Trends in IRS Compliance Activities

The Treasury Inspector for Tax Administration (TIGTA) has issued a report that presents statistical information and trend analyses of the data for Collection and Examination activities of the IRS. Click here to review the full report.

The Will of Michael Jackson

So much hype about Michael Jackson. TaxProf Blog has published a copy of the will. See the will here.

Court declares Son of Boss Illegitimate

In Clearmeadow Investments LLC v. United States, ___ Fed. Cl. ___ (2009), decided 6/19/2007 [I will link to the decision when posted on website], the Court of Federal Claims (Judge Allegra) uses the parent-son metaphor to call a Son-of-Boss transaction the illegitimate child of an illegitimate father, although some might question the timing and use of the metaphor immediately before Father's Day (today). The opinion is long and very good. But, you'll get the key points from the following introduction from the decision (although I question Judge Allegra's inference that Son-of-Boss transactions present a sexy legal issue):

"When pondering sexy legal issues," one commentator recently noted, "it is doubtful that tax law crosses the minds of many." Yet, once in a while (alright, a long while), a tax dispute bursts into the mainstream. Take, for example, the legal controversy swirling around the so-called "Son of BOSS" transactions -- the quoted phrase being short for "sales option bond strategy," the legatee of the "bond and option sales" or "BOSS" strategy. While this case involves a Son of BOSS transaction, perhaps it is best to start by examining the earlier BOSS strategy -- "qualis pater talis filius," as the Romans used to say.

The BOSS strategy employed a series of transactions seemingly to increase the tax basis of an asset that would eventually be sold, supposedly at a loss. In its simplest form, it worked like this:

• Two companies are set up by a promoter -- Company A and Company B.
• Company A buys a bond with a market value of $50.
• Taxpayer X buys the bond from Company A for $1,000,050. However, Taxpayer X pays only $50 in cash, with the remainder of the purchase price taking the form of a promissory note payable by Taxpayer X to Company A for $1 million due in twenty years. Taxpayer X claims that his adjusted tax basis in the bond is $1,000,050.
• Taxpayer X then sells the bond to Company B for $50. Because Taxpayer X claims a basis in the bond of $1,000,050 and sells it for only $50, he argues that he has incurred a $1 million loss, which he promptly deducts to offset income that would otherwise be subject to tax.

In the Community Renewal Tax Relief Act of 2000 (the 2000 Renewal Act), Pub. L. No. 106554, § 309, 114 Stat. 2763A-587 to 638, Congress devitalized this strategy by modifying key provisions in the Internal Revenue Code (the Code) to prevent, in absolute terms, the increase in basis essential to generating the large loss deductions. n2 Even before the passage of the Act, however, tax planners had begun to direct their creative energies elsewhere, focusing, in particular, on the partnership provisions of the Code as a potential new engine for producing large tax losses.

Their efforts eventually led to the christening of the "Son of BOSS" strategy. Under this brainchild, the taxpayer typically would form a partnership and contribute to it an option he had purchased. The partnership would contemporaneously assume a second option that represented a liability of the taxpayer. The taxpayer would then claim that his basis in the partnership was increased by the cost of the purchased option, but not reduced by the partnership's assumption of the obligation. As in the BOSS transactions, this ultimately led the taxpayer to claim a sizable loss deduction when he sold either the partnership interest itself, or some asset whose tax basis was derivable therefrom. Though clothed in the partnership provisions of the Code, the Son of BOSS strategy shared a common aspiration with its forebear -- to generate large tax loss deductions with little in the way of capital outlays. And the Internal Revenue Service (the Service) reacted to the "son" much as it had to the "father" -- disallowing the claimed loss deductions and assessing a range of penalties.

That, in a nutshell, is what happened in the case sub judice, which is a partnership proceeding involving a Son of BOSS transaction, pending before the court on the parties' cross-motions for summary judgment. After carefully considering the parties' briefs and oral argument, the court grants defendant's motion for summary judgment and denies plaintiff's cross-motion for summary judgment. As will be described below, the court finds, as a matter of law, that the Son of BOSS transactions that led to the tax losses at issue did not, under the Code, generate the losses claimed and, at all events, lacked economic substance. It also holds that, aside from any defenses the individual partners may raise in later proceedings, the Service properly asserted the gross valuation overstatement penalty of section 6662 of the Code.

My only comment relates to Judge Allegra's "simplest form" illustration of the concept. I ask the readers to re-read the simplest form illustration. Judge Allegra describes nothing more or less than the exceedingly hokey -- and perhaps even fraudulent -- tax shelters of the late 1970s and early 1980s where all sorts of properties -- from paintings to plastic recylcing shelters -- were overvalued, purchased for the hyper-inflated values (usually with nonrecourse financing or some economic equivalent), and then purchaser-taxpayer or a flow-through entity claimed purchase price basis supported improper tax deductions. For an example of this type of earlier shelter, see Addington v. Commissioner, 205 F.3d 54 (2d. Cir. 2000).

Partner Level Adjustments without a Partnership TEFRA audit

In Muruelo v. Commissioner, 132 T.C. No. 18, here, the Court held that partnership affected items which are more properly determined at the partner level could be the subject of a notice of deficiency to the partner even without a TEFRA audit proceeding at the partnership level. The affected items that could be determined at the partnership level were (1) a partner's at risk with respect to the partnership, (2) the 704(d) limitation on partnership loss allocations to the partner's basis in his or her partnership interest, and (3) the accuracy related penalty. (Note that some courts hold that the good faith defense to the accuracy related penalty may be asserted at the partnership level in some cases, but that does not gainsay its application normally at the partner level).

The general progress of partnership tax contests starts with the partnership level audit and is thereafter followed with the partner level adjustments and further proceedings, if any, as to matters more properly determined at the partnership level. This case reminds practitioners that step 1 -- the partnership audit -- does not have to occur first.

The case is a cryptic as to why the IRS started with the partner level notice of deficiency. The tiered partnership whose activity was at issue had invested in a tax shelter that was a subject of a grand jury proceeding. Hence, I speculate, the IRS may not have wanted to move civilly via a partnership TEFRA proceeding. Alternatively, the IRS may have just recently learned of this particular shelter investment. It is clear that that partnership's and the partner's normal statutes of limitations absent fraud were about to expire when the IRS issued the notice of deficiency to the taxpayer-partner. The expiration of the partner's statute of limitation is irrelevant provided the IRS timely starts the partnership TEFRA proceeding, but the IRS had not done that here. Hence, it looks like the IRS was not certain that it would be able to prove fraud at the partnership level so as to extend the partnership level statute of limitations (thus automatically extending the partner level period for flow-through adjustments) and, rather than putting the bottom-line tax at the partner level at risk, it issued a notice of deficiency to the partner to use overlapping tools to deny the loss directly at the partner level.

Two Cases on Tax Shelter Exception to FATP-7525 Privilege

In Valero Energy Corp. v. United States, ___ F.3d ___ (7th Cir. 2009), available here, the Seventh Circuit blew the hopes of some taxpayers and professions that the tax shelter exception to the Federally Authorized Tax Practitioner ("FATP") privilege would apply only to mass-marketed, so called cookie-cutter tax shelters. Section 7525 confers the equivalent of attorney-client communications privilege for communications between a client and an FATP. SEction 7525(b)(2) excepts from the privilege "in connection with the promotion * * * in any tax shelter (as defined in section 6662(d)(2)(C)(ii))." Valero argued that the word "promotion" -- interpreted both literally and with recourse to the legislative history -- should confine the application of the exception to widely promoted tax shelters and not to one-on-one tax advice for a specific client for a special situtation. The Seventh Circuit disagreed. The opinion is straight-forward, well-written and short. I feel that would disserve the reader by trying to summarize the opinion beyond its bottom-line holding.

I will provide a short quote where the Court gives useful background and analysis for the FATP privilege that should serve as a guide for practitioners desiring to protect client communications:

We begin by noting that there is no general accountant-client privilege. United States v. Frederick, 182 F.3d 496, 500 (7th Cir. 1999). In 1998, Congress provided a limited shield of confidentiality between a federally authorized tax practitioner and her client. This privilege is no broader than the existing attorney-client privilege. It merely extends the veil of confidentiality to federally authorized tax practitioners who have long been able to practice before the IRS, see 5 U.S.C. § 500(c); 31 C.F.R. § 10.3, to the same extent communications would be privileged if they were between a taxpayer and an attorney. 26 U.S.C. § 7525(a)(1) (privilege does not apply in criminal proceedings). Nothing in the statute "suggests that these nonlawyer practitioners are entitled to privilege when they are doing other than lawyers' work. . . ." Frederick, 182 F.3d at 502; see also United States v. BDO Seidman, 337 F.3d 802, 810 (7th Cir. 2003) (BDO II). Accounting advice, even if given by an attorney, is not privileged.

This means that the success of a claim of privilege depends on whether the advice given was general accounting advice or legal advice. Admittedly, the line between a lawyer's work and that of an accountant can be blurry, especially when it involves a large corporation like Valero seeking advice from a broad-based accounting firm like Arthur Anderson. But we have set some guideposts to help distinguish between the two. For starters, the preparation of tax returns is an accounting, not a legal service, therefore information transmitted so that it might be used on a tax return is not privileged. In re Grand Jury Proceedings, 220 F.3d 568, 571 (7th Cir. 2000); Frederick, 182 F.3d at 500-01; United States v. Lawless, 709 F.2d 485, 487 (7th Cir. 1983). On the other side of the spectrum, communications about legal questions raised in litigation (or in anticipation of litigation) are privileged. In re Grand Jury Proceedings, 220 F.3d at 571; Frederick, 182 F.3d at 502. Of course, there is a grey area between these two extremes, but to the extent documents are used for both preparing tax returns and litigation, they are not protected from the government's grasp. In re Grand Jury Proceedings, 220 F.3d at 571; Frederick, 182 F.3d at 501. This circumscribed reading of the tax practitioner-client privilege is in sync with our general take on privileges, which we construe narrowly because they are in derogation of the search for truth. United States v. Evans, 113 F.3d 1457, 1461 (7th Cir. 1997).

I should also note to balance this discussion that the Tax Court recently gave a relatively taxpayer friendly application of the tax shelter exception to the FATP. In Countryside Limited Partnership v. Commissioner, 132 T.C. No. 17 (2009), here, the Tax Court held that, once the taxpayer establishes that the FATP privilege is applicable, the Government then bears the burden of showing that an exception -- there the tax shelter exception -- makes the privilege inapplicable. There, the long-time tax advisor merely responded to inquiries from the taxpayer and gave advice. The Tax Court held that the IRS had not established that these actions were a "promotion" of a tax shelter, reasoning:

Respondent has focused on Mr. Egan as "promoting the Countryside transactions." We read the conferees' statements quoted above as distinguishing tax advice given in the course of a relationship such as that between Mr. Egan and the Winn organization from the "promotion" of a client's participation in a tax shelter. There may be a point at which an FATP's actions cross the line, and will no longer be encompassed within the routine relationship between an FATP and his client and will amount to tax shelter promotion. Respondent has, however, failed to show us that Mr. Egan's communications with the Winn organization with respect to the partnership redemptions and associated transactions before us crossed that line. He rendered advice when asked for it; he counseled within his field of expertise; his tenure as an adviser to the Winn organization was long; and he retained no stake in his advice beyond his employer's right to bill hourly for his time. Respondent has failed to show us that he crossed the line from trusted adviser to promoter.