2008 IRS Enforcement Statistics

Interesting statistics on IRS enforcement activities in 2008. See the statistics.

Statistical Portrayal of CI Released

The Treasury Inspector for Tax Administration has issued the Statistical Portrayal of the Criminal Investigation Division’s Enforcement Activities for Fiscal Years 2000 Through 2008. This report presents the results of the Inspector's review of statistical information that reflects activities of the Criminal Investigation Division. The overall objective of this review was to provide statistical information and trend analyses for the Division’s enforcement activities for Fiscal Years (FY) 2000 through 2008.

Five-Year Anniversary of TaxProf Blog

Congratulations to TaxProf Blog on its fifth anniversity. This is one of the best and most interesting tax blogs that exist. This is the first place many tax practitioners go each day to get an update and we are one of them. See some interesting facts about TaxProf Blog. Paul Caron does an excellent job in publishing this blog.

Beware of IRS’ 2009 “Dirty Dozen” Tax Scams

The IRS has released what it is calling the "Dirty Dozen" or tax scams for 2009. As we all practice tax law there are more and more thing to consider. See IR-2009-41.

Tax Court Puts Another Nail in the Coffin of Helmer Tax Shelters

In New Phoenix Sunrise Corp., et. al. v. Commissioner, 132 T.C. No. 9 (4/9/09), the Tax Court rejected a Helmer tax shelter claim. In Helmer v. Commissioner, T.C. Memo. 1975-160, at the IRS's request, the Court held that contingent liabilities contributed to a partnership do not enter the basis reduction calculation. Taking Helmer at face (taking anything at face is often dangerous in the tax context), tax shelter promoters created many variations of a gambit that would permit a large artificial basis upon which to claim a large artificial loss. New Phoenix involved one of the variations (the so-called digital option), masterminded (if that is the right word) by the Daugerdas-Jenkins & Gilchrist team.

In beginning its discussion of his conclusions, the Tax Court moved quickly to the core point:

We note at the outset that neither Mr. Wray, New Phoenix, nor Capital actually
suffered a $10 million economic loss during 2001. The loss claimed as a result
of the stepped-up basis in the Cisco stock was purely fictional.

From that core observation, the result surely followed:

Absent the benefit of the claimed tax loss, there was nothing but a cash flow that was negative for all relevant periods -- the "'hallmark[] of an economic sham'" as the Court of Appeals for the Sixth Circuit has held. Dow Chem. Co. v. United States, 435 F.3d at 602 (quoting Am. Elec. Power Co. v. United States, 326 F.3d 737, 742 (6th Cir. 2003). Such a deal lacks economic substance. Id. Because we find that the transaction at issue lacked economic substance, we do not consider Mr. Wray's and Capital's profit motive in entering into the transaction. Id. at 605; Rose v. Commissioner, 868 F.2d at 853; Illes v. Commissioner, 982 F.2d at 165. Pursuant to the aforementioned cases, the BLISS transaction must be ignored for Federal income tax purposes. Accordingly, the overstated loss claimed as a result of the sale of the CISCO stock is disregarded, as is the flowthrough loss from Olentangy Partners.

Not only did the Court disallow the loss, the Court also disallowed the attorneys fees the taxpayer incurred in undertaking the transaction. Then, piling at least penalty, if not insult, to the substantive injury, the Court made the following key points on penalties:

1. The 40% gross valuation / basis misstatement penalty applies, specifically rejecting the notion that, because the deductions were denied on the basis of lack of economic substance. In doing so, the Court distinguished and rejected Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990). Any notion derived from Heasley and its progeny that this penalty does not apply is quickly losing ground in the circuits.

2. The 20% substantial understatement of tax penalty applies. The Court found that the position lacked substantial authority and that the transaction was a tax shelter. Returning to his opening theme, The Court quoted Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 58 as follows: "At bottom, the fictional nature of the transaction and its lack of economic reality outweigh Helmer in the substantial authority assessment."

3. The 20% negligence and intentional disregard penalty applies. The taxpayer urged in effect that Helmer and its progeny were substantial authority, and that authority had not been eroded below reasonable basis. In so holding, the Court noted that the IRS had already issued a statement of its position in Notice 2000-44 on Helmer and the taxpayer did not seek independent advice.

4. The taxpayer did not have reasonable cause and good faith for all the obvious reasons and some special twists unique to the facts.

5. Important to the penalty holdings was Jenkins & Gilchrist's clear conflict of interest that the taxpayer simply chose to ignore, thus eroding the reasonableness of reliance of the tax shelter opinion.

6. These penalties may not be stacked. Accordingly, the 40% penalty applies to the portion of the underlying tax attributable to the basis overstatement, but 20% penalty (either substantial understatement or negligence) applies to the balance.

Altogether, given the shift in the winds and prior precedents, this is not an altogether surprising opinion. Players in this area should note that interest on these penalties apply from the date the tax is due, so the cumulative cost of the tax, the penalties and the interest can be quite substantial.

TEFRA Tax Matters Partner Consents to Extend the Statute of Limitations

In United States v. Martinez, ___ F.3d ___ (5th Cir. 2009), decided 4/3/09, the Fifth Circuit held that actions taken by the tax matters partner in a TEFRA partnership were not ineffective to toll the statute of limitations because of an alleged disabling conflict between the tax matters partner and the other partners. The specific actions involved executing consents to extend the statute of limitations and filing a Tax Court proceeding. Under the TEFRA scheme, both of these actions result in the extension of the statute of limitations at the partnership level and thus extension of the statute of limitations for the TEFRA partnership adjustments at the individual partner level.

The Fifth Circuit distinguished an earlier Second Circuit case which had found a disqualifying conflict between the tax matters partner and the partners that made it unreasonable and inappropriate for the IRS to rely upon consents given by the tax matters partner. The Fifth Circuit concluded that (i), unlike the facts in Transpac Drilling, the IRS had not sought consents from the partners and been denied the consents, (ii) the IRS did not have a pending criminal investigation against the tax matters partner, (iii) the tax matters partner’s request for a quid pro quo via relief from the preparer penalties was not disabling because the IRS had already determined not to seek the penalty, and (iv), although the IRS believed the tax matters partner was dishonest, that alone did not create a per se conflict between his interests and the limited partners’ interests sufficient to put the IRS' reliance unreasonable under the circumstances.

A Loser on Avoiding the 6 Year Statute for 25% Omissions

Our readers will recall that Section 6501(e)(1)(A) gives the IRS a six year statute for a “substantial omission” – defined as an omission from gross income in an amount exceeding 25% of the amount of gross income stated in the return. An exception to this extended statute of limitations is provided if the omitted income is disclosed on the return even though it is not included in gross income on the return.

Consider this discussion from Benson v. Commissioner, ___ F.3d ___, ___ (9th Cir. 2009) where there was a 25% omission and no disclosure:

The Bensons also argue that Colony can be read to preclude the application of the extended limitations period because the Commissioner was able to discover the unreported income, despite their omissions. For this proposition, the Bensons cite the Court's language stating that the extended limitations period was meant to give the Commissioner additional time to "investigate tax returns in cases where, because of a taxpayer's omission to report some taxable item, the Commissioner is at a special disadvantage in detecting errors." Colony, 357 U.S. at 36. The Bensons argue that the Commissioner was at no such special disadvantage here, as evidenced by the fact that the Commissioner actually detected the errors, and therefore the six-year period should not apply. However, the Supreme Court's gloss on the statutory language does not alter the statute's plain language, which simply provides that the Commissioner is afforded extra time whenever a taxpayer “omits” a certain amount from his or her gross income. 26 U.S.C. § 6501(e)(1)(A). The Bensons omitted the constructive dividends from their tax returns.

The taxpayer’s argument was, of course, circular. If the IRS did not discover the omission, then the statute was six years but would be meaningless because the IRS did not discover the omission even in the six years. If the IRS did discover it in the six year period, then the six year period would not apply because the IRS discovered it.

So the question is Shakespearean - to disclose or not to disclose. For taxpayers who pay close attention to odds (viewing tax reporting like gambling), disclosing solely to avoid a six year limitations period is not generally a recommended option. Providing that the taxpayer is reasonably certain he or she can avoid civil and criminal penalties for the omission, the taxpayer may want to take the risks involved in having a six year rather than a three year statute of limitations. The IRS hardly ever commences audits of returns that are over 2 ½ years old anyway, so that the additional three year risk may not be that great. Thus, for each year during the first three years when the statute is open under the general rule, the odds of an IRS audit of the return are far greater than in the succeeding three years (Years 4 through 6). Nevertheless, even with the decreased odds in the “out years,” the IRS will sometimes stumble upon an out year problem while auditing years within the normal statute of limitations and will seek to invoke § 6501(e). And, of course, a disclosure will likely eliminate the far worse risk than a 6 year statute of limitations – a criminal investigation and prosecution.

Tax Court Invalidates Two Year Rule for Innocent Spouse Relief

In the past the IRS has contended that someone asking for innocent spouse relief under Section 6015(f) of the Internal Revenue Code would have to file for innocent spouse relief within two years of the first collection action taken by the IRS. The IRS has consistently disallowed claims that were not filed within this two year period.

In the case of Lantz v. Commissioner, 132 T.C. No. 8 (Apr. 7, 2009), the Tax Court has held that the two year rule imposed by the Regulation Section 1-6015-5(b)(1) is invalid. If request for innocent spouse relief has been denied by the IRS based on the two year rule, it should be requested again.

Enrolled Agent Suspended

An enrolled agent has been suspended from practice before the Internal Revenue Service by the Office of Professional Responsibility for not performing services related to offers in compromise paid for by taxpayers. In IR 2009-35 the IRS states that the enrolled agent admitted a lack of due diligence in representing the taxpayers. The announcement also states: "The IRS is taking a closer look at tax resolution companies, and is also litigating known OIC abuses to ensure that tax professionals fulfill their legal and ethical obligations to their clients in dealing with IRS tax matters".
It is time more action is taken against those who represent taxpayers before the IRS and do not perform work in a competent and professional manner.

Tips for Choosing a Tax Preparer

The IRS offers some points for taxpayers when someone else prepares their return.
In addition see: FS-2009-7, How to Choose a Tax Preparer and Avoid Preparer Fraud