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))

STADNYK v. COMM., Cite as 105 AFTR 2d 2010-XXXX, 02/26/2010
________________________________________
DANIEL J. STADNYK and BRENDA J. STADNYK, Petitioners-Appellants, 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. 09-1485,
Date Decided: 02/26/2010.
Disposition:
HEADNOTE
.
Reference(s):
OPINION
UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT,
BEFORE: GUY, CLAY, and KETHLEDGE, Circuit Judges.
ON APPEAL FROM THE UNITED STATES TAX COURT
Judge: CLAY, Circuit Judge.
NOT RECOMMENDED FOR FULL-TEXT PUBLICATION
File Name: 10a0128n.06
Petitioners Daniel and Brenda Stadnyk appeal from the order entered by the United States Tax Court denying their petition for redetermination of a deficiency. For the reasons set forth below, we AFFIRM the Tax Court's order.
BACKGROUND
On December 11, 1996, Petitioners purchased a used 1990 Geo Storm from Nicholasville Road Auto Sales, Inc. (“Nicholasville Auto”) for $3,430.00. Brenda Stadnyk tendered two checks to Nicholasville Auto as partial payment, check number 1080 for $100 and check number 1087 for $1,100, from a checking account with Bank One, Kentucky, N.A. (“Bank One”). After Petitioners drove approximately seven miles from the dealership, the car broke down. Petitioners spent $479.78 to repair the car. They attempted to call Nicholasville Auto about the Geo Storm, but their calls were ignored, placed on hold for long periods of time, and not returned.
Because of their dissatisfaction with the car, Mrs. Stadnyk contacted Bank One to place a stop payment order on check number 1087 for $1,100. Bank One's record of the stop payment order indicates “dissatisfied purchase” as the reason for the stop payment. However, Bank One incorrectly stamped the check “NSF” for insufficient funds and returned it to Nicholasville Auto. On February 4, 1997, Nicholasville Auto filed a criminal complaint against Mrs. Stadnyk for issuing and passing a worthless check in the amount of $1,100.
At approximately 6:00 p.m. on February 23, 1997, officers of the Fayette County Sheriff's Department arrested Mrs. Stadnyk at her home in the presence of her husband, her daughter, and a family friend, and transported her to the Fayette County Detention Center. She arrived at the detention center at approximately 6:30 p.m., and she was handcuffed, photographed, and confined to a holding area. At approximately 11:00 p.m., Mrs. Stadnyk was transferred to Jessamine County Jail, where she was searched via pat-down and use of an electric wand. Mrs. Stadnyk was required to undress to her undergarments, remove her brassiere in the presence of officers, and put on an orange jumpsuit. She was released on bail at approximately 2:00 a.m. on February 24, 1997. On April 23, 1997, Mrs. Stadnyk was indicted for “theft by deception over $300.00” based on the returned check marked for insufficient funds. These charges were later dropped.
Mrs. Stadnyk testified that she did not suffer any physical injury as a result of her arrest and detention. According to Mrs. Stadnyk, nobody put their hands on her, grabbed her, jerked her around, bruised her, or hurt her. As a result of the incident, Mrs. Stadnyk visited a psychologist every 1.5 to two weeks for approximately eight sessions. The cost of these sessions was covered by Mrs. Stadnyk's insurance and employer. Mrs. Stadnyk did not pay any out-of-pocket medical expenses for physical injury or mental distress as a result of the arrest and detention.
On August 25, 1999, Mrs. Stadnyk filed a Complaint against J.R. Maze, the owner of Nicholasville Auto, Nicholasville Auto, and Bank One. On July 5, 2000, she filed a First Amended Complaint, alleging that Bank One breached its fiduciary duty of care by improperly and negligently marking her check “NSF” for insufficient funds. Mrs. Stadnyk's First Amended Complaint also included the following claims against J.R. Maze and Nicholasville Auto: malicious prosecution, abuse of process, false imprisonment, defamation, and outrageous conduct. The First Amended Complaint repeated and incorporated by reference these allegations against Bank One.
On March 7, 2002, Mrs. Stadnyk entered into a mediation agreement with Bank One, under which Bank One agreed to pay Mrs. Stadnyk $49,000 to settle her claims and provide her with a letter of apology. In return, Mrs. Stadnyk agreed to dismiss her complaint against Bank One. The mediation agreement form stated that “Bank One shall pay the total sum of $49,000, by 3/15/02, by official check” and that “[t]he suit shall be dismissed with prejudice with each party to pay their own costs & fees.” (App. at 206). It contained no language indicating the purpose for which the settlement was paid. On March 14, 2002, Bank One issued a check to Mrs. Stadnyk for $49,000, and on May 3, 2002, Mrs. Stadnyk's complaint against Bank One was dismissed with prejudice. 1
During the trial before the Tax Court, Mrs. Stadnyk testified that her attorney, the attorney for Bank One, and the mediator all advised her that the settlement proceeds would not be subject to income tax. Based on this advice, the Stadnyks did not report the $49,000 settlement on their 2002 Form 1040 income tax return, although Bank One issued Mrs. Stadnyk a Form 1099-MISC reporting the payment of the $49,000 settlement. On March 14, 2005, Respondent issued a notice of deficiency to Petitioners, after determining that Petitioners were liable for a tax deficiency of $13,119.00 and an accuracy-related penalty of $2,624.00 under Internal Revenue Code (“I.R.C.”) § 6662(a). Petitioners timely appealed to the Tax Court. On January 12, 2009, the Tax Court ruled in favor of Respondent with respect to the deficiency and in favor of Petitioners with respect to the penalty. On April 15, 2009, Petitioners filed a timely notice of appeal.

DISCUSSION

I. Standard of Review

We review the Tax Court's conclusions of law de novo and its findings of facts for clear error.Limited, Inc. v. Comm'r , 286 F.3d 324, 331 [89 AFTR 2d 2002-1924] (6th Cir. 2002). We will conclude that a factual finding is clearly erroneous only if, upon review of the entire record, we are ““left with the definite and firm conviction that a mistake has been committed.”” Zack v. Comm'r, 291 F.3d 407, 412 [89 AFTR 2d 2002-2578] (6th Cir. 2002) (quoting Sanford v. Harvard Indus., Inc., 262 F.3d 590, 595 (6th Cir. 2001)).
II. The Definition of Income Under I.R.C. § 61(a)
Under I.R.C. § 61(a), taxpayers are liable for all gross income, which is defined as “all income from whatever source derived.” 26 U.S.C. § 61(a). The Supreme Court has instructed that § 61 “be construed liberally “in recognition of the intention of Congress to tax all gains except those specifically exempted.”” Greer v. United States, 207 F.3d 322, 326 [85 AFTR 2d 2000-1876] (6th Cir. 2000) (quotingComm'r v. Glenshaw Glass Co. , 348 U.S. 426, 430 [47 AFTR 162], 75 S. Ct. 473, 99 L. Ed. 483 (1955)). Nevertheless, the I.R.C. provides for a number of exclusions from income.
Petitioners argue that the $49,000 settlement award Mrs. Stadnyk received from Bank One does not classify as income under I.R.C. § 61(a) because Mrs. Stadnyk was made whole—not enriched—by the compensatory damages. Petitioners cite toGlenshaw for the proposition that the term “income” for tax purposes is commonly defined as all “accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” 348 U.S. at 431. According to Petitioners, because Mrs. Stadnyk's award was compensation for something she had lost, not an “accession to wealth,” her settlement award does not classify as income under § 61(a).
However, Petitioners' reliance on Glenshaw for the proposition that income does not include compensatory damages awards is misplaced. In Glenshaw, the Supreme Court observed that it “has given a liberal construction to this broad phraseology [of income] in recognition of the intention of Congress to tax all gains except those specifically exempted.” Id. at 430 (internal citations omitted). On multiple subsequent occasions, the Supreme Court has reaffirmed the “sweeping scope” of I.R.C. § 61(a).See Comm'r v. Schleier , 515 U.S. 323, 327 [75 AFTR 2d 95-2675], 115 S. Ct. 2159, 2167, 132 L. Ed. 2d 294 (1995). See also United States v. Burke, 504 U.S. 229, 233 [69 AFTR 2d 92-1293], 112 S. Ct. 1867, 119 L. Ed. 2d 34 (1992) (noting that I.R.C. § 61(a) “sweeps broadly” and includes all income “subject only to the exclusions specifically enumerated elsewhere in the Code”); Comm'r v. Banks, 543 U.S. 426, 433 [95 AFTR 2d 2005-659], 125 S. Ct. 826, 160 L. Ed.2d 859 (2005) (“Banks II”) (noting that the definition of gross income “extends broadly to all economic gains not otherwise exempted”). Consistent with interpreting the definition of income broadly, the Supreme Court has “also emphasized the corollary to § 61(a)'s broad construction, namely, the “default rule of statutory interpretation that exclusions from income must be narrowly construed.”” Schleier, 515 U.S. at 328 (quoting Burke, 504 U.S. at 248 (Souter, J. concurring in judgment)). The Supreme Court's instructions to interpret § 61(a) broadly and exceptions narrowly have led courts to the conclusion that “subject to certain exemptions, which are to be construed narrowly, § 61(a) applies to all income, including settlement payments.”Polone v. Comm'r , 505 F.3d 966, 969 [100 AFTR 2d 2007-6277] (9th Cir. 2007).
The fact that the damages award is compensatory does not make it nontaxable. The Supreme Court has found compensatory settlement awards that are not otherwise excluded to be taxable as gross income under I.R.C. § 61(a). See, e.g., Burke, 504 U.S. at 233 (“[t]here is no dispute that the settlement awards in this case would constitute gross income within the reach of § 61(a)”);Schleier , 515 U.S. at 328 (“[r]espondent recognizes § 61(a)'s “sweeping” definition and concedes that his settlement constitutes gross income unless it is expressly excepted by another provision in the Tax Code”). While the Supreme Court has never explicitly ruled that compensation received for personal injury is income pursuant to § 61(a), nothing in the Court's analysis of the scope of § 61(a) supports Petitioners' argument that the Court would come to a different conclusion in the context of personal injury awards than in the context of backpay. Settlement awards for back pay, like settlement awards for personal injury, are compensatory in nature because they make the recipient whole.
Furthermore, if damages awards received on account of personal injury were not income, there would be no need for the exclusion laid out in § 104(a)(2), which exempts from income taxation any damages received on account of personal physical injuries or physical sickness. See Lukhard v. Reed, 481 U.S. 368, 376 (1987) (rejecting the argument “that personal injury awards are [generally] not treated as income under the Internal Revenue Code” and noting that “in each of these instances [where personal injury awards are excluded from § 61(a)] there is an express provision that personal injury awards are not to be treated as income—which causes them not only to fail to support the proposition that the term “income” automatically excludes personal injury awards, but to support the opposite proposition that absent express exclusion it embraces them”). See also Murphy v. I.R.S., 493 F.3d 170, 180 [100 AFTR 2d 2007-5075] (D.C. Cir. 2007) (holding that money received in compensation for emotional injuries is taxable income pursuant to § 61 (a) because the 1996 amendments to § 104(a)(2) would make little sense if § 61(a) did not include compensation for personal injuries).
Accordingly, Mrs. Stadnyk's $49,000 settlement classifies as gross income under § 61(a), and Petitioners can only avoid paying taxes on the damages award if it falls under an exclusion.
III. The Exclusion in I.R.C. § 104(a)(2)
The exclusion from § 61(a) at issue in the instant case is contained in § 104(a)(2), which permits taxpayers to exclude from income “the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.” 26 U.S.C. § 104(a)(2).
The Supreme Court has held that a taxpayer must meet two independent requirements before a recovery may be excluded under § 104(a)(2). “First, the taxpayer must demonstrate that the underlying cause of action giving rise to the recovery is based upon tort or tort type rights; and second, the taxpayer must show that the damages were received on account of personal injuries or sickness.” Schleier, 515 U.S. at 337 (internal quotations omitted). To satisfy the second prong, the taxpayer must present “concrete evidence demonstrating the precise causal connection” between the taxpayer's asserted personal injuries and the settlement she received. Banks v. Comm'r, 345 F.3d 373, 378–79 [92 AFTR 2d 2003-6298] (6th Cir. 2003) (“Banks I”) (overruled on other grounds byBanks II ) (citing Greer, 207 F.3d at 334).
In 1996, I.R.C. § 104(a)(2) was amended to add the word “physical” to the phrase “personal injuries or sickness.” See Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838. Prior to the amendment, I.R.C. § 104(a)(2) encompassed damages compensating all personal injuries, including non-physical injuries. See Burke, 504 U.S. at 235 n.6. However, the amendment to I.R.C. § 104(a)(2) expressly limits the type of damages excludable from income to those received “on account of personal physical injuries or physical sickness,” and expressly states that emotional distress does not constitute a physical injury or sickness. Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838.
Petitioners argue that their settlement award satisfies the two-part test laid out in Schleier, and, thus, may be excluded from taxation under § 104(a)(2).
A. Prong One: Tort or Tort Type Right
Under the first prong, the question is whether Mrs. Stadnyk's claims against Bank One giving rise to her recovery are based upon tort or tort type rights. The mediation agreement between Mrs. Stadnyk and Bank One did not state what claims provided the basis for the settlement award, nor does the remainder of the record surrounding the settlement provide any insight. Thus, we must look to the complaint to shed light on what claims gave rise to the award. In Mrs. Stadnyk's First Amended Complaint, she alleged a number of tort claims against J.R. Maze and Nicholasville Auto, including malicious prosecution, abuse of process, false imprisonment, defamation, and outrageous conduct, and she repeated, realleged, and incorporated these claims by reference against Bank One. By incorporating these claims by reference, Mrs. Stadnyk raised these tort claims against Bank One.
In addition, Mrs. Stadnyk alleged in her First Amended Complaint that Bank One breached its fiduciary duty of care by improperly and negligently marking her check “NSF” for insufficient funds. Kentucky's banking statutes recognize elements of both contract and tort law in the bank-depositor relationship. Under Kentucky law, banks are required to exercise good faith and ordinary care in the handling of customer accounts, thereby incorporating common law rules of negligence.See Bullitt County Bank v. Publisher's Printing Co. , 684 S.W.2d 289, 291–92 (Ky. Ct. App. 1984);Pulliam v. Pulliam , 738 S.W.2d 846, 849 (Ky. Ct. App. 1987); American Nat'l Bank v. Morey, 69 S.W. 759, 760 (Ky. 1902) (recognizing that a bank customer may have a tort claim against a bank for the wrongful dishonor of a check). Furthermore, under Kentucky law, arrest is a reasonably foreseeable consequence of a bank's wrongful dishonor, and a bank customer may sue for damages resulting from an arrest over such an error. See Ky. Rev. Stat. § 355.4-402 (“A payor bank is liable to its customers for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other consequential damages.”).
Based on these Kentucky banking laws and the circumstances of this case, the Tax Court found that Mrs. Stadnyk's independent claims against Bank One sounded in tort:
It is incorrect to characterize [Mrs. Stadnyk's] complaint against Bank One as a contract claim or merely a dispute over the wrongful dishonor of a check. Rather, [Mrs. Stadnyk] decided to sue Bank One because of the ordeal she suffered as a result of her arrest and detention. [Mrs. Stadnyk] did not suffer an economic loss from Bank One's alleged mishandling of her check. She did not sue Bank One to recover on economic rights arising from a contract with Bank One. [Mrs. Stadnyk] sought damages against Bank One that resulted from her arrest, detention, and indictment.
(App. at 85–86.) We agree with the Tax Court's analysis. Based on the finding that Mrs. Stadnyk alleged tort claims against Bank One in her complaint, we conclude that Mrs. Stadnyk's settlement with Bank One was based on tort or tort type rights.
B. Prong Two: “On Account of Personal Physical Injuries”
Having satisfied the first prong, to obtain an exclusion under § 104(a)(2), Mrs. Stadnyk must show that she sustained the damages on account of personal physical injuries or sickness. Under the 1996 Amendment, I.R.C. § 104(a)(2) expressly limits the type of damages excludable from income to personalphysical injuries or physical sickness and expressly states that emotional distress does not constitute a physical injury or sickness. Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838. Kentucky courts have defined false imprisonment as “any deprivation of the liberty of one person by another or detention for however short a time without such person's consent and against his will, whether done by actual violence, threats or otherwise.” Grayson Variety Store, Inc. v. Shaffer, 402 S.W.2d 424, 425 (Ky. 1966). The tort of false imprisonment protects personal interest in freedom from physical restraint; the interest is “in a sense a mental one” and the injury is “in large part a mental one.”Banks v. Fritsch , 39 S.W.3d 474, 479 (Ky. Ct. App. 2001).
During her deposition, Mrs. Stadnyk testified that she did not suffer any physical injury as a result of her arrest and detention. According to Mrs. Stadnyk, nobody carrying out her arrest or detention put their hands on her, grabbed her, jerked her around, bruised her, or hurt her. Petitioners' brief concedes that the actions of the police were proper and that Mrs. Stadnyk presumes that she was treated in the same manner as anyone else arrested for passing a bad check. Nothing in the record suggests that Mrs. Stadnyk suffered physical, as opposed to emotional, injuries as a result of Bank One's actions.
The Tax Court correctly noted that “[t]he damages sought by [Mrs. Stadnyk] against Bank One are stated in terms of recovery for nonphysical personal injuries: [e]motional distress, mortification, humiliation, mental anguish, and damage to reputation.” (App. at 88). These are all emotional injuries, and are thus not excludable under § 104(a)(2). See Sanford v. Comm'r, 95 T.C.M. (CCH) 1618 [TC Memo 2008-158] (2008) (settlement award for emotional distress relating to sexual harassment and discrimination claims is not excludable); Polone v. Comm'r, 86 T.C.M. (CCH) 698 [TC Memo 2003-339] (2003) (settlement award for defamation claim is not excludable),aff'd 505 F.3d 966 [100 AFTR 2d 2007-6277] (9th Cir. 2007); Venable v. Comm'r, 86 T.C.M. (CCH) 254 [TC Memo 2003-240] (2003) (settlement payment for mental anguish and loss of reputation relating to malicious prosecution claim is not excludable), aff'd 110 Fed. App'x 421 [94 AFTR 2d 2004-6408] (5th Cir. 2004).
However, despite Mrs. Stadnyk's testimony, Petitioners argue that Mrs. Stadnyk suffered a physical injury because “[p]hysical restraint and detention and the resulting deprivation of [Mrs. Stadnyk's] personal liberty is [itself] a physical injury ... that Mrs. Stadnyk endured for an eight hour period.” (Pets.' Br. at 15.) Petitioners further argue that Mrs. Stadnyk suffered physical damages in addition to emotional damages because “to be falsely imprisoned, the person must first be physically restrained or held against their will” and “[t]hus the damages received from false imprisonment arise from the person's physical loss of their freedom and the mental suffering and humiliation that accompany this deprivation.” (Pets.' Br. at 15.)
In other words, Petitioners are asking the Court to create aper se rule that every false imprisonment claim necessarily involves a physical injury, even though physical injury is not a required element of false imprisonment under Kentucky law. To be sure, a false imprisonment claim may cause a physical injury, such as an injured wrist as a result of being handcuffed. But the mere fact that false imprisonment involves a physical act—restraining the victim's freedom—does not mean that the victim is necessarily physically injured as a result of that physical act. In the instant case, Mrs. Stadnyk unequivocally testified that she suffered no physical injuries as a result of her physical restraint. Thus, Petitioners have failed to establish that Mrs. Stadnyk suffered from personal physical injuries or physical sickness.
In addition, the Supreme Court has construed the “on account of” phrase to require a direct causal link between the physical injury and the damages recovery in order to qualify for the income exclusion. See Schleier, 515 U.S. at 329–31. This direct causal connection must be more than a “but for” link, because a “but for” analysis would “bring virtually all personal injury lawsuit damages within the scope of the provision, since: but for the personal injury, there would be no lawsuit, and but for the lawsuit, there would be no damages.” O'Gilvie v. United States, 519 U.S. 79, 82 [78 AFTR 2d 96-7454], 117 S.Ct. 452, 136 L. Ed. 2d 454 (1996) (internal quotation marks omitted). Rather, the “on account of” phrase requires that the damages be awarded by reason of, or because of, a personal physical injury. Id. at 83.See also Greer , 207 F.3d at 327 (requiring that “the agreement was executed “in lieu” of the prosecution of the tort claim and “on account of” the personal injury”). Petitioners bear the burden of “present[ing] concrete evidence demonstrating the precise causal connection” between the personal physical injuries and the settlement payment. Id. at 334.
The settlement agreement does not include any express language of purpose. It only provides that “Bank One shall pay the total sum of $49,000” and that the “suit shall be dismissed with prejudice.” (App. at 206). Petitioners' only evidence arguably supporting the purpose necessary for exclusion under § 104(a)(2) is Mrs. Stadnyk's testimony that her attorney, the attorney for Bank One, and the mediator all advised her that the settlement proceeds would not be subject to income tax. However, even assuming the attorneys did give her this advice, there is no evidence concerning the basis for the advice. The attorneys may have advised Mrs. Stadnyk based on any number of incorrect beliefs, such as the belief that all personal injury awards are excludable from income, as Petitioner argues here, or the belief that a physical injury was unnecessary. Given that the settlement agreement included no indication that Bank One paid the settlement on account of any physical injury and that all of Mrs. Stadnyk's damages were stated in terms of emotional distress, Petitioners have failed to offer any concrete evidence demonstrating a causal connection between any physical injury and the settlement award.
Thus, Petitioner's settlement award may not be excluded from taxation under § 104(a)(2).
IV. The Constitutionality of I.R.C. § 104(a)(2)
Petitioners argue that § 104(a)(2), as amended by Congress in 1996, violates the Sixteenth Amendment to any extent that it purports to subject compensation for personal injuries to income tax. According to Petitioners, the Sixteenth Amendment only allows Congress to impose a tax on “incomes,” and a personal injury recovery is not income because it is not an accession to wealth. In arguing that Congress cannot comply with the Sixteenth Amendment by subjecting a personal injury recovery to income tax, Petitioners have recycled their argument that a personal injury award does not classify as income because it is compensatory rather than an accession to wealth. Thus, given our conclusion that a personal injury award is income under § 61(a), we must also reject Petitioner's related constitutional argument. See Murphy, 493 F.3d at 186.
In the alternative, Petitioners argue in the last two sentences of their brief that § 104(a)(2) is unconstitutional because it is a direct tax and is nonapportioned. Because Petitioners did not raise thus argument below, it is waived. Armstrong v. City of Melvindale, 432 F.3d 695, 700 (6th Cir. 2006). Furthermore, Petitioner's conclusory assertion is not enough to raise the issue now. Leary v. Livingston County, 528 F.3d 438, 449 (6th Cir. 2008) (“It is a settled appellate rule that issues averred in a perfunctory manner, unaccompanied by some effort at developed argumentation, are deemed waived.”).
However, assuming Petitioners have properly presented this argument, it is meritless. Even if the Court were to find that the damages award is not income within the meaning of the I.R.C. § 61(a) and the Sixteenth Amendment, a tax on Mrs. Stadnyk's settlement award would only be unconstitutional if it were a direct tax requiring apportionment or not uniform.See U.S. Const. art. I, § 8 (“all duties, imposts, and excises shall be uniform throughout the United States”); U.S. Const. art. I, § 9 (“No capitation, or other direct, tax shall be laid, unless in proportion to the census or enumeration herein before directed to be taken.”).
The tax on Petitioner's damages award is not a direct tax. Only three taxes are definitively known to be direct: (1) a capitation, (2) a tax upon real property, and (3) a tax upon personal property. See Murphy, 493 F.3d at 181. However, a tax on damages sustained on account of personal injury is not a tax on property; rather, it is a tax on thereceipt of a damages award. Id. at 184 (“it does not appear that this tax is upon ownership; rather, as the Government points out, [the taxpayer] is taxed only after she receives a compensatory award, which makes the tax seem to be laid upon a transaction”). Thus, it need not be apportioned. See Tyler v. United States, 281 U.S. 497, 502 [8 AFTR 10912], 50 S. Ct. 356, 4 L. Ed. 991 (1930) (“A tax laid upon the happening of an event, as distinguished from its tangible fruits, is an indirect tax which Congress ... undoubtably may impose.”).
Moreover, so long as Congress has the power to levy the tax, it is irrelevant whether it was proper for the tax to be labeled income tax or collected pursuant to § 61(a). See Penn Mut. Indemn. Co. v. Comm'r , 277 F.2d 16, 20 [5 AFTR 2d 1171] (3d Cir. 1960) (“[i]t is not necessary to uphold the validity of the tax imposed by the United States that the tax itself bear an accurate label”); Simmons v. United States, 308 F.2d 160, 166 [10 AFTR 2d 5523] n.21 (4th Cir. 1962) (“if Congress has the power to impose the tax in question, it is not material that it call the tax one on income, for it has been clearly established that the labels used do not determine the extent of the taxing power”).
Finally, even assuming the tax in this case is an excise subject to the uniformity requirement, the tax in this case meets this standard. See United States v. Ptasynski, 462 U.S. 74, 82 [52 AFTR 2d 83-6495], 103 S. Ct. 2239, 76 L. Ed. 2d 427 (1983) (“tax is uniform when it operates with the same force and effect in every place where the subject of it is found”) (internal citations and quotations omitted).
Thus, the Tax Court did not err by concluding that I.R.C. § 104(a)(2) does not violate the Constitution.
CONCLUSION
Because the Tax Court properly found that Petitioners owe income taxes on the damages award received pursuant to their settlement with Bank One and that I.R.C. § 104(a)(2) does not violate the Constitution, we AFFIRM the Tax's Court's order.
________________________________________
1
Mrs. Stadnyk's claims against J.R. Maze and Nicholasville Auto had already been dismissed with prejudice pursuant to an order entered on June 8, 2001. The record contains no information as to the terms of the dismissal.

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.

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.

If the IRS takes the position that something is a sham trust, they cannot take an inconsistent position that it is not a sham trust.


BEMONT INVESTMENTS, LLC v. U.S., Cite as 105 AFTR 2d 2010-XXXX, 03/09/2010
________________________________________
BEMONT INVESTMENTS, LLC, by and through its Tax Matters Partner, et al., Plaintiffs, v. UNITED STATES OF AMERICA, Defendant.

Case Information:


Code Sec(s):
Court Name: IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TEXAS SHERMAN DIVISION,
Docket No.: CASE NO. 4:07cv9 (consolidated with 4:07cv10),
Date Decided: 03/09/2010.
Disposition:
HEADNOTE
.
Reference(s):
OPINION

IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF TEXAS SHERMAN DIVISION,
MEMORANDUM OPINION AND ORDER REGARDING MOTION FOR PARTIAL SUMMARY JUDGMENT REGARDING INAPPLICABILITY OF VALUATION MISSTATEMENT PENALTY
Judge: DON D. BUSH UNITED STATES MAGISTRATE JUDGE

Before the Court is Plaintiffs' Motion for Partial Summary Judgment Regarding Inapplicability of Valuation Misstatement Penalty (Dkt. 137). The Court has considered the motion, as well as the response filed by the United States. The motion is GRANTED.

Plaintiffs, the partnerships herein, filed this suit contesting the determination by the Internal Revenue Service that the transactions which created partnership losses were sham transactions to create sham losses. The United States calls these tax shelters Son of Boss transactions.

The very narrow issue presented here is whether the United States can impose a penalty for valuation misstatements. The United States contends that the value of the currency swaps as reported results in a misstatement of over 8000%.
Section 6662 of the Internal Revenue Code allows an imposition of a penalty for underpayment of taxes when any one of the following factors is demonstrated: (1) negligence or disregard of rules or regulations; (2) any substantial understatement of income tax; (3) any substantial valuation misstatement under chapter 1; (4) any substantial overstatement of pension liabilities; or (5) any substantial estate or gift tax valuation understatement. 26 U.S.C. § 6662 (b)(1–5). Section 6662(h)(2) allows for a 40% penalty, if the substantial valuation misstatement is 400% or more. 26 U.S.C. § 6662(h)(2).

In October 2006, the I.R.S. sent both partnerships a Notice of Final Partnership Administrative Adjustment, or FPAA. Curiously, the notice states that, if the partnerships do nothing and do not enter into a binding settlement, they will be billed for any additional tax plus interest that they may owe under the FPAA. Nothing is said about penalties. However, the notice states that, if the partnerships accept the FPAA and sign the required form, then they are signing on for any additional penalties as determined by the I.R.S. This begs the question, why settle?

In the form 886-A, Explanation of Items, attached to the FPAA the I.R.S. notes a number of factors for its decision to disallow the transaction. First, the I.R.S. questions whether BPB Investments is a partnership as a matter of fact. Second, the I.R.S. states that the partnership was formed solely for the purposes of tax avoidance by artificially overstating basis in the partnership interests of its purported partners. Third, the transaction was noted by the I.R.S. as an economic sham with no business purpose. The I.R.S. makes the determination that the foreign currency swaps were acquired directly by the partners and not BPB Investments, LLC. The I.R.S. also concludes that the swap assumed by BM Investments, LLC is disregarded and any gains or losses on the swap is treated as having been realized by the partners. The I.R.S. then determines that the partners of BPB Investments are not to be treated as partners. It is also determined by the I.R.S. that obligations under the short positions transferred to BM Investments LLC are liabilities which reduce the purported partners' bases in BM Investments, LLC in the amount of $202,5000,000. The I.R.S. determines that there was no profit motive with this transaction and that any losses were not at risk. The I.R.S. also determines that none of the partners of BM Investments, LLC or PBP Investments, LLC established an adjusted basis in their respective interests in an amount greater than zero (0). The I.R.S. also determines that the sale, liquidation, or exchange of the above noted partnerships failed to establish a basis above zero for the partners' partnership interest.

Plaintiffs contend that, under well settled Fifth Circuit law, the I.R.S.'s determination that the transaction was a sham — and thus disallowed — forecloses assessment of the 40% penalty. The United States responds that current Fifth Circuit law either (1) does not apply to this transaction because the transaction is distinguishable or has been superseded by changes in the law and Treasury Regulations, or (2) precedent binding decisions were incorrectly decided. The United States points out that, when considering these type of tax shelters, most of the Circuits have upheld the 40% penalty provision. The United States concedes that the case law in the Ninth Circuit and Fifth Circuit reaches a contrary result.
Therefore, the task before the Court is relatively simple. If Fifth Circuit law operates in Plaintiffs' favor, there is little else to do than grant the motion. This Court is bound by precedent, not policy.
Plaintiffs contend that, under Todd v. Comm'r, 862 F.2d 540, 541–42 [63 AFTR 2d 89-523] (5th Cir. 1988), Heasley v. Comm'r, 902 F.2d 380, 382–83 [66 AFTR 2d 90-5068] (5th Cir. 1990), and their progeny, these penalties are not applicable if the I.R.S.'s disallowance of tax benefits is not “attributable to” a valuation misstatement. See Klamath Strategic Inv. Fund v. United States, 472 F. Supp.2d 885, 899–900 [99 AFTR 2d 2007-850] (E.D.Tex. 2007) aff'd in part, 568 F.3d at 553 (holding that a disallowance was not “attributable to” a valuation misstatement when the I.R.S. disallowed a transaction as lacking economic substance). In Todd, the Fifth Circuit held that, because deductions and credits were disallowed for a reason totally unrelated to any valuation overstatement, the resulting underpayment could not be “attributable to a valuation overstatement” and misstatement penalties should not apply.Todd, 862 F.2d at 542.

In Heasley, the Fifth Circuit determined:
Whenever the I.R.S. totally disallows a deduction or credit, the I.R.S. may not penalize the taxpayer for a valuation overstatement included in that deduction or credit. In such a case, the underpayment is not attributable to a valuation overstatement. Instead, it is attributable to claiming an improper deduction or credit.

Heasley, 902 F.2d at 383. The Fifth Circuit has reaffirmed the validity of the Todd/Heasley reasoning. See Weiner v. U.S., 389 F.3d 152, 160–62 [94 AFTR 2d 2004-6518] (5th Cir. 2004) (citing Todd/Heasley with approval); see also Southgate Master Fund, LLC ex rel. Montgomery Capital LLC v. United States, 651 F.Supp. 2d 596, 664 [104 AFTR 2d 2009-6053] (N.D. Tex. 2009) (noting that the Fifth Circuit reaffirmed the validity of Todd/Heasley in the 2004 opinion in Weiner).
Here, the Court must take into account the I.R.S.'s rationale for disallowing the transactions entered into by Plaintiffs. First and foremost, the transaction is not disallowed because of a substantial valuation misstatement. The I.R.S. determined that the transaction was created for no business purpose other than for tax avoidance. Accordingly, the I.R.S. disregards the partnerships and transactions in full. The I.R.S. goes on to hold that the transaction lacked economic substance and was an economic sham. All losses are not allowed. All increase in basis of assets are not allowed to eliminate gain, and increases to the adjusted basis of partnership interests are not allowed. In essence, the I.R.S. rips the whole transaction apart.
But, there is no finding in the explanation of benefits that the reason for doing so is because of a gross valuation misstatement. In fact, in its explanation of Accuracy - Related Penalties, the I.R.S. once again states that the tax shelter was created without substantial authority for the position taken and that there was no reasonable belief by the partners that the position taken was more likely than not the correct treatment of the shelter and related transactions.
The I.R.S. then “hedges its bet”, noting that, in addition, all underpayments of tax are due to, at a minimum, substantial understatements of income tax, gross valuation misstatement(s); or negligence or disregarded rules or regulations.
The United States argues that the earlier Fifth Circuit cases noted above dealt with shelters from the 1980s involving penalty provisions that are no longer in effect. However, the Fifth Circuit's decision in Weiner forecloses this argument. See Weiner, 389 F.3d at 161. Further, the United States's argument that Treas. Reg. Section 1.6662-5(g) mandates a finding that, when the basis is determined to be zero, the deemed valuation misstatement is considered to be a gross valuation statement is vain. As Plaintiffs point out, this section is only applicable when any portion of the underpaymentis attributable to a substantial valuation misstatement. See Treas. Reg., Section 1.6662-5(a).
Are Todd, Heasley and Weiner distinguishable? Although the degree of sophistication or motivation on the part of the taxpayers in the above cases might generate a more sympathetic treatment, the principle relied upon by Plaintiffs and cited above does not appear to hinge on the motives of the taxpayers, but rather how the United States treats the transaction. Therefore, although the United States invites this Court to ignore binding precedent, the Court will not and cannot do so. Any distinctions that might exist as to taxpayer motives, if such exist, are a matter of concern for the Fifth Circuit. Any attempt by the United States to establish a 40% penalty is foreclosed by its own actions in this case.
SO ORDERED.
SIGNED this 9th day of March, 2010.
DON D. BUSH
UNITED STATES MAGISTRATE JUDGE

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) .