Tax Attorney: The US Supreme Court has granted a Petition for Certiorari in Deductibility of Trust Fees in William L. Rudkin Testamentary Trust v. Commissioner, CA-2, 467 F3d 149, 2006-2 USTC ¶50,569. Investment-advice fees incurred by a testamentary trust were not fully deductible in calculating its adjusted gross income. Because Code Sec. 67(e)(1) unambiguously exempted from the 2-percent floor of Code Sec. 67(a) only those costs incurred by the trust that could not have been incurred if the property were held by an individual, the fees were deductible only to the extent that they exceeded two percent of the trust's adjusted gross income. This case is interesting because it applies rules of construction to interpret IRC 67(e)(1). Section 67(e)(1) unambiguously exempts from the two-percent floor of §67(a) only those costs incurred by a trust that could not have been incurred if the property were held by an individual, we conclude that the Trust's investment-advice fees are deductible only to the extent that they exceed two percent of the Trust's adjusted gross income. The Second Circuit concluded that individual property owners can incur investment-advice fees and from the regulation explicitly including investment-advice fees among an individual's miscellaneous itemized deductions subject to §67(a)'s two-percent floor. See Temp. Treas. Reg. §1.67-1T(a)(1)(ii). Accordingly, the Court concluded that investment-advice fees the Trust paid t do not meet the requirements of §67(e)(1) and therefore are not fully deductible.



DISCUSSION



This appeal, which we have jurisdiction to consider under 26 U.S.C. §7482(a)(1) (2000), presents a question of statutory interpretation. In interpreting a statute, "[w]e start, as always, with the language of the statute." Williams v. Taylor, 529 U.S. 420, 431 (2000). "We give the words of a statute their ordinary, contemporary, common meaning, absent an indication Congress intended them to bear some different import." Id. (internal quotation marks omitted). "Our inquiry must cease if the statutory language is unambiguous and the statutory scheme is coherent and consistent." Robinson v. Shell Oil Co., 519 U.S. 337, 340 (1997) (internal quotation marks omitted). "The plainness or ambiguity of statutory language is determined by reference to the language itself, the specific context in which that language is used, and the broader context of the statute as a whole." Id. at 341. "[A]lthough a court appropriately may refer to a statute's legislative history to resolve statutory ambiguity, there is no need to do so" if the statutory language is clear. Toibb v. Radloff, 501 U.S. 157, 162 (1991).

In considering the question of statutory interpretation presented on this appeal, we review the legal conclusions of the tax court de novo. Reimels v. Comm'r [ 2006-1 USTC ¶50,147], 436 F.3d 344, 346 (2d Cir. 2006); 26 U.S.C. §7482(a)(1) (providing that the courts of appeals "shall have exclusive jurisdiction to review the decisions of the Tax Court...in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury"). "In particular, `[w]e owe no deference to the Tax Court's statutory interpretations, its relationship to us being that of a district court to a court of appeals, not that of an administrative agency to a court of appeals.' " Callaway v. Comm'r [ 2000-2 USTC ¶50,744], 231 F.3d 106, 115 (2d Cir. 2000) (quoting Exacto Spring Corp. v. Comm'r [ 99-2 USTC ¶50,964], 196 F.3d 833, 838 (7th Cir. 1999) (Posner, C.J.)).



I. Statutory Framework

Under the IRC, "the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual," subject to one exception relevant to this appeal. 26 U.S.C. §67(e). The exception provides that "the deductions for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate" shall be fully deductible from gross income in calculating adjusted gross income. Id. §67(e)(1). In order to understand this provision's operation, it is necessary first to comprehend the manner in which adjusted gross income is calculated for individuals.

Section 1 of the IRC imposes a tax on all "taxable income" of individuals and trusts. 26 U.S.C. §1. In calculating taxable income, a taxpayer must first determine the amount of "gross income," which is defined as "all income from whatever source derived." Id. §61(a). The taxpayer then arrives at "adjusted gross income" by subtracting from gross income certain "above-the-line" deductions, such as trade and business expenses and losses from the sale of property. Id. §62(a). Finally, "taxable income" is calculated by subtracting from adjusted gross income any "itemized" (or "below-the-line") deductions. Id. §63. In the case of an individual, "below-the-line" deductions include, inter alia, "all the ordinary and necessary expenses paid or incurred during the taxable year...for the management, conservation, or maintenance of property held for the production of income." Id. §212.

Again in the case of an individual, "the miscellaneous itemized deductions [ i.e., "below-the-line" deductions] for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income." Id. §67(a). Stated differently, the rule creates a "two-percent floor" for an individual's itemized deductions of the sort at issue here. Section 67(b) exempts from the two-percent floor certain specifically enumerated itemized deductions. Id. §67(b). Investment-advice fees are generally treated as itemized deductions under §212. 26 C.F.R. §1.212-1(g) (specifying the circumstances in which "[f]ees for services of investment counsel...are deductible under section 212"). They are not listed in §67(b), so are therefore not exempt from the two-percent floor established by §67(a). Temp. Treas. Reg. §1.67-1T(a)(1)(ii) (1988) (stating that "investment advisory fees" are subject to the two-percent floor of §67(a)).

As noted, under §67(e), trusts are generally subject to the same rules for calculating adjusted gross income that apply to individuals, with one exception that is relevant to this appeal. A trust's costs are fully deductible, rather than subject to the two-percent floor, if they satisfy both of the following two requirements: (1) they are "paid or incurred in connection with the administration of the...trust"; and (2) they "would not have been incurred if the property were not held in such trust." 26 U.S.C. §67(e)(1). There is no dispute here that the investment-advice fees at issue meet the requirement of the first clause, that is, that the fees Knight paid to Warfield were incurred in connection with the administration of the Trust. Instead, the issue presented here, on which our some of our sister circuits have disagreed, is whether the investment-advice fees also satisfy the requirement of the second clause of §67(e)(1) and therefore are fully deductible without regard to the two-percent floor of §67(a).



II. The Circuit Split

The Sixth Circuit was the first federal court of appeals to consider the question presented here. It held that "the investment advisor fees paid by the Trust were costs incurred because the property was held in trust, thereby making them eligible for the §67(e) exception and not subject to the base of two percent of adjusted gross income." O'Neill v. Comm'r [ 93-1 USTC ¶50,332], 994 F.2d 302, 304 (6th Cir. 1993). The Sixth Circuit reasoned that because a trustee has a fiduciary duty to manage trust assets as a "prudent investor," investment-advisory fees are "necessary to" the trust's administration and "caused by" the fiduciary duty of the trustee. Id. The court reasoned further that although individual investors often incur costs for investment advice, "they are not required to consult advisors and suffer no penalties or potential liability if they act negligently for themselves." Id. In short, O'Neill established the rule that a trust's costs attributable to the trustee's fiduciary duty, and not required outside the administration of trusts, fall within the §67(e)(1) exception and are therefore fully deductible. 1

The Federal Circuit rejected this reasoning in Mellon Bank, N.A. v. United States [ 2001-2 USTC ¶50,621], 265 F.3d 1275 (Fed. Cir. 2001). In Mellon Bank, the court held that the second clause of §67(e)(1) "serves as a filter" with respect to the first clause and "treats as fully deductible only those trust-related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of trusts." Id. at 1280-81. Because "[i]nvestment advice and management fees are commonly incurred outside of trusts," the court reasoned, "these costs are not exempt under section 67(e)(1) and are required to meet the two percent floor of section 67(a)." Id. at 1281. The Federal Circuit also found its construction to be consistent with the statute's legislative history. Id. It concluded by noting that the trust's reading of the statute, which would find all costs arising out of the trustee's fiduciary duties to fall within the second clause of §67(e)(1), rendered that clause superfluous "because any costs associated with a trust will always be deductible." Id.

The Fourth Circuit subsequently joined the Federal Circuit in holding that investment-advice fees incurred by a trust are subject to the two-percent floor of §67(a). Scott v. United States [ 2003-1 USTC ¶50,428], 328 F.3d 132, 140 (4th Cir. 2003). Noting that the "text is clear and unambiguous," the Fourth Circuit stated that "trust-related administrative expenses are subject to the 2% floor if they constitute expenses commonly incurred by individual taxpayers." Id. at 139-40. Applying this rule, the court concluded that because investment-advice fees are commonly incurred outside the context of trust administration, they are subject to the two-percent floor. Id. The court noted, however, that "[o]ther costs ordinarily incurred by trusts, such as fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing fiduciary income tax returns, are not ordinarily incurred by individual taxpayers, and they would be fully deductible under the exception created by §67(e)." Id. These costs, the court explained, are "solely attributable to a trustee's fiduciary duties, and as such are fully deductible under §67(e)." Id. Stating a rationale similar to the Federal Circuit's in Mellon Bank, the court said that to find a trust's investment-advice fees to be fully deductible would lead to the conclusion that "[a]ll trust-related administrative expenses could be attributed to a trustee's fiduciary duties," rendering the second clause of §67(e)(1) meaningless. Id.



III. Analysis

The Trust contends that the Sixth Circuit construed §67(e)(1) correctly and that the Federal and Fourth Circuits interpreted the provision inconsistently with both its plain language and legislative history. The Trust's principal textual argument is that the second clause of §67(e)(1) creates a "but for" causation test, excluding from full deduction only those costs which would have been incurred even in the absence of the trust's ownership of the property, i.e., without the trustee. The Trust also relies on the drafting history of §67(e)(1) to make the somewhat different argument that by enacting that particular section, Congress intended only to prevent trusts from fully deducting those administrative expenses incurred by pass-through entities in which they had invested. For the reasons that follow, we reject both arguments.




A. A. Statutory Language



The Trust reads §67(e)(1) to reflect Congress's intent to allow a full deduction for the administrative costs of a trust that are attributable to the fiduciary duty of the trustee. The Trust argues that the statute sets forth a "but for" causal test: if the cost would not have been incurred without the trustee, then it is attributable to the trustee's performance of its fiduciary duty and is thus fully deductible under §67(e)(1). According to the Trust, therefore, the second prong of §67(e)(1) requires no consideration of whether a generic individual owner of the same assets may have incurred the cost at issue. Rather, the Trust contends that the causation test "plainly" entails "a simple exercise of removing the trustee from the property and seeing which costs remain and which ones disappear without him." The Trust points to specific statutory language in advancing this view. It reads the statute's use of the language "such trust" to refer to the specific trust under consideration, its trustee and that trustee's duties, rather than to the generic trust of §67(e)'s introductory language, that is, a trust of the type to which §67(e) is applicable. 2 Under the Trust's construction, the statute requires consideration of whether a particular cost would have been incurred if the trustee had never existed. It would ignore, however, how an individual property owner managing the same assets would have acted. For the following reasons, we find the Trust's interpretation unreasonable.

As an initial matter, had Congress intended to create a causation test of the type the Trust advances, which disregards what an individual asset owner may have done if the assets were not held in trust, it could have done so in language clearly expressing that intent. Such a "but for" causation test, however, is not apparent from the text's "ordinary, common meaning." See Luyando v. Grinker, 8 F.3d 948, 950 (2d Cir. 1993) (noting we interpret a statute according to the "ordinary, common meaning" of the statute's "plain language"). On the contrary, the phrase "if the property were not held in such trust" more logically directs the inquiry away from the trust and back toward the hypothetical ownership of the property by an individual. That is, the introductory language of §67(e) takes as its point of reference the rules that apply to individual taxpayers, and by using the phrase, "if the property were not held in such trust," Congress has aimed the inquiry at the costs that a hypothetical individual property owner could incur with respect to that property. We therefore agree with the Fourth Circuit's statement in Scott that the second prong of §67(e)(1) does not ask whether the costs at issue are commonly incurred in the administration of trusts or are incurred as a result of a particular trustee's fiduciary duty. It focuses the inquiry, instead, on the hypothetical situation where the assets are in the hands of an individual. See [ 2003-1 USTC ¶50,428] 328 F.3d at 140.

Although the statutory language directs the inquiry toward the counterfactual condition of assets held individually instead of in trust, the statute does not require a subjective and hypothetical inquiry into whether a particular, individual asset owner would have incurred the particular cost at issue. Nothing in the statute indicates that Congress intended the test for the exception to the two-percent floor to give rise to factual disputes about whether an individual asset owner (or owners) is insufficiently financially savvy or the assets sufficiently large such that he or she unquestionably would have sought investment advice. Instead, the plain meaning of §67(e)(1)'s second clause excludes from full deduction those costs of a type that could be incurred if the property were held individually rather than in trust. In other words, for the trust to avoid the two-percent floor and have advantage of the full deduction, the plain language of the statute requires certainty that a particular cost "would not have been incurred" if the property were not held in trust.

For that reason, the statute demands not a subjective and hypothetical inquiry, but rather an objective determination of whether the particular cost is one that is peculiar to trusts and one that individuals are incapable of incurring. In other words, the statute sets an objective limit on the availability of a full deduction and, as the source of that limit, looks to those costs that individual property holders are capable of incurring and permitted to deduct from adjusted gross income. For example, the fact that investment-advice fees are subject to the two-percent floor under regulations applicable to individual taxpayers proves the fees to be a cost that individual taxpayers are capable of incurring. Investment-advice fees and other costs that individual taxpayers are capable of incurring are, therefore, not fully deductible pursuant to §67(e)(1) when incurred by a trust. By contrast, costs that individuals are incapable of incurring, like "fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing fiduciary income tax returns," Scott [ 2003-1 USTC ¶50,428], 328 F.3d at 140, are fully deductible.

We thus join the Federal and Fourth Circuits in holding that §67(e)(1) does not exempt from §67(a)'s two-percent floor investment-advice fees incurred by trusts. We disagree, however, with their statement that costs "not customarily incurred outside of trusts" are the ones not subject to the floor, Mellon Bank [ 2001-2 USTC ¶50,621], 265 F.3d at 1281 (emphasis added); Scott [ 2003-1 USTC ¶50,428], 328 F.3d at 139-40 (citing Mellon Bank and stating that §67(e)(1) subjects "expenses commonly incurred by individual taxpayers" to the two-percent floor (emphasis added)), because, as explained above, we believe §67(e)(1) is more restrictive than that. While the Federal and Fourth Circuits' approach properly focuses the inquiry on the hypothetical situation of costs incurred by individuals as opposed to trusts, that inquiry into whether a given cost is "customarily" or "commonly" incurred by individuals is unnecessary and less consistent with the statutory language. We believe the plain text of §67(e) requires that we determine with certainty that costs could not have been incurred if the property were held by an individual. We therefore hold that the plain meaning of the statute permits a trust to take a full deduction only for those costs that could not have been incurred by an individual property owner.

In so doing, we reject the Trust's argument that, in construing §67(e)(1) to refer to costs incurred by a generic trust rather than the particular trust under consideration, we must ignore the word "such" in the second clause of §67(e)(1). The statute's introductory language references a generic "estate or trust" by stating that, "[f]or the purposes of this section, the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual," subject to the exception under consideration on this appeal. 26 U.S.C. §67(e) (emphasis added). The first clause of §67(e)(1) next uses the different phrase "the estate or trust" in setting forth the condition that, to qualify for a full deduction, a cost must be "paid or incurred in connection with the administration of the estate or trust." Id. §67(e)(1) (emphasis added). The second clause of §67(e)(1) refers to "such estate or trust" in establishing that an administrative cost is fully deductible only if it "would not have been incurred if the property were not held in such trust or estate." Id. (emphasis added). For the following reason, we agree with the Commissioner that, as used here, "such trust" is best understood as referring to the generic trust of §67(e)'s introductory language and not to any actual, particular trust that incurred a cost subject to scrutiny. In the first clause of §67(e)(1), the language "the estate or trust" plainly refers not to a particular trust under consideration, but to the generic estate or trust mentioned in the provision's introductory language. The phrase "such trust or estate" of §67(e)(1)'s second clause also refers, therefore, to the generic estate or trust mentioned in both the introductory language of §67(e) and in the first clause of §67(e)(1). Moreover, as explained, nothing in the statute indicates that Congress intended to make applicability of the deduction dependent on what costs are peculiarly incurred by a specific trust.

Even if the statute's meaning were not plain and the Trust's alternative interpretation were not unreasonable, canons of statutory interpretation favor the Commissioner's interpretation of the statute. See Natural Res. Def. Council, Inc. v. Muszynski, 268 F.3d 91, 98 (2d Cir. 2001) ("If the plain meaning of a statute is susceptible to two or more reasonable meanings, i.e., if it is ambiguous, then a court may resort to the canons of statutory construction."). Specifically, our conclusion accords with the canon of statutory interpretation requiring that when the statute is ambiguous, we resolve interpretive disputes as to the availability of a tax deduction in favor of the government. "It is a common principle of taxation that where doubt exists, courts should resolve deductions in favor of the government: `Whether and to what extent deductions shall be allowed depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed.' " Holmes v. United States [ 96-1 USTC ¶50,299], 85 F.3d 956, 961 n.3 (2d Cir. 1966) (quoting New Colonial Ice Co. v. Helvering [ 4 USTC ¶1292], 292 U.S. 435, 440 (1934)).




B. Legislative History



The Trust also invokes the statute's legislative history to support a construction that is somewhat different from, and not obviously consistent with, its textual argument. 3 It contends that the drafting history indicates that Congress added the second clause of §67(e)(1) in order to restrict a trust's use of pass-through entities to avoid the two-percent floor of §67(a) and not to limit the deductibility of any other administrative costs of a trust. Because we find the statute's text "clear and unambiguous," we need not address the Trust's legislative history arguments. See Scott [ 2003-1 USTC ¶50,428], 328 F.3d at 139. Even if it were not, however, we disagree that this history supports the Trust's proposed interpretation of the statute discussed above or provides any reason to depart from our reading of the statute's meaning. 4

Pass-through entities, such as partnerships, S corporations, common trust funds, and nonpublic mutual funds, generally do not pay income taxes at the entity level, but instead pass their tax liabilities on to ultimate taxpayers - generally individuals. See Temp. Treas. Reg. 1.67-2T (1988). In the Tax Reform Act of 1986, Congress sought to eliminate the ability of wealthy taxpayers to avoid the two-percent floor of §67(a) by funneling income through pass-through entities. See Issues Relating to Passthrough Entities: Hearings Before the Subcomm. on Select Revenue Measures of the H. Comm. on Ways and Means on H.R. 1658, H.R. 2571, H.R. 3397, H.R. 4448, 99th Cong. 1 (1986) (stating the Subcommittee's intent to scrutinize the role of pass-through entities in "facilitating and encouraging tax avoidance techniques"). If there were no restrictions on such entities, an individual could deduct the full cost of investment advice, for example, by placing his or her investments in a pass-through entity, deducting the cost of the advice at the entity level and reporting only the net investment income on his or her individual tax return. Congress addressed this problem by enacting §67(c), which provides, inter alia, that regulations shall be issued "which prohibit the indirect deduction through pass-thru entities of amounts which are not allowable as a deduction if paid or incurred directly by an individual." 26 U.S.C. §67(c)(1). Congress also provided, however, that this rule, except as provided in regulations, shall not apply to trusts. Id. §67(c)(3)(B).

At the time Congress added §67(c), the bill provided that all costs incurred in connection with the administration of a trust were exempted from the two-percent floor of §67(a) and thus permitted trusts to deduct fully all of their administrative costs. Section 67(e)(1)'s second clause was not included in the versions of the bill that emerged initially from the House and Senate, but was added only in the joint conference draft. 5 Accordingly, under the draft language of §67(e) at the time Congress added §67(c), a trust, unlike an individual, could fully deduct the cost of investment advice and other administrative expenses incurred by pass-through entities in which the trust had invested. To correct this problem, the Trust argues, Congress added the second clause of §67(e)(1): trusts and estates could fully deduct only those administrative costs that "would not have been incurred if the property were not held in such trust or estate." According to the Trust, this language was intended to create a limited exception within an exception. Although trust income is to be calculated in the same way as individual income, administrative costs incurred by a trust are not subject to the two-percent floor of §67(a), except for those administrative costs incurred by a pass-through entity in which the trust has invested (which are subject to the floor). 6

If Congress's only purpose had been to restrict the ability of trusts as ultimate taxpayers to deduct fully their share of the administrative costs of pass-through entities in which they had invested, however, it could have drafted the second clause of §67(e)(1) more narrowly. It could have, for example, permitted full deductibility for those administrative costs "which are not pass-through costs restricted under section 67(c)." Instead, Congress chose the broader language of §67(e)(1). Thus, notwithstanding the narrow purpose the Trust attributes to Congress in enacting the second clause of §67(e)(1), the broad statutory language is the best indication that Congress intended to treat those administrative costs that would be subject to the two-percent floor when incurred by an individual as similarly subject to that floor when incurred by a trust. Nothing in the legislative history suggests a clearly expressed congressional intent contrary to the plain meaning of the statute itself. 7 See Toibb, 501 U.S. at 162.




CONCLUSION



Because §67(e)(1) unambiguously exempts from the two-percent floor of §67(a) only those costs incurred by a trust that could not have been incurred if the property were held by an individual, we conclude that the Trust's investment-advice fees are deductible only to the extent that they exceed two percent of the Trust's adjusted gross income. This conclusion follows from the fact that individual property owners obviously can incur investment-advice fees and from the regulation explicitly including investment-advice fees among an individual's miscellaneous itemized deductions subject to §67(a)'s two-percent floor. See Temp. Treas. Reg. §1.67-1T(a)(1)(ii). Accordingly, the investment-advice fees the Trust paid to Warfield do not meet the requirements of §67(e)(1) and therefore are not fully deductible. For the foregoing reasons, we AFFIRM the judgment of the tax court.

* Judge Wilfred Feinberg, originally a member of the panel, recused himself subsequent to oral argument. Because the remaining members of the Panel are in agreement, we decide this case in accordance with §0.14(b) of the rules of this Court.

1 The American Bankers Association and the New York Bankers Association, appearing in this case as amici curiae, advocate the position adopted by the Sixth Circuit. They contend that investment-advice fees incurred by a trustee are fully deductible under the statute "because the prudent execution of the duties imposed upon a trustee rendered it necessary to obtain investment advisory services."

2 The Trust thus contends that the word "such" in the statute, emphasized below, refers to "the" estate or trust mentioned in the first clause of §67(e)(1), also emphasized below, which it understands to refer not to the generic estate or trust mentioned in the introductory text of §67(e)(1), but to the particular trust at issue.

For purposes of this section, the adjusted gross income of an estate or trust shall be computed in the same manner as is the case of an individual, except that -(1) the deductions for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate....

26 U.S.C. §67(e)(1) (emphasis added).

3 While the Trust's textual argument is essentially that fiduciary administrative costs are exempt from the two-percent floor, its argument based on the drafting history, as explained below, is that the second clause of §67(e)(1) makes only the indirect administrative costs of a pass-through entity in which a trust has invested subject to the two-percent floor. If the second clause were so limited, one might think that the statute exempts from the two-percent floor more than simply fiduciary administrative costs. On this view, the statute would appear to exempt from the two-percent floor all costs incurred in connection with the administration of a trust except a trust's share of the administrative costs of a pass-through entity owned, at least in part, by the trust.

4 We note that the legislative history upon which the Federal Circuit relied in Mellon Bank [ 2001-2 USTC ¶50,621], 265 F.3d at 1281, chiefly H.R. Rep. No. 99-426 (1985) and S. Rep. No. 99-313 (1986), predates the introduction of §67(e)(1)'s second clause, and this history relates to a bill that treated all costs incurred in the administration of a trust or an estate as fully deductible. Thus, unlike the Federal Circuit, we do not view this history as persuasive evidence of the meaning of §67(e)(1).

5 The House bill included the following language:

(c) DETERMINATION OF ADJUSTED GROSS INCOME IN CASE OF ESTATES AND TRUSTS. --For purposes of this section, the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual, except that the deductions for costs which are paid or incurred in connection with the administration of the estate or trust shall be treated as allowable in arriving at adjusted gross income.

H.R. 3838, 99th Cong. §67(c) (1985). The Senate Committee on Finance did not amend this provision, but expressed the view that "the bill attempts to reduce the benefits arising from the use of trusts...by revising the rate schedule applicable to trusts." S. Rep. No. 99-313, 99th Cong. 868 (1986). The second clause of §67(e)(1) appeared for the first time in the final version of the bill that emerged in the Joint Conference Agreement. See H.R. Rep. No. 99-841, vol. II, at 34 (1986) (Conf. Rep.), reprinted at 1986 U.S.C.C.A.N. 4075, 4122.

6 The Trust relies most heavily in making this argument on the House Conference Report, which provides some indication that the second clause of §67(e)(1) was drafted to address indirect deductions through pass-through entities. The Trust relies on the following passage from the Report:

Pursuant to Treasury regulations, the [two-percent] floor is to apply with respect to indirect deductions through pass-through entities (including mutual funds) other than estates, nongrantor trusts, cooperatives, and REITs. The floor also applies with respect to indirect deductions through grantor trusts, partnerships, and S corporations by virtue of present-law grantor trust and pass-through rules. In the case of an estate or trust, the conference agreement provides that the adjusted gross income is to be computed in the same manner as in the case of an individual, except that the deductions for costs that are paid or incurred in connection with the administration of the estate or trust and that would not have been incurred if the property were not held in such trust or estate are treated as allowable in arriving at adjusted gross income and hence are not subject to the floor. The regulations to be prescribed by the Treasury relating to application of the floor with respect to indirect deductions through certain pass-through entities are to include such reporting requirements as may be necessary to effectuate this provision.

H.R. Rep. No. 99-841, at 34, reprinted at 1986 U.S.C.C.A.N. 4075, 4122 (emphasis added).

7 The Trust also argues that its reading of the statute in light of the legislative history eliminates the superfluity problem that the Federal and Fourth Circuits, as well as the Commissioner in this case, identified. The Federal and Fourth Circuits both concluded that to interpret §67(e)(1)'s second clause similarly to the "but for" causation test the Trust advances here renders that clause superfluous because "[a]ll trust-related administrative expenses could be attributed to a trustee's fiduciary duties." Scott [ 2003-1 USTC ¶50,428], 328 F.3d at 140; Mellon Bank [ 2001-2 USTC ¶50,621], 265 F.3d at 1281 ( "Under Mellon's construction, the second prerequisite of section 67(e)(1) would be rendered superfluous because any costs associated with a trust will always be deductible."). We do not adopt the Federal and Fourth Circuits' view. The Trust contends that the second clause is necessary to filter out a specific subset of the administrative costs described in the first clause -those incurred by pass-through entities in which a trust has invested. Assuming arguendo that such costs are "incurred in connection with the administration" of a trust for purposes of the statute (and satisfy the first clause), they are not caused by the trustee's fiduciary duty (and so fall outside the Trust's reading of the second clause). We find it difficult to conceive that a trustee's fiduciary duty could require that trust assets be invested in a particular vehicle.

Back Taxes: Note especially the flaws identified in the IRS Determination Letter



Blog – IRS abused its discretion in an innocent spouse case



The IRS abused its discretion in denying an individual Innocent Spouse equitable relief from joint and several liability under IRS Code Sec. 6015(f). Most of the factors in section 4.03 of Rev. Proc. 2003-61, 2003-2 CB 296, either favored granting her relief or were of neutral impact. Although the taxpayer had constructive knowledge of the taxes due because she signed the returns, the liabilities reported on those returns were solely attributable to her husband's businesses. Further, she derived no significant benefit from the failure to pay the tax liabilities for the years at issue and she would suffer even greater economic hardship than already existed if forced to pay the outstanding tax liability. See Cynthia K. Beatty v. Commissioner. Dkt. No. 22047-04 , TC Memo. 2007-167, June 27, 2007. Although the taxpayer had constructive knowledge of the taxes due because she signed the returns, the liabilities reported on those returns were solely attributable to her husband, who exercised absolute control over all the couple's financial matters. Further, the taxpayer derived no significant benefit from the failure to pay the tax liabilities for the years at issue and she would suffer ever greater economic hardship than already existed if forced to pay the outstanding tax liability. The wife stated thatt she did not review the returns and had no idea of the amount of taxes due, if any. Since she signed the returns without looking at any of the figures, she had no information to make the determination as to whether the taxes could be paid or not. The wife and her attorney mentioned on numerous occasions that she just signed without questioning because she believed her husband would go to jail if she didn't sign. Although the Tax Court did not emphasize this intimidation, it likely that this fact was given more weight than other factors. The following is text of the Tax Court opinion:


*******

Revenue Procedure 2000-15 as amplified by the provisions of Revenue Procedure 2003-61 provides a list of elements to be developed to determine the extent, if any of relief to be granted under these innocent spouse provisions. * * * The merits and circumstances of each case will dictate the weight assigned to each factor in reaching a decision to grant or reject innocent spouse relief.



Divorced, separated or living apart for at least 12 months when claim is filed



This condition is not met. Mr. & Mrs. Beatty are not divorced or separated. They lived together during the years under consideration and are still living together. Mrs. Beatty filed delinquent returns with her husband in November of 2001.



Payment of the tax liabilities would cause hardship



Economic hardship is defined as: the payment of the tax would make it impossible to meet your basic living expenses for housing, clothing, food, transportation medical etc. Reasonable belief that tax would be paid. Mr. Beatty is self-employed, yearly household income fluctuates to some extent. Current expense information was gathered from an interview as well as from a check spread performed using 2000 bank records. Income information was derived from tax returns filed for 2001. (The most recent return filed) Comparison of monthly household income to monthly basic living expenses indicates that the Beattys are having financial difficulties. This is also evident from the bankruptcies that have been filed. The question is not whether hardship exists, but whether a hardship will be created if innocent spouse relief is not granted. In this case, hardship already exists and will continue to exist whether or not relief is granted to Mrs. Beatty. The two still live in the same household so even if [she] is relieved, Mr. Beatty's liability will impact on the family's ability to pay personal living expenses. This condition is not met.



Attribution



Mrs. Beatty's attorney states that having heard the stern warning from the court that if returns were not filed her husband would go to jail, Mrs. Beatty signed whatever was placed in front of her. She contends that this caused Mrs. Beatty to do something she wouldn't ordinarily have done. The liability is solely attributable to Mr. Beatty's income and Mrs. Beatty did not receive a significant benefit from the unpaid taxes beyond that of minimal living expenses. The underpayments of tax are attributed to Mr. Beatty. The taxpayer alone did not have sufficient income to require her to file a return. The tax liabilities rest solely with Mr. Beatty for failure to file timely returns and to pay his income tax annually.



Marital Abuse



If abuse does not rise to the level duress, then the electing spouse's level of influence with respect to the unpaid tax must be evaluated.



There have not been any claims of marital abuse.



The representative explained that duress is the most compelling reason for requesting equitable relief. Mrs. Beatty would not have signed joint tax returns with her husband if she had not heard the judge order returns to be filed. She feared that her husband would go to jail if she did not sign the returns presented to her. Mrs. Beatty did not have a filing obligation of her own because she had withholdings from her paycheck to more than cover any taxes due on her own income. She certainly would not have filed jointly if she had understood the ramifications.



Mrs. Beatty signed the tax returns under duress. The returns may be invalid joint return.



Joint Returns: Joint and Several Liability: Duress, fraud or misrepresentation



A wife was liable for tax on a joint return where the evidence failed to show that she was unwilling to sign the return or that her husband made her sign the return under threat of force. Fear alone is insufficient to prove duress.



Although it is unfortunate that Mrs. Beatty was not aware of and was not informed of her options, ignorance of the law is no excuse. Mrs. Beatty cannot be relieved of her joint liability simply because she didn't know the tax laws. In order for duress to be a factor, Mrs. Beatty would have to show that she had no choice and that she was reluctant to sign a joint return. In this case, Mrs. Beatty did have a choice. She could have filed separately whether or not she realized it at the time. Further, she was not reluctant to sign the joint returns. In fact, she was eager to do whatever was asked of her at the time. No one forced Mrs. Beatty to sign joint tax returns against her will. Duress did not occur and is not a factor to consider in this case.



Reasonable belief that the tax would be paid:





Non-requesting spouse's legal obligation to pay A stipulation in the property settlement or a decree of divorce must be evidenced that requires the non electing spouse to assume responsibility for the unpaid income taxes for the periods at issue. Since the parties are still married and living together a marital agreement such as this does not exist.



Knowledge



She signed the joint tax returns because her husband was under court order to file returns with both the State of Maryland and the federal government. He was charged with willful failure to file tax returns by the State. In order to receive a reduced sentence, he was required to file all returns or face a substantial jail sentence. Mrs. Beatty was not involved in the tax preparation process. Returns were prepared using extrapolations and estimates computed by the State of Maryland. Mr. Beatty had some documentation for business expenses but was not very good at keeping the documentation. When the returns were completed, Mr. and Mrs. Beatty went to the CPA's office. She did not review or question the returns and signed them.



Significant Benefit



Other than usual and customary living expenses there is no evidence to indicate that you derived a significant benefit from the failure to report these sources of income. The Beatty's did not live extravagantly or take trips, they didn't have any investments, life insurance, savings, or anything else of value to show for the money earned. When Mrs. Beatty became aware of the amount of money her husband earned, she couldn't understand where the funds went. She then found out that her husband had a problem with Keno gambling. He lost their money and then became involved with loan sharks to fund his addiction. Other than customary basic living expenses the taxpayer did not derive a significant benefit from the unpaid federal income taxes.





DETERMINATION



We look to the court case of Alice Berger, et al. v. Commissioner T.C. Memo. 1996-76, 71 TCM 2160. Alice Berger asserts that the Chancery Court ordered her to sign the 1988 return and that she signed it because she believed she had no choice and was afraid of the "consequences" of defying a court order. Although she signed the return at the courthouse, she does not appear to have been signed it before a judge who was threatening improper or oppressive "consequences against her. Alice Berger did not testify that the Chancery Court had threatened "consequences" directly to her. This court case demonstrates that signing a return at the order of a Court because one is afraid of the "consequences" of defying a court order does not equal a showing of abuse of discretion or theat of improper sanction sufficient to invalidate the return. In Mrs. Beatty's case, the court didn't even ask her to sign returns. The court didn't abuse its authority and did not force Mrs. Beatty to sign joint tax returns.



Another court case of interest is Hazel Stanley v. Comm. 45 TC 555. Mrs. Stanley's husband was very domineering and sometimes violent. She would go along with her husband in many situations simply to avoid conflict. Mrs. Stanley signed joint returns as directed by her husband. However, she failed to demonstrate that she did so unwillingly and was found to be jointly liable. Mrs. Beatty does not claim any undue influence from her husband; however the important point to note in this case is the "willingness" to file jointly. Like Mrs. Stanley, Mrs. Beatty has not demonstrated that she filed unwillingly.



Although it is unfortunate that Mrs. Beatty was not aware of and was not informed of her options, ignorance of the law is no excuse. Mrs. Beatty cannot be relieved of her joint liability simply because she didn't know the tax laws and their impact on her.



The taxpayer had complete awareness of the balances due when the returns were filed. She was well aware that the family did not have the funds to pay the tax. She did not have a reasonable belief that the taxes would be paid. It has been established that the taxpayer's do not qualify for economic hardship. The representative had made reference to a substantial gambling debt that she insists causes economic hardship. However she has failed to submit documentation of such an expense.



The taxpayers still reside together as a married couple. Abuse is not a factor. The taxpayer claims that the level of duress caused by this situation merits innocent spouse relief. This is a misnomer as explained. The cumulative effect of the development of these equitable relief elements clearly demonstrates that the taxpayer does not qualify for innocent spouse relief under the provisions of IRC Section 6015(f).





CONCLUSION



Since the taxpayer will not execute a form 870-IS and has expressed her intention to litigate this matter there remains no alternative but to recommend that a statutory notice of claim disallowance be issued. [Reproduced literally.]



On December 29, 2004, petitioner and Mr. Beatty refinanced the mortgage loan on the house in which they resided. Around January 4, 2005, petitioner and Mr. Beatty used funds that they received from that refinancing to make a $151,423.56 payment to the IRS with respect to the unpaid liabilities for the taxable years 1998 and 1999. After the refinancing of the mortgage loan on their house, petitioner and Mr. Beatty had no equity in that house and were required to make a monthly mortgage loan payment of $3,400.



During 2004, petitioner received $12,906 as an employee of RIG, Inc., as well as $1,274 in unemployment compensation. On January 6, 2006, petitioner filed late a Federal return for her taxable year 2004 (2004 return) that showed a $2 refund due.



On January 6, 2006, petitioner submitted to respondent Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals (Form 433-A). That form contained several sections identified as section 1 through 9. In section 2 of Form 433-A that petitioner submitted to respondent (petitioner's Form 433-A), petitioner did not respond to a question relating to whether she or Mr. Beatty was self-employed or operated a business, although she indicated in section 3 of that form that she was unemployed. In section 3 of petitioner's Form 433-A, petitioner did not indicate whether Mr. Beatty was employed.



In section 5 of petitioner's Form 433-A, petitioner indicated that she (1) maintained a checking account with a $200 account balance, (2) had $50 cash on hand, (3) had a credit card balance of $400, (4) owed $4,700 with respect to an equity line of credit, and (5) had $400 of credit available to her.



In sections 5 and 6 of petitioner's Form 433-A, petitioner provided the responses indicated to the following questions:



16. LIFE INSURANCE. Do you have life insurance with a cash value? : [x] No [] Yes



* * * * * * *



17a. Are there any garnishments against your wages? [x] No [] Yes



* * * * * * *



17b. Are there any judgments against you? [x] No [] Yes



* * * * * * *



17d. Did you ever file bankruptcy? [] No [x] Yes



If yes, date filed 9/14/2000 Date discharged 12/27/2000



17e. In the past 10 years did you transfer any assets out of your name for less than their actual value? [x] No [] Yes



* * * * * * *



17f. Do you anticipate any increase in household income in the next two years? [] No [x] Yes



If yes, why will the income increase? I hope to find seasonal employment * * *



How much will it increase? $??? In 2004, I earned $12,906



17g. Are you a beneficiary of a trust or estate? [x] No [] Yes



* * * * * * *



17h. Are you a participant in a profit sharing plan? [x] No [] Yes



In section 7 of petitioner's Form 433-A, petitioner indicated that she owned (1) a 2005 Jeep Liberty valued at $18,785 with respect to which there was a $23,000 outstanding loan balance and (2) two vehicles, neither of which had any value. In section 7 of petitioner's Form 433-A, petitioner also indicated that in 1991 she purchased real estate in Ocean City for $130,000, that the current value of that real estate was $500,000, and that there was a $450,000 outstanding mortgage loan with respect to that real estate, which was required to be paid in full in 2035.



In section 7 of petitioner's Form 433-A, petitioner indicated that she had personal assets valued at $6,000.



Section 9 of Form 433-A listed various income items and various living expense items. With respect to the income items listed in that section, petitioner stated that she was unemployed. With respect to the expense items listed in section 9 of Form 433-A, petitioner indicated that she had total monthly living expenses of $4,003, consisting of $3,600 of monthly expenses for housing and utilities and $403 of monthly expenses for food, clothing, housekeeping supplies, and personal care products.





OPINION



We review respondent's denial of relief under section 6015(f) for abuse of discretion. Butler v. Commissioner, 114 T.C. 276, 292 (2000). Respondent's denial of such relief constitutes an abuse of discretion if such denial was arbitrary, capricious, or without sound basis in fact or law. Woodral v. Commissioner, 112 T.C. 19, 23 (1999). The question whether respondent's denial of relief under section 6015(f) was arbitrary, capricious, or without sound basis in fact is a question of fact. Cheshire v. Commissioner, 115 T.C. 183, 197-198 (2000), affd. 282 F.3d 326 (5th Cir. 2002).



Petitioner bears the burden of proving that respondent abused respondent's discretion in denying her relief under section 6015(f). See Jonson v. Commissioner, 118 T.C. 106, 125 (2002), affd. 353 F.3d 1181 (10th Cir. 2003). That this case was submitted under Rule 122 does not change that burden or the effect of a failure of proof. See Rule 122(b); Borchers v. Commissioner, 95 T.C. 82, 91 (1990), affd. 943 F.2d 22 (8th Cir. 1991).



Section 6015(f) grants respondent discretion to relieve an individual who files a joint return from joint and several liability with respect to that return. That section provides:



SEC. 6015. RELIEF FROM JOINT AND SEVERAL LIABILITY ON JOINT RETURN.



* * * * * * *



(f) Equitable Relief. --Under procedures prescribed by the Secretary, if --



(1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either); and



(2) relief is not available to such individual under subsection (b) or (c),



the Secretary may relieve such individual of such liability.



In the instant case, the parties agree that relief is not available to petitioner under section 6015(b) or (c), thereby satisfying section 6015(f)(2). They disagree over whether petitioner is entitled to relief under section 6015(f).



As directed by section 6015(f), respondent has prescribed procedures in Rev. Proc. 2003-61, 2003-2 C.B. 296 (Revenue Procedure 2003-61)2 that are to be used in determining whether it would be inequitable to find the requesting spouse liable for part or all of the liability in question. Section 4.01 of Revenue Procedure 2003-61 lists seven conditions (threshold conditions) which must be satisfied before the IRS will consider a request for relief under section 6015(f). In the instant case, respondent concedes that those conditions are satisfied. Where, as here, the requesting spouse satisfies the threshold conditions, section 4.01 of Revenue Procedure 2003-61 provides that a requesting spouse may be relieved under section 6015(f) of all or part of the liability in question if, taking into account all the facts and circumstances, respondent determines that it would be inequitable to hold the requesting spouse liable for such liability.



Where, as here, the requesting spouse satisfies the threshold conditions, section 4.02(1) of Revenue Procedure 2003-61 sets forth the circumstances under which respondent ordinarily will grant relief to that spouse under section 6015(f) in a case, like the instant case, where a liability is reported in a joint return but not paid. Petitioner concedes that she does not qualify for relief under section 4.02(1) of Revenue Procedure 2003-61. Instead, she relies on section 4.03 of that revenue procedure in support of her claim for relief under section 6015(f). Section 4.03 of Revenue Procedure 2003-61 provides a list of factors which respondent is to take into account in considering whether to grant an individual relief under section 6015(f). No single factor is to be determinative in any particular case; all factors are to be considered and weighed appropriately; and the list of factors is not intended to be exhaustive. Rev. Proc. 2003-61, sec. 4.03, 2003-2 C.B. at 298.



As pertinent here, section 4.03(2)(a) of Revenue Procedure 2003-61 sets forth the following factors which are to be considered and weighed appropriately:



(i) Marital status. Whether the requesting spouse is separated (whether legally separated or living apart) or divorced from the nonrequesting spouse. * * *



(ii) Economic hardship. Whether the requesting spouse would suffer economic hardship (within the meaning of section 4.02(1)(c) of this revenue procedure) if the Service does not grant relief from the income tax liability.



(iii) Knowledge or reason to know.



(A) Underpayment cases. In the case of an income tax liability that was properly reported but not paid, whether the requesting spouse did not know and had no reason to know that the nonrequesting spouse would not pay the income tax liability.



* * * * * * *



(C) Reason to know. For purposes of (A) * * * above, in determining whether the requesting spouse had reason to know, the Service will consider the requesting spouse's level of education, any deceit or evasiveness of the nonrequesting spouse, the requesting spouse's degree of involvement in the activity generating the income tax liability, the requesting spouse's involvement in business and household financial matters, the requesting spouse's business or financial expertise, and any lavish or unusual expenditures compared with past spending levels.



(iv) Nonrequesting spouse's legal obligation. Whether the nonrequesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. * * *



(v) Significant Benefit. Whether the requesting spouse received significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency. See Treas. Reg. §1.6015-2(d).



(vi) Compliance with income tax laws. Whether the requesting spouse has made a good faith effort to comply with income tax laws in the taxable years following the taxable year or years to which the request for relief relates.



(We shall hereinafter refer to the factors set forth in section 4.03(2)(a)(i), (ii), (iii), (iv), (v), and (vi) of Revenue Procedure 2003-61 as the marital status factor, the economic hardship factor, the knowledge or reason to know factor, the legal obligation factor, the significant benefit factor, and the tax law compliance factor, respectively.)



Section 4.03(2)(b) of Revenue Procedure 2003-61 sets forth the following factors which, if present in a case, will weigh in favor of granting an individual relief under section 6015(f), but will not weigh against granting such relief if not present:



(i) Abuse. Whether the nonrequesting spouse abused the requesting spouse. * * *



(ii) Mental or physical health. Whether the requesting spouse was in poor mental or physical health on the date the requesting spouse signed the return or at the time the requesting spouse requested relief. The Service will consider the nature, extent, and duration of illness when weighing this factor.



(We shall hereinafter refer to the factors set forth in section 4.03(2)(b)(i) and (ii) as the abuse factor and the mental or physical health factor, respectively.)



Before turning to the factors set forth in section 4.03(2)(a) and (b) of Revenue Procedure 2003-61, we address respondent's position that, in determining whether petitioner is entitled to relief under section 6015(f), we should consider only respondent's administrative record with respect to petitioner's taxable years at issue. We stated our position on that issue in Ewing v. Commissioner, 122 T.C. 32 (2004). In Ewing, we held that our determination of whether a taxpayer is entitled to relief under section 6015(f) "is made in a trial de novo and is not limited to matter contained in respondent's administrative record". Id. at 44. Respondent urges us to reconsider that position since the United States Court of Appeals for the Ninth Circuit vacated our decision in Ewing on jurisdictional grounds.3 See Commissioner v. Ewing, 439 F.3d 1009 (9th Cir. 2006), revg. 118 T.C. 494 (2002), vacating 122 T.C. 32 (2004).



Assuming arguendo that we were to accept respondent's position that, in determining whether petitioner is entitled to relief under section 6015(f), we should consider only respondent's administrative record with respect to petitioner's taxable years at issue, on the record before us, we find that petitioner has carried her burden of showing that respondent abused respondent's discretion in denying her such relief with respect to the unpaid liabilities for the years at issue.4 We turn now to the factors set forth in section 4.03(2)(a) of Revenue Procedure 2003-61 that support our finding.



With respect to the marital status factor set forth in section 4.03(2)(a)(i) of that revenue procedure, the parties agree on brief that that factor is neutral.



However, the notice of determination stated in pertinent part:



Divorced, separated or living apart for at least 12 months when claim is filed



This condition is not met. Mr. & Mrs. Beatty are not divorced or separated. They lived together during the years under consideration and are still living together. * * *



As we understand it, the Appeals Office concluded in the notice of determination that the marital status factor weighed against granting petitioner relief under section 6015(f). We reject that conclusion as unfounded. We agree with the parties' position on brief, and we find, that the marital status factor is neutral.



With respect to the economic hardship factor set forth in section 4.03(2)(a)(ii) of Revenue Procedure 2003-61,5 petitioner argues that that factor weighs in favor of granting her relief under section 6015(f). On brief, respondent contends that not granting such relief will have no effect on petitioner's economic situation.6



However, the notice of determination stated in pertinent part:



Mr. Beatty is self-employed, yearly household income fluctuates to some extent. Current expense information was gathered from an interview as well as from a check spread performed using 2000 bank records. Income information was derived from tax returns filed for 2001. (The most recent return filed) Comparison of monthly household income to monthly basic living expenses indicates that the Beattys are having financial difficulties. This is also evident from the bankruptcies that have been filed. The question is not whether hardship exists, but whether a hardship will be created if innocent spouse relief is not granted. In this case, hardship already exists and will continue to exist whether or not relief is granted to Mrs. Beatty. The two still live in the same household so even if [she] is relieved, Mr. Beatty's liability will impact on the family's ability to pay personal living expenses. This condition is not met. [Reproduced literally.]



As we understand it, the Appeals Office concluded in the notice of determination that the economic hardship factor weighed against granting petitioner relief under section 6015(f) because the Appeals Office's failure to grant such relief would not "create" economic hardship, since economic "hardship already exists and will continue to exist whether or not relief is granted to Mrs. Beatty." We reject as unfounded the rationale stated by the Appeals Office for its conclusion that the economic hardship factor weighed against granting petitioner relief under section 6015(f). The Appeals Office implicitly acknowledged in the notice of determination that payment of the unpaid liabilities for the years at issue would cause even greater economic hardship than already existed.7 We find that the economic hardship factor weighs in favor of granting petitioner relief under section 6015(f).



With respect to the knowledge or reason to know factor set forth in section 4.03(2)(a)(iii) of Revenue Procedure 2003-61, petitioner argues that she did not know and had no reason to know that Mr. Beatty would not pay the tax shown due in each of the respective joint returns for the years at issue and that therefore that factor weighs in favor of granting her relief under section 6015(f). Respondent disagrees.



The notice of determination stated in pertinent part:



Mrs. Beatty states that she did not review the returns and had no idea of the amount of taxes due, if any. Since Mrs. Beatty signed the returns without looking at any of the figures, she had no information to make the determination as to whether the taxes could be paid or not. Mrs. Beatty and her attorney mentioned on numerous occasions that she just signed without questioning because she believed her husband would go to jail if she didn't sign. There was no thought given at that point in time as to whether or not the taxes would be paid. Therefore, there was no belief that the taxes would be paid.



In support of her argument that the knowledge or reason to know factor set forth in section 4.03(2)(a)(iii) of Revenue Procedure 2003-61 weighs in favor of granting her relief under section 6015(f), petitioner asserts:



Petitioner acknowledged in her responses set forth on the Innocent Spouse Questionnaire * * * that she did not review the returns prior to signing and therefore, had no actual knowledge of the tax reported on the returns, or actual knowledge that the tax reported would not be paid. Petitioner further believed that, based on the Beattys standard of living, they had very little income and thus, had no reason to know that Mr. Beatty would not pay, or be able to pay, the tax due. * * * Petitioner did not know that Mr. Beatty had a long-time Keno gambling problem or that he was spending significant sums betting on Keno and repaying high interest rate advances to loansharks. * * * Since Mr. Beatty had been ordered by the court in his criminal proceedings to file his missing returns, it was certainly reasonable for Petitioner to believe that Mr. Beatty would ultimately pay the tax due.



In addition, Petitioner did not understand that she was not required to file a return for most of the years at issue, or that she had the option of filing separately for those years she was required to file (1998, 1999 and 2000). Petitioner also did not understand that she would be liable for any tax owed on Mr. Beatty's self-employment income. * * * Mr. Beatty's accountant, Mr. Vinson, told Agent Renshaw that "he didn't think about any impact on Mrs. Beatty when returns were prepared and filed. He didn't explain the implications of filing jointly or notify them [the Beattys] that they had a choice. He figured they didn't have any assets anyway so he didn't give it any thought." In this regard, Petitioner is similar to the taxpayer in Washington v. Commissioner, 120 T.C. 137 (2003).8 [Reproduced literally.]



We turn first to petitioner's reliance on Washington v. Commissioner, 120 T.C. 137 (2003).9 In Washington, the taxpayer took the position that she relied on her spouse to pay the tax shown due in the return in question and that she believed that her spouse would pay such tax. In contrast, in the instant case, petitioner took the position before the IRS, and takes the position before the Court, that at the time she signed each of the respective joint returns for the years at issue (1) she did not know that each such return showed tax due, and (2) therefore she did not know at that time that Mr. Beatty would not pay such tax. On the record before us, we find Washington v. Commissioner, supra, to be materially distinguishable from the instant case and petitioner's reliance on that case to be misplaced.



We address now whether petitioner has carried her burden of establishing that the knowledge or reason to know factor weighs in favor of granting relief. In support of her position for relief under section 6015(f), petitioner chose to present her case to the IRS and to the Court by claiming that she did not know that there was a tax shown due in each of the respective joint returns for the years at issue. Petitioner must bear the consequences of that choice. Assuming arguendo that we were to accept petitioner's contention that she did not know that each of the joint returns for the years at issue showed tax due, on the record before us, we find that, by signing each such return, petitioner is charged with constructive knowledge of, inter alia, the tax shown due therein. See Park v. Commissioner, 25 F.3d 1289, 1299 (5th Cir. 1994), affg. T.C. Memo. 1993-252; see also Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C. Memo. 1992-228. We further find that petitioner should have inquired about whether the tax shown due in each of the joint returns for the years at issue, as to which she had constructive knowledge, would be paid. It would be inequitable to allow petitioner to turn a blind eye to the tax shown due in each such return. The amount of such tax was large enough as to put petitioner on notice that further inquiry should be made as to whether it would be paid. She failed to do so. Petitioner thus failed to present any evidence to the IRS and to the Court with respect to whether the tax shown due in each of the respective joint returns for the years at issue would be paid. We find that the knowledge or reason to know factor weighs against granting petitioner relief under section 6015(f).



With respect to the legal obligation factor set forth in section 4.03(2)(a)(iv) of Revenue Procedure 2003-61, the parties agree on brief that that factor is neutral.



However, the notice of determination stated in pertinent part:



Non-requesting spouse's legal obligation to pay



A stipulation in the property settlement or a decree of divorce must be evidenced that requires the non electing spouse to assume responsibility for the unpaid income taxes for the periods at issue. Since the parties are still married and living together a marital agreement such as this does not exist.



As we understand it, the Appeals Office concluded in the notice of determination that the legal obligation factor weighed against granting petitioner relief under section 6015(f). We reject that conclusion as unfounded. We agree with the parties' position on brief, and we find, that the legal obligation factor is neutral.



With respect to the significant benefit factor set forth in section 4.03(2)(a)(v) of Revenue Procedure 2003-61, petitioner argues that that factor weighs in favor of granting her relief under section 6015(f). On brief, respondent argues that the significant benefit factor is neutral.



The notice of determination stated in pertinent part:



Other than usual and customary living expenses there is no evidence to indicate that you derived a significant benefit from the failure to report these sources of income. The Beatty's did not live extravagantly or take trips, they didn't have any investments, life insurance, savings, or anything else of value to show for the money earned. When Mrs. Beatty became aware of the amount of money her husband earned, she couldn't understand where the funds went. She then found out that her husband had a problem with Keno gambling. He lost their money and then became involved with loan sharks to fund his addiction. Other than customary basic living expenses the taxpayer did not derive a significant benefit from the unpaid federal income taxes. [Reproduced literally.]



As we understand it, although the Appeals Office found in the notice of determination that petitioner did not receive a significant benefit from the failure to pay the unpaid liabilities for the years at issue,10 that office did not conclude that therefore the significant benefit factor weighed in favor of granting petitioner relief under section 6015(f). We reject as unfounded the Appeals Office's failure to conclude in the notice of determination that the significant benefit factor favored granting petitioner such relief. Under cases where Revenue Procedure 2003-61 is applicable, we consider the lack of significant benefit by the taxpayer seeking relief from joint and several liability to be a factor that favors granting relief under section 6015(f).11 We find that the significant benefit factor weighs in favor of granting petitioner relief under section 6015(f).



With respect to the tax law compliance factor set forth in section 4.03(2)(a)(vi) of Revenue Procedure 2003-61, petitioner argues that that factor weighs in favor of granting her relief under section 6015(f). On brief, respondent asserts:



If the Court restricts itself to the administrative record then this factor favors petitioner. If the Court considers information outside of the administrative record then this factor weighs against relief. [Reproduced literally.]



The notice of determination failed to address whether petitioner made a good faith effort to comply with the tax laws for any of the taxable years following the taxable years at issue. However, respondent acknowledges on brief that petitioner "appears to have been compliant at the time the Notice of Determination was issued." We reject as unfounded the Appeals Office's failure to conclude in the notice of determination that the tax law compliance factor favored granting petitioner relief under section 6015(f).



After the Appeals Office issued the notice of determination, petitioner failed to file timely her 2004 return that showed a $2 refund due. We find that petitioner's failure to file timely her 2004 return weighs against granting petitioner relief under section 6015(f). However, given (1) that petitioner's noncompliance is limited to only one delinquently filed return for 2004 that showed a refund due and (2) the other facts and circumstances in the instant case, we further find that the tax law compliance factor is not a significant factor weighing against relief in this case.



We turn now to the factors set forth in section 4.03(2)(b) of Revenue Procedure 2003-61. The parties agree, and we find, that the abuse factor and the mental or physical health factor set forth in section 4.03(2)(b)(i) and (ii), respectively, of Revenue Procedure 2003-61 are neutral.



Based upon our examination of the entire record before us, we find that petitioner has carried her burden of showing that respondent abused respondent's discretion when the Appeals Office determined in the notice of determination to deny her relief under section 6015(f) with respect to the unpaid liabilities for the years at issue.12



We have considered all of the contentions and arguments of the parties that are not discussed herein, and we find them to be without merit, irrelevant, and/or moot.



To reflect the foregoing,



Decision will be entered for petitioner.


1 All section references are to the Internal Revenue Code in effect at all relevant times. All Rule references are to the Tax Court Rules of Practice and Procedure.

2 We note that Revenue Procedure 2003-61 superseded Rev. Proc. 2000-15, 2000-1 C.B. 447. Revenue Procedure 2003-61 is effective for requests for relief under sec. 6015(f) which were filed on or after Nov. 1, 2003, and for requests for such relief which were pending on, and for which no preliminary determination letter had been issued as of, that date. Rev. Proc. 2003-61, sec. 7, 2003-2 C.B. at 299. Revenue Procedure 2003-61 is applicable in the instant case. That is because as of Nov. 1, 2003, no preliminary determination letter had been issued to petitioner with respect to petitioner's request for relief under sec. 6015(f), and that request was still pending.

3 In further support of respondent's position that, in determining whether petitioner is entitled to relief under sec. 6015(f), we should consider only respondent's administrative record with respect to petitioner's taxable years at issue, respondent relies on Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006), revg. 123 T.C. 85 (2004), a case under sec. 6330. The Court to which an appeal in this case would ordinarily lie is the United States Court of Appeals for the Fourth Circuit. We are not bound by Robinette. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th Cir. 1971).

4 If, as we held in Ewing v. Commissioner, 122 T.C. 32 (2004), we were to consider in this case respondent's administrative record with respect to petitioner's taxable years at issue as well as matters that the parties stipulated that are not part of that administrative record, our holding under sec. 6015(f) would remain the same.

5 In determining whether a requesting spouse will suffer economic hardship, sec. 4.02(1)(c) of Revenue Procedure 2003-61, to which sec. 4.03(2)(a)(ii) of that revenue procedure refers, requires reliance on rules similar to those provided in sec. 301.6343-1(b)(4), Proced. & Admin. Regs.Sec. 301.6343-1(b)(4), Proced. & Admin. Regs., generally provides that an individual suffers an economic hardship if the individual is unable to pay his or her reasonable basic living expenses. Sec. 301.6343-1(b)(4), Proced. & Admin. Regs., provides, in pertinent part:

(ii) Information from taxpayer. --In determining a reasonable amount for basic living expenses the director will consider any information provided by the taxpayer including --

(A) The taxpayer's age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;

(B) The amount reasonably necessary for food, clothing, housing (including utilities, home-owner insurance, home-owner dues, and the like), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer's production of income (such as dues for a trade union or professional organization, or child care payments which allow the taxpayer to be gainfully employed);

(C) The cost of living in the geographic area in which the taxpayer resides;

(D) The amount of property exempt from levy which is available to pay the taxpayer's expenses;

(E) Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and

(F) Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.

6 On brief, respondent contends in pertinent part with respect to the economic hardship factor that petitioner provided respondent with no evidence of this economic hardship. * * * Whether she is jointly liable for the income tax or not does not affect her economic situation: she does not have any economic responsibilities.

* * * * * * *

* * * Accordingly, petitioner will not experience economic hardship if relief is not granted. * * *

Respondent's administrative record with respect to petitioner's taxable years at issue belies respondent's position on brief about the economic hardship factor. As quoted below, the notice of determination, which was based upon that record, also belies that position.

7 Additional facts not presented to the Appeals Office but presented to the Court further support what the Appeals Office implicitly acknowledged. For example, on Dec. 29, 2004, petitioner and Mr. Beatty refinanced the mortgage loan on the house in which they resided. On or about Jan. 4, 2005, petitioner and Mr. Beatty used $151,423.56 of the funds that they received from that refinancing to pay their unpaid liabilities for 1998 and 1999. After the refinancing of the mortgage loan on their house, petitioner and Mr. Beatty had no equity in that house and were required to make a monthly mortgage payment of $3,400 on that refinanced loan.

8 Despite the above-quoted assertions of petitioner, she acknowledges on brief that

ignorance of the law does not excuse a spouse from joint and several liability for tax due on a joint return under § 6013(d)(3). Petitioner further acknowledges prior decisions of this court that charge a taxpayer with constructive knowledge of the underpayment where the taxpayer signed the returns without reviewing them, and a duty to inquire "whether such a tax shown due would be paid." Simon v. Commissioner, T.C. Memo. 2005-220 (and cases cited therein); see also Weist [sic]v. Commissioner, T.C. Memo. 2003-91.

9 In support of her argument that she did not know and had no reason to know that Mr. Beatty would not pay the tax shown due in each of the respective joint returns for the years at issue, petitioner also cites Keitz v. Commissioner, T.C. Memo. 2004-74, and Levy v. Commissioner, T.C. Memo. 2005-92. We find those cases to be materially distinguishable from the instant case and petitioner's reliance on them to be misplaced.

10 On brief, respondent agrees that petitioner did not receive a significant benefit from the failure to pay the unpaid liabilities for the taxable years at issue.

11 See Magee v. Commissioner, T.C. Memo. 2005-263. We also note that, based on cases decided under former sec. 6013(e), we consider the lack of significant benefit by the taxpayer seeking relief from joint and several liability to be a factor that favors granting relief under sec. 6015(f). Ferrarese v. Commissioner, T.C. Memo. 2002-249.<

12 Our finding is the same regardless whether we limit our consideration to respondent's administrative record with respect to petitioner's taxable years at issue.

Tax Help: 75% Civil Fraud Penalty not imposed even though taxpayer made disclosures to IRS Examiner after the audit examination began. The IRS failed to meet its heavy burden of establishing by clear and convincing evidence that taxpayer had the requisite fraudulent intent for any of the years at issue. Several aspects of taxpayer’s conduct were markedly inconsistent with fraudulent intent. At her first meeting with the IRS Agent , taxpayer voluntarily disclosed the existence of her personal accounts, the very accounts in which respondent alleges that she hid her income. When Taxpayer discovered that the first set of letters she had presented were not originals, she disclosed that information to the Agent. Taxpayer also freely disclosed her unreported tip income and that she had cash expenditures for personal expenses even though she had nearly zero cash withdrawals from her bank accounts. In effect, petitioner consistently drew respondent's attention to those areas in which her explanations were less than satisfactory. Such behavior is hardly consistent with intent "to conceal, mislead, or otherwise prevent the collection of taxes". This case is very unusual because ‘willfulness” was negated by voluntary disclosures even though the disclosures may not have been made without the IRS examination. Voluntary disclosures are very important in negating either civil or criminal “willfulness.”



Elizabeth Lai v. Commissioner, Dkt. No. 142-05 , TC Memo. 2007-165, June 26, 2007.





OPINION

Generally, the Commissioner's determinations of deficiencies in a notice of deficiency are presumed correct, and the taxpayer bears the burden of showing that the Commissioner's determinations are in error. See Rule 142(a); Welch v. Helvering , 290 U.S. 111, 115 (1933).5 The U.S. Court of Appeals for the Ninth Circuit (to which an appeal of this matter would lie) has held that the Commissioner must establish "some evidentiary foundation" connecting the taxpayer with the income-producing activity, Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir. 1979), revg. 67 T.C. 672 (1977), or demonstrate that the taxpayer actually received unreported income, see Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982) (the Commissioner's assertion of a deficiency is presumptively correct once some substantive evidence is introduced demonstrating that the taxpayer received unreported income), for the presumption of correctness to attach to the deficiency determination in unreported income cases. If the Commissioner introduces some evidence that the taxpayer received unreported income, the burden shifts to the taxpayer to show by a preponderance of the evidence that the deficiency was arbitrary or erroneous. See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), affg. T.C. Memo. 1997-97.

Respondent has introduced adequate evidence to show that petitioner received unreported income during 1999, 2000, and 2001. With regard to respondent's determinations that resulted from respondent's bank deposit analyses, respondent is not required to show a link between petitioner's bank deposits and a likely taxable source of income. See, e.g., Tokarski v. Commissioner, supra; Kudo v. Commissioner, T.C. Memo. 1998-404, affd. 11 Fed. Appx. 864 (9th Cir. 2001). Respondent's determinations regarding the cashier's check and petitioner's cash income are founded on statements from third parties such as banks and brokerage firms, and on petitioner's admissions that she received cash income that she failed to report on her tax returns. Moreover, petitioner's nail salon business clearly qualifies as an income-producing activity. See, e.g., Hamilton v. Commissioner, T.C. Memo. 2004-66 (ownership of interests in businesses sufficient to prove likely source of unreported income). Respondent has therefore introduced adequate substantive evidence to show that petitioner received unreported income in the amounts determined, and, as noted supra, the burden of proof falls on petitioner to demonstrate that respondent's determinations are arbitrary or erroneous.



In addition to her own testimony, petitioner offered testimony from her sisters Hong Lai and Sharon Huynh, and her daughter Victoria Lai Hutchins to support her contention that the deposits into her personal accounts represent loan proceeds and repayments from intrafamily loans. Petitioner also offered the second set of letters that she gave to Agent Cedergreen during the examination of petitioner's 1999, 2000, and 2001 income tax returns.



Petitioner, Hong Lai, Sharon Huynh, Victoria Lai Hutchins all testified that petitioner participated in several intrafamily loans during the years at issue in an effort to help family members establish financial stability as they arrived and settled in the United States. Petitioner testified that she deposited the proceeds of several loans into her personal accounts during the years at issue. Hong Lai, who had indepth knowledge of her extended family's financial affairs, corroborated that several letters from the second set were authentic and that she recognized the handwriting and signatures of her sisters in Vietnam on 31 of the letters.6 Sharon Hunyh's and petitioner's testimony regarding the letters corroborated Hong Lai's testimony.



We decide whether a witness is credible on the basis of objective facts, the reasonableness of the testimony, and the demeanor of the witness. Quock Ting v. United States, 140 U.S. 417, 420-421 (1891); Wood v. Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C. 593 (1964); Dozier v. Commissioner, T.C. Memo. 2000-255. Having had the opportunity to observe the above-mentioned witnesses at trial, we find petitioner, Hong Lai, Sharon Huynh, and Victoria Lai Hutchins to be honest, forthright, and credible. Based on this testimony and the 31 letters from the second set of letters, we find that petitioner deposited proceeds she received from intrafamily loans into her personal accounts as follows:







Penalties

A. Section 6663



Section 6663 imposes a penalty equal to 75 percent of the portion of any underpayment which is attributable to fraud. Sec. 6663(a). The penalty in the case of fraud is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from a taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391, 401 (1938). Fraud is intentional wrongdoing on the part of the taxpayer with the specific purpose to evade a tax believed to be owing. McGee v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th Cir. 1975).



The Commissioner has the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b). To satisfy this burden, the Commissioner must show: (1) An underpayment exists; and (2) the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Parks v. Commissioner, 94 T.C. 654, 660-661 (1990). The Commissioner must meet this burden through affirmative evidence because fraud is never imputed or presumed. Petzoldt v. Commissioner, 92 T.C. at 699; Recklitis v. Commissioner, 91 T.C. 874, 909-910 (1988); Beaver v. Commissioner, 55 T.C. 85, 92 (1970).



The Commissioner must prove that a portion of the underpayment for each taxable year in issue was due to fraud. Profl. Servs. v. Commissioner, 79 T.C. 888, 930 (1982). If the Commissioner establishes that any portion of an underpayment in a particular year is attributable to fraud, the entire underpayment is treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud. Sec. 6663(b).



The existence of fraud is a question of fact to be resolved from the entire record. Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383 (8th Cir. 1978).



Respondent has failed to meet his heavy burden of establishing by clear and convincing evidence that petitioner had the requisite fraudulent intent for any of the years at issue. Several aspects of petitioner's conduct are markedly inconsistent with fraudulent intent. At her first meeting with Agent Cedergreen, petitioner voluntarily disclosed the existence of her personal accounts, the very accounts in which respondent alleges that she hid her income. When petitioner discovered that the first set of letters she had presented were not originals, she disclosed that information to respondent. Petitioner also freely disclosed her unreported tip income and that she had cash expenditures for personal expenses even though she had nearly zero cash withdrawals from her bank accounts. In effect, petitioner consistently drew respondent's attention to those areas in which her explanations were less than satisfactory. Such behavior is hardly consistent with intent "to conceal, mislead, or otherwise prevent the collection of taxes". Katz v. Commissioner, 90 T.C. 1130, 1143 (1988).



Petitioner contradicted herself on a few occasions during the examination and at trial. However, having had the opportunity to observe petitioner as a witness at trial, and considering that many of her contradictions and disclosures could not have advanced her cause, we do not attribute petitioner's contradictions to fraudulent intent. Rather, we attribute them to a series of misunderstandings and to petitioner's fear of governmental attention due to negative experiences with foreign governments.



Finally, and most importantly, the evidence before us is sufficiently credible to convince us that petitioner did actually participate in the kind of intrafamily transactions which would explain the deposits in her personal accounts, though the record is not sufficiently detailed to establish that all of the deposits into petitioner's personal accounts represent proceeds from such transactions. We therefore do not sustain respondent's imposition of the section 6663 penalty.



B. Burden of Production



Section 7491(c) provides that the Commissioner will bear the burden of production with respect to the liability of any individual for additions to tax and penalties. "The Commissioner's burden of production under section 7491(c) is to produce evidence that it is appropriate to impose the relevant penalty, addition to tax, or additional amount." Swain v. Commissioner, 118 T.C. 358, 363 (2002); see also Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner has done so, the burden of proof is upon the taxpayer to establish reasonable cause and good faith. Higbee v. Commissioner, supra at 449.



C. Section 6662(a)



Pursuant to section 6662(a), a taxpayer may be liable for a penalty of 20 percent of the portion of an underpayment of tax (1) attributable to a substantial understatement of tax or (2) due to negligence or disregard of rules or regulations. Sec. 6662(b). The term "understatement" means the excess of the amount of tax required to be shown on a return over the amount of tax imposed which is shown on the return, reduced by any rebate (within the meaning of section 6211(b)(2)). Sec. 6662(d)(2)(A). Generally, an understatement is a "substantial understatement" when the understatement exceeds the greater of $5,000 or 10 percent of the amount of tax required to be shown on the return. Sec. 6662(d)(1)(A). The term "negligence" in section 6662(b)(1) includes any failure to make a reasonable attempt to comply with the Code. Sec. 6662(c). Negligence has also been defined as the failure to exercise due care or the failure to do what a reasonable person would do under the circumstances. See Allen v. Commissioner, 92 T.C. 1, 12 (1989), affd. 925 F.2d 348, 353 (9th Cir. 1991); Neely v. Commissioner, 85 T.C. 934, 947 (1985). The term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c). Failure to keep adequate records may be evidence not only of negligence, but also of intentional disregard of regulations. See sec. 1.6662-3(b)(1) and (2), Income Tax Regs.; see also Benson v. Commissioner, T.C. Memo. 2007-113.



In the matter before us, respondent has met the burden of production imposed on him by section 7491(c). Respondent has shown that petitioner failed to keep adequate records for the years at issue. To avoid application of the penalty, petitioner must therefore demonstrate that the underpayments of tax for 1999, 2000, and 2001 were due to reasonable cause and good faith. See sec. 6664(c)(1); Higbee v. Commissioner, supra at 449.



The decision as to whether a taxpayer acted with reasonable cause and in good faith depends upon all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Relevant factors include the taxpayer's efforts to assess his or her proper tax liability, including the taxpayer's reasonable and good faith reliance on the advice of a professional such as an accountant. See id. However, reliance on the advice of a professional tax advisor does not necessarily establish reasonable cause and good faith. Id. Particularly, reliance on the advice of a tax professional is not reasonable when a taxpayer fails to disclose a fact that he or she knows, or reasonably should know, is relevant to the proper tax treatment of an item. Sec. 1.6664-4(c)(1)(i), Income Tax Regs.



Petitioner has not demonstrated that any of her underpayments are due to reasonable cause and good faith. Petitioner did not mention her tip income to Mr. Nguyen during his preparation of petitioner's income tax returns. Although petitioner may have believed that tip income was not taxable, that belief is not reasonable. Petitioner has failed to demonstrate that she acted with reasonable cause and good faith with regard to any particular portion of the underpayments in this case. Therefore, to the extent that we uphold respondent's determination of deficiencies for the years at issue, we conclude that petitioner is liable for the section 6662(a) penalties.



To reflect the foregoing,



Decision will be entered under Rule 155.

Tax Attorney: Taxpayer wins “reasonable cause” argument and avoid the negligence penalty

Taxpayer avoids underpayment “negligence” penalty because of the complexity of the law, temporary homelessness, his health issues, and the technical nature of the law under section 104. Viewing all the facts and circumstances, including the experience, knowledge, and education of the taxpayer, the Tax Court concluded that the taxpayer demonstrated reasonable cause for failing to report the settlement proceeds as income and that he acted in good faith under section 6664(c). Accordingly, taxpayer was not liable for the accuracy-related penalty under section 6662(a). This case should be used as precedent in arguing “reasonable cause” in other cases.

Taxpayer wins on avoiding a negligence penalty by proving “reasonable cause” for an underpayment of tax. Reginald James Smith, Petitioners V. Commissioner, TC Summary Opinion 2007-106, Docket No. 8241-06S. . Filed June 25, 2007.

Reasonable cause was demonstrated by the technical nature of the law, the hardship endured by the individual as a result of his joblessness, and the experience, knowledge and education of the individual.

The IRS required the taxpayer to include in income an amount obtained as part of a settlement agreement against a former employer, but was not subject to the accuracy-related penalty for his underpayment. The individual filed a lawsuit alleging, among other claims, sexual and racial harassment. The two parties settled, and the individual failed to include the settlement amount in his income. However, the settlement was not excluded from income under Code Sec. 104 because it was not for a personal injury or sickness. The settlement did not mention a personal injury or sickness and there was no indication that the paying former employer intended to compensate the individual for a personal injury or sickness. However, an accuracy-related penalty under Code Sec. 6662 was not imposed because the individual demonstrated reasonable cause for the underpayment and good faith with respect to the underpayment.



Respondent determined a deficiency in petitioner's 2004 Federal income tax of $12,546. Respondent also determined an accuracy-related penalty in accordance with section 6662(a) in the amount of $2,509 for 2004. After concessions,1 the issues for decision are: (1) Whether a settlement payment received by petitioner is excludable from gross income under section 104(a); and (2) whether petitioner is liable under section 6662(a) for an accuracy-related penalty.





Background



Petitioner worked as a warehouse employee at Onyx Environmental Services (hereinafter Onyx) from April 15, 2002 through November 2002 when he was terminated. On December 16, 2003, petitioner and another individual filed a complaint for damages for sexual and racial harassment, failure to take reasonable steps to prevent and correct harassment, and retaliation, against Onyx and petitioner's former supervisor in the Superior Court of the State of California, County of Contra Costa. In his suit against Onyx, petitioner stated a prayer for relief for compensatory damages, mental and emotional distress damages, punitive damages, interest, attorney's fees, and costs of suit incurred.



In September 2004, petitioner reached a settlement agreement with Onyx and petitioner's former supervisor with respect to the suit he filed on December 16, 2003. Pursuant to the settlement agreement, Onyx paid petitioner $41,651.81 in 2004. Petitioner timely filed his 2004 Federal income tax return, but he did not report the amount received from the settlement on the return. Respondent determined that $41,6512 was includable in petitioner's gross income and issued a notice of deficiency to petitioner on March 13, 2006.





Discussion



In general, the Commissioner's determinations set forth in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that these determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant to section 7491(a), the burden of proof as to factual matters shifts to respondent under certain circumstances. Because the facts are not in dispute, we decide this case without regard to the burden of proof.




I. Taxability of Payment Petitioner Received

A taxpayer's gross income includes all income from whatever source derived unless excluded by a specific provision of the Internal Revenue Code. Sec. 61(a). Gross income does not include "the amount of any damages (other than punitive 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". Sec. 104(a)(). To qualify for this exclusion, the taxpayer must demonstrate: (1) The underlying cause of action giving rise to the recovery is based upon tort or tort type rights; and (2) the damages were received on account of personal physical injuries or physical sickness. Commissioner v. Schleier, 515 U.S. 323, 337 (1995); Allum v. Commissioner, T.C. Memo. 2005-177, affd. 99 AFTR 2d 2007-2527, 2007-1 USTC par 50489 (9th Cir. 2007). The terms "physical injury" and "physical sickness" do not include emotional distress, except to the extent of damages not in excess of the amount paid for medical care attributable to emotional distress. Sec. 104(a); see also Prasil v. Commissioner, T.C. Memo. 2003-100.



When damages are received pursuant to a settlement agreement, the nature of the claim that was the actual basis for settlement controls whether such amounts are excludable under section 104(a)(2). United States v. Burke, 504 U.S. 229, 237 (1992); Prasil v. Commissioner, supra. The determination of the nature of the claim is a factual inquiry and is generally made by reference to the settlement agreement. Robinson v. Commissioner, 102 T.C. 116, 126 (1994), affd. in part and revd. in part 70 F.3d 34 (5th Cir. 1995). If the settlement agreement lacks express language stating what the settlement amount was paid to settle, we look to the intent of the payor, based on all the facts and circumstances of the case, including the complaint that was filed and the details surrounding the litigation. Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Allum v. Commissioner, supra.



Here, the settlement agreement provides that Onyx will pay petitioner $41,651.81 in exchange for petitioner's release and discharge of all claims against Onyx. The settlement agreement does not mention any physical injury or sickness. It refers generally to "all issues and claims" surrounding petitioner's employment at Onyx, and releases Onyx from "all claims, rights, demands, actions, obligations, and causes of action of any and every kind, known or unknown" by petitioner.



Looking beyond the settlement agreement, we likewise find no indication that Onyx intended the $41,651.81 to compensate petitioner for physical injury. As mentioned supra, the complaint that petitioner filed in State court alleges sexual and racial harassment, failure to take reasonable steps to prevent and correct harassment, and retaliation, and the prayer for relief requests compensatory damages, mental and emotional distress damages, punitive damages, interest, attorney's fees, and costs incurred. The complaint says nothing about physical injury or physical sickness sustained by petitioner. There is nothing in the record linking the settlement proceeds to any physical injury or sickness. Accordingly, respondent's determination on this issue is sustained. Based on our resolution of this issue, we do not address whether the underlying cause of the State court action was based upon tort or tort type rights. See Allum v. Commissioner, supra.




II. Accuracy-Related Penalty Under Section 6662(a)

Section 6662(a) provides that a taxpayer may be liable for a penalty of 20 percent of the portion of an underpayment of tax attributable to negligence or disregard of rules or regulations. Sec. 6662(a) and (b)(1). The term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Sec. 6662(c). The term "disregard" includes any careless, reckless, or intentional disregard. Id. The Commissioner bears the burden of production with respect to the accuracy-related penalty. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001).



An exception to the section 6662 penalty applies when the taxpayer demonstrates: (1) There was reasonable cause for the underpayment, and (2) the taxpayer acted in good faith with respect to the underpayment. Sec. 6664(c). Whether the taxpayer acted with reasonable cause and in good faith is determined by the relevant facts and circumstances on a case-by-case basis. See Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec. 1.6664-4(b)(1), Income Tax Regs. "Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer." Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess the proper tax liability. Stubblefield v. Commissioner, supra; sec. 1.6664-4(b)(1), Income Tax Regs.



As discussed above, petitioner worked for Onyx as a warehouse employee, stocking and keeping inventory. After he was terminated in 2002, petitioner had difficulty finding a new job. Petitioner was evicted from his home and lived in his car for several months because he could not pay the rent and had no other place to stay. Petitioner also fell behind on paying bills and student loans. Although petitioner eventually found a new job, it paid close to minimum wage and provided no health benefits. Petitioner sustained at least one injury from an accident while he was uninsured, and he had to pay the related expenses out of pocket.



The record is unclear as to whether petitioner received the Form 1099-MISC, Miscellaneous Income, issued by Onyx.3 Given the circumstances described herein, it seems unlikely that petitioner would have appreciated the significance of the Form 1099-MISC even if he did receive it, even though failure to receive a Form 1099-MISC does not necessarily constitute reasonable cause for failure to report income. See Goode v. Commissioner, T.C. Memo. 2006-48.



We find that petitioner's termination from employment, his eviction resulting in temporary homelessness, his health issues, and the technical nature of the law as to the exclusion of income under section 104 are factors that weigh in his favor. Viewing all the facts and circumstances, including the experience, knowledge, and education of the taxpayer, we conclude that petitioner has demonstrated reasonable cause for failing to report the settlement proceeds as income and that he acted in good faith. See sec. 6664(c). Accordingly, he is not liable for the accuracy-related penalty under section 6662(a).



To reflect the foregoing,



Decision will be entered under Rule 155.


1 Respondent concedes that petitioner is not liable for self-employment tax. Additionally, respondent introduced a Form 4340, Certificate of Assessments, Payments, and Other Specified Matters, showing an assessment of tax on July 24, 2006, 2 months after petitioner timely filed a petition with this Court. Respondent was uncertain as to the basis for the assessment. We presume that respondent has abated or will abate the assessment and will make no further assessments until the decision of the Court is final. See sec. 6213(a).

2 The 81-cent difference between the amount paid and listed in the notice of deficiency is presumably due to rounding by respondent.

3 The parties stipulated that petitioner received the settlement proceeds, and that Onyx issued a Form 1099-MISC, which was submitted as an exhibit. The record does not state that petitioner actually received the Form 1099-MISC.

Back Taxes: IRS Guidance on Political Campaign Intervention by 501(c)(3) Organizations (Rev. Rul. 2007-41)

Congress has been very concerned about nonprofit churches and other organizations promotion or campaigning for political candidates. That activity is prohibited by law and could result in the loss of tax exempt status.

The IRS has issued guidance with regard to the facts and circumstances to be evaluated in determining whether or not a Code Sec. 501(c)(3) organization has participated or intervened in a political campaign either for or against a candidate for public office. The guidance principally is described in 21 fact situations (or examples), divided into seven categories.

Code Sec. 501(c)(3) organizations are organized and operated exclusively for religious, charitable, scientific, or educational purposes, for the prevention of cruelty to children or animals, or for public safety testing. No "action" organization --one that participates or intervenes, directly or indirectly, in any political campaign on behalf of, or in opposition to, any candidate for public office --is considered to operate exclusively for one or more of these exempt purposes. Whether or not an organization is participating or intervening in a campaign for public office depends on all of the facts and circumstances involved in each case.

Code Sec. 501(c)(3) organizations can conduct voter education, voter registration and get-out-the-vote drives, including such activities as hosting public candidate forums, publishing voter education guides, and encouraging people to participate in the electoral process, without becoming action organizations, providing these activities are carried out in a nonpartisan manner.

The leaders of 501(c)(3) organizations are not restricted in their free expression on political matters if they speak for themselves as individuals. However, such leaders' partisan comments will be attributed to the organization if they are made at official organization functions or in official organization publications.

Organizations may host candidate appearances without jeopardizing their tax-exempt status, if done in a nonpartisan manner. Issues considered in this context include: (1) whether opponents for the same office are provided equal opportunity to participate, (2) whether the organization indicates any support for or opposition to a candidate, and (3) whether political fund-raising occurs. Candidates may appear at events in a capacity other than as political candidates if they are current or former political office holders, experts in a nonpolitical field of interest to the organization, or a celebrity or otherwise led a distinguished public career. Whether or not a candidate's appearance is in a noncandidate capacity is determined based on all of the facts and circumstances.

Code Sec. 501(c)(3) organizations may take public positions on issues of public policy, even if those issues are dividing candidates running for public office. Issue advocacy must not, however, include any message favoring or opposing a particular candidate, or it becomes political campaign intervention. Such intervention need not state a candidate's name; merely referring to political party affiliation or distinctive biographical or platform information may suffice to constitute campaign intervention.

Business activity can also constitute participation or intervention in a political campaign. Activities such as leasing of office or meeting spaces, the selling of mailing lists, and the acceptance of paid political advertising may constitute impermissible political intervention. Factors to consider include whether the activity is an ongoing activity of the organization or only conducted for one candidate, whether the fees changed candidates are at usual and customary rates, and whether the goods, services or facilities are available equally to all candidates in the same election.

Information posted on organizations' websites will be treated in the same manner as oral statements, printed materials or broadcasts in determining whether or not the information is nonpartisan. In addition, organizations control whether or not to include links to other websites over which they have no control. The placing of links to candidates' websites is not --by itself --political campaign intervention, but the context for the link on the organization's website, whether all candidates for a particular election are represented, whether any exempt purpose may be served by including the link, and whether the way in which the link is created results in any inference favoring or opposing a particular candidate for public office will be examined.

The factual situations contained in this guidance include examples of both permissible organization activities and impermissible campaign intervention.





Rev. Rul. 2007-41 , I.R.B. 2007-25, June 1, 2007.


Exempt organizations: Action organization: Political intervention. --


Organizations that are exempt from income tax under section 501(a) of the Internal Revenue Code as organizations described in section 501(c)(3) may not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

ISSUE

In each of the 21 situations described below, has the organization participated or intervened in a political campaign on behalf of (or in opposition to) any candidate for public office within the meaning of section 501(c)(3)?

LAW

Section 501(c)(3) provides for the exemption from federal income tax of organizations organized and operated exclusively for charitable or educational purposes, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation (except as otherwise provided in section 501(h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

Section 1.501(c) (3)-1(c)(3)(i) of the Income Tax Regulations states that an organization is not operated exclusively for one or more exempt purposes if it is an "action" organization.

Section 1.501(c)(3)-1(c)(3)(iii) of the regulations defines an "action" organization as an organization that participates or intervenes, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office. The term "candidate for public office" is defined as an individual who offers himself, or is proposed by others, as a contestant for an elective public office, whether such office be national, State, or local. The regulations further provide that activities that constitute participation or intervention in a political campaign on behalf of or in opposition to a candidate include, but are not limited to, the publication or distribution of written statements or the making of oral statements on behalf of or in opposition to such a candidate.

Whether an organization is participating or intervening, directly or indirectly, in any political campaign on behalf of or in opposition to any candidate for public office depends upon all of the facts and circumstances of each case. For example, certain "voter education" activities, including preparation and distribution of certain voter guides, conducted in a non-partisan manner may not constitute prohibited political activities under section 501(c)(3) of the Code. Other so-called "voter education" activities may be proscribed by the statute. Rev. Rul. 78-248, 1978-1 C.B. 154, contrasts several situations illustrating when an organization that publishes a compilation of candidate positions or voting records has or has not engaged in prohibited political activities based on whether the questionnaire used to solicit candidate positions or the voters guide itself shows a bias or preference in content or structure with respect to the views of a particular candidate. See also Rev. Rul. 80-282, 1980-2 C.B. 178, amplifying Rev. Rul. 78-248 regarding the timing and distribution of voter education materials.

The presentation of public forums or debates is a recognized method of educating the public. See Rev. Rul. 66-256, 1966-2 C.B. 210 (nonprofit organization formed to conduct public forums at which lectures and debates on social, political, and international matters are presented qualifies for exemption from federal income tax under section 501(c)(3)). Providing a forum for candidates is not, in and of itself, prohibited political activity. See Rev. Rul. 74-574, 1974-2 C.B. 160 (organization operating a broadcast station is not participating in political campaigns on behalf of public candidates by providing reasonable amounts of air time equally available to all legally qualified candidates for election to public office in compliance with the reasonable access provisions of the Communications Act of 1934). However, a forum for candidates could be operated in a manner that would show a bias or preference for or against a particular candidate. This could be done, for example, through biased questioning procedures. On the other hand, a forum held for the purpose of educating and informing the voters, which provides fair and impartial treatment of candidates, and which does not promote or advance one candidate over another, would not constitute participation or intervention in any political campaign on behalf of or in opposition to any candidate for public office. See Rev. Rul. 86-95, 1986-2 C.B. 73 (organization that proposes to educate voters by conducting a series of public forums in congressional districts during congressional election campaigns is not participating in a political campaign on behalf of any candidate due to the neutral form and content of its proposed forums).


ANALYSIS OF FACTUAL SITUATIONS

The 21 factual situations appear below under specific subheadings relating to types of activities. In each of the factual situations, all the facts and circumstances are considered in determining whether an organization's activities result in political campaign intervention. Note that each of these situations involves only one type of activity. In the case of an organization that combines one or more types of activity, the interaction among the activities may affect the determination of whether or not the organization is engaged in political campaign intervention.



Voter Education, Voter Registration and Get Out the Vote Drives

Section 501(c)(3) organizations are permitted to conduct certain voter education activities (including the presentation of public forums and the publication of voter education guides) if they are carried out in a non-partisan manner. In addition, section 501(c)(3) organizations may encourage people to participate in the electoral process through voter registration and get-out-the-vote drives, conducted in a non-partisan manner. On the other hand, voter education or registration activities conducted in a biased manner that favors (or opposes) one or more candidates is prohibited.

Situation 1. B, a section 501(c)(3) organization that promotes community involvement, sets up a booth at the state fair where citizens can register to vote. The signs and banners in and around the booth give only the name of the organization, the date of the next upcoming statewide election, and notice of the opportunity to register. No reference to any candidate or political party is made by the volunteers staffing the booth or in the materials available at the booth, other than the official voter registration forms which allow registrants to select a party affiliation. B is not engaged in political campaign intervention when it operates this voter registration booth.

Situation 2. C is a section 501(c)(3) organization that educates the public on environmental issues. Candidate G is running for the state legislature and an important element of her platform is challenging the environmental policies of the incumbent. Shortly before the election, C sets up a telephone bank to call registered voters in the district in which Candidate G is seeking election. In the phone conversations, C `s representative tells the voter about the importance of environmental issues and asks questions about the voter's views on these issues. If the voter appears to agree with the incumbent's position, C `s representative thanks the voter and ends the call. If the voter appears to agree with Candidate G `s position, C `s representative reminds the voter about the upcoming election, stresses the importance of voting in the election and offers to provide transportation to the polls. C is engaged in political campaign intervention when it conducts this get-out-the-vote drive.



Individual Activity by Organization Leaders

The political campaign intervention prohibition is not intended to restrict free expression on political matters by leaders of organizations speaking for themselves, as individuals. Nor are leaders prohibited from speaking about important issues of public policy. However, for their organizations to remain tax exempt under section 501(c)(3), leaders cannot make partisan comments in official organization publications or at official functions of the organization.

Situation 3. President A is the Chief Executive Officer of Hospital J, a section 501(c)(3) organization, and is well known in the community. With the permission of five prominent healthcare industry leaders, including President A, who have personally endorsed Candidate T, Candidate T publishes a full page ad in the local newspaper listing the names of the five leaders. President A is identified in the ad as the CEO of Hospital J. The ad states, "Titles and affiliations of each individual are provided for identification purposes only." The ad is paid for by Candidate T `s campaign committee. Because the ad was not paid for by Hospital J, the ad is not otherwise in an official publication of Hospital J, and the endorsement is made by President A in a personal capacity, the ad does not constitute campaign intervention by Hospital J.

Situation 4. President B is the president of University K, a section 501(c)(3) organization. University K publishes a monthly alumni newsletter that is distributed to all alumni of the university. In each issue, President B has a column titled "My Views." The month before the election, President B states in the "My Views" column, "It is my personal opinion that Candidate U should be reelected." For that one issue, President B pays from his personal funds the portion of the cost of the newsletter attributable to the "My Views" column. Even though he paid part of the cost of the newsletter, the newsletter is an official publication of the university. Because the endorsement appeared in an official publication of University K, it constitutes campaign intervention by University K.

Situation 5. Minister C is the minister of Church L, a section 501(c)(3) organization and Minister C is well known in the community. Three weeks before the election, he attends a press conference at Candidate V `s campaign headquarters and states that Candidate V should be reelected. Minister C does not say he is speaking on behalf of Church L. His endorsement is reported on the front page of the local newspaper and he is identified in the article as the minister of Church L. Because Minister C did not make the endorsement at an official church function, in an official church publication or otherwise use the church's assets, and did not state that he was speaking as a representative of Church L, his actions do not constitute campaign intervention by Church L.

Situation 6. Chairman D is the chairman of the Board of Directors of M, a section 501(c)(3) organization that educates the public on conservation issues. During a regular meeting of M shortly before the election, Chairman D spoke on a number of issues, including the importance of voting in the upcoming election, and concluded by stating, "It is important that you all do your duty in the election and vote for Candidate W." Because Chairman D `s remarks indicating support for Candidate W were made during an official organization meeting, they constitute political campaign intervention by M.

Candidate Appearances

Depending on the facts and circumstances, an organization may invite political candidates to speak at its events without jeopardizing its tax-exempt status. Political candidates may be invited in their capacity as candidates, or in their individual capacity (not as a candidate). Candidates may also appear without an invitation at organization events that are open to the public.

When a candidate is invited to speak at an organization event in his or her capacity as a political candidate, factors in determining whether the organization participated or intervened in a political campaign include the following:

l Whether the organization provides an equal opportunity to participate to political candidates seeking the same office;

l Whether the organization indicates any support for or opposition to the candidate (including candidate introductions and communications concerning the candidate's attendance); and

l Whether any political fundraising occurs.

In determining whether candidates are given an equal opportunity to participate, the nature of the event to which each candidate is invited will be considered, in addition to the manner of presentation. For example, an organization that invites one candidate to speak at its well attended annual banquet, but invites the opposing candidate to speak at a sparsely attended general meeting, will likely have violated the political campaign prohibition, even if the manner of presentation for both speakers is otherwise neutral.

When an organization invites several candidates for the same office to speak at a public forum, factors in determining whether the forum results in political campaign intervention include the following:

l Whether questions for the candidates are prepared and presented by an independent nonpartisan panel,

l Whether the topics discussed by the candidates cover a broad range of issues that the candidates would address if elected to the office sought and are of interest to the public,

l Whether each candidate is given an equal opportunity to present his or her view on each of the issues discussed,

l Whether the candidates are asked to agree or disagree with positions, agendas, platforms or statements of the organization, and

l Whether a moderator comments on the questions or otherwise implies approval or disapproval of the candidates.

Situation 7. President E is the president of Society N, a historical society that is a section 501(c)(3) organization. In the month prior to the election, President E invites the three Congressional candidates for the district in which Society N is located to address the members, one each at a regular meeting held on three successive weeks. Each candidate is given an equal opportunity to address and field questions on a wide variety of topics from the members. Society N `s publicity announcing the dates for each of the candidate's speeches and President E `s introduction of each candidate include no comments on their qualifications or any indication of a preference for any candidate. Society N `s actions do not constitute political campaign intervention.

Situation 8. The facts are the same as in Situation 7 except that there are four candidates in the race rather than three, and one of the candidates declines the invitation to speak. In the publicity announcing the dates for each of the candidate's speeches, Society N includes a statement that the order of the speakers was determined at random and the fourth candidate declined the Society's invitation to speak. President E makes the same statement in his opening remarks at each of the meetings where one of the candidates is speaking. Society N `s actions do not constitute political campaign intervention.

Situation 9. Minister F is the minister of Church O, a section 501(c)(3) organization. The Sunday before the November election, Minister F invites Senate Candidate X to preach to her congregation during worship services. During his remarks, Candidate X states, "I am asking not only for your votes, but for your enthusiasm and dedication, for your willingness to go the extra mile to get a very large turnout on Tuesday." Minister F invites no other candidate to address her congregation during the Senatorial campaign. Because these activities take place during official church services, they are attributed to Church O. By selectively providing church facilities to allow Candidate X to speak in support of his campaign, Church O `s actions constitute political campaign intervention.


Candidate Appearances Where Speaking or Participating as a Non-Candidate

Candidates may also appear or speak at organization events in a non-candidate capacity. For instance, a political candidate may be a public figure who is invited to speak because he or she: (a) currently holds, or formerly held, public office; (b) is considered an expert in a non political field; or (c) is a celebrity or has led a distinguished military, legal, or public service career. A candidate may choose to attend an event that is open to the public, such as a lecture, concert or worship service. The candidate's presence at an organization-sponsored event does not, by itself, cause the organization to be engaged in political campaign intervention. However, if the candidate is publicly recognized by the organization, or if the candidate is invited to speak, factors in determining whether the candidate's appearance results in political campaign intervention include the following:

l Whether the individual is chosen to speak solely for reasons other than candidacy for public office;

l Whether the individual speaks only in a non-candidate capacity;

l Whether either the individual or any representative of the organization makes any mention of his or her candidacy or the election;

l Whether any campaign activity occurs in connection with the candidate's attendance;

l Whether the organization maintains a nonpartisan atmosphere on the premises or at the event where the candidate is present; and

l Whether the organization clearly indicates the capacity in which the candidate is appearing and does not mention the individual's political candidacy or the upcoming election in the communications announcing the candidate's attendance at the event.

Situation 10. Historical society P is a section 501(c)(3) organization. Society P is located in the state capital. President G is the president of Society P and customarily acknowledges the presence of any public officials present during meetings. During the state gubernatorial race, Lieutenant Governor Y, a candidate, attends a meeting of the historical society. President G acknowledges the Lieutenant Governor's presence in his customary manner, saying, "We are happy to have joining us this evening Lieutenant Governor Y." President G makes no reference in his welcome to the Lieutenant Governor's candidacy or the election. Society P has not engaged in political campaign intervention as a result of President G `s actions.

Situation 11. Chairman H is the chairman of the Board of Hospital Q, a section 501(c)(3) organization. Hospital Q is building a new wing. Chairman H invites Congressman Z, the representative for the district containing Hospital Q, to attend the groundbreaking ceremony for the new wing. Congressman Z is running for reelection at the time. Chairman H makes no reference in her introduction to Congressman Z' s candidacy or the election. Congressman Z also makes no reference to his candidacy or the election and does not do any political campaign fundraising while at Hospital Q. Hospital Q has not intervened in a political campaign.

Situation 12. University X is a section 501(c)(3) organization. X publishes an alumni newsletter on a regular basis. Individual alumni are invited to send in updates about themselves which are printed in each edition of the newsletter. After receiving an update letter from Alumnus Q, X prints the following: "Alumnus Q, class of `XX is running for mayor of Metropolis." The newsletter does not contain any reference to this election or to Alumnus Q `s candidacy other than this statement of fact. University X has not intervened in a political campaign.

Situation 13. Mayor G attends a concert performed by Symphony S, a section 501(c)(3) organization, in City Park. The concert is free and open to the public. Mayor G is a candidate for reelection, and the concert takes place after the primary and before the general election. During the concert, the chairman of S `s board addresses the crowd and says, "I am pleased to see Mayor G here tonight. Without his support, these free concerts in City Park would not be possible. We will need his help if we want these concerts to continue next year so please support Mayor G in November as he has supported us." As a result of these remarks, Symphony S has engaged in political campaign intervention.



Issue Advocacy vs. Political Campaign Intervention

Section 501(c)(3) organizations may take positions on public policy issues, including issues that divide candidates in an election for public office. However, section 501(c)(3) organizations must avoid any issue advocacy that functions as political campaign intervention. Even if a statement does not expressly tell an audience to vote for or against a specific candidate, an organization delivering the statement is at risk of violating the political campaign intervention prohibition if there is any message favoring or opposing a candidate. A statement can identify a candidate not only by stating the candidate's name but also by other means such as showing a picture of the candidate, referring to political party affiliations, or other distinctive features of a candidate's platform or biography. All the facts and circumstances need to be considered to determine if the advocacy is political campaign intervention.

Key factors in determining whether a communication results in political campaign intervention include the following:

l Whether the statement identifies one or more candidates for a given public office;

l Whether the statement expresses approval or disapproval for one or more candidates' positions and/or actions;

l Whether the statement is delivered close in time to the election;

l Whether the statement makes reference to voting or an election;

l Whether the issue addressed in the communication has been raised as an issue distinguishing candidates for a given office;

l Whether the communication is part of an ongoing series of communications by the organization on the same issue that are made independent of the timing of any election; and

l Whether the timing of the communication and identification of the candidate are related to a non-electoral event such as a scheduled vote on specific legislation by an officeholder who also happens to be a candidate for public office.

A communication is particularly at risk of political campaign intervention when it makes reference to candidates or voting in a specific upcoming election. Nevertheless, the communication must still be considered in context before arriving at any conclusions.

Situation 14. University O, a section 501(c)(3) organization, prepares and finances a full page newspaper advertisement that is published in several large circulation newspapers in State V shortly before an election in which Senator C is a candidate for nomination in a party primary. Senator C represents State V in the United States Senate. The advertisement states that S. 24, a pending bill in the United States Senate, would provide additional opportunities for State V residents to attend college, but Senator C has opposed similar measures in the past. The advertisement ends with the statement "Call or write Senator C to tell him to vote for S. 24." Educational issues have not been raised as an issue distinguishing Senator C from any opponent. S. 24 is scheduled for a vote in the United States Senate before the election, soon after the date that the advertisement is published in the newspapers. Even though the advertisement appears shortly before the election and identifies Senator C `s position on the issue as contrary to O `s position, University O has not violated the political campaign intervention prohibition because the advertisement does not mention the election or the candidacy of Senator C, education issues have not been raised as distinguishing Senator C from any opponent, and the timing of the advertisement and the identification of Senator C are directly related to the specifically identified legislation University O is supporting and appears immediately before the United States Senate is scheduled to vote on that particular legislation. The candidate identified, Senator C, is an officeholder who is in a position to vote on the legislation.

Situation 15. Organization R, a section 501(c)(3) organization that educates the public about the need for improved public education, prepares and finances a radio advertisement urging an increase in state funding for public education in State X, which requires a legislative appropriation. Governor E is the governor of State X. The radio advertisement is first broadcast on several radio stations in State X beginning shortly before an election in which Governor E is a candidate for re-election. The advertisement is not part of an ongoing series of substantially similar advocacy communications by Organization R on the same issue. The advertisement cites numerous statistics indicating that public education in State X is under funded. While the advertisement does not say anything about Governor E `s position on funding for public education, it ends with "Tell Governor E what you think about our under-funded schools." In public appearances and campaign literature, Governor E `s opponent has made funding of public education an issue in the campaign by focusing on Governor E `s veto of an income tax increase the previous year to increase funding of public education. At the time the advertisement is broadcast, no legislative vote or other major legislative activity is scheduled in the State X legislature on state funding of public education. Organization R has violated the political campaign prohibition because the advertisement identifies Governor E, appears shortly before an election in which Governor E is a candidate, is not part of an ongoing series of substantially similar advocacy communications by Organization R on the same issue, is not timed to coincide with a non election event such as a legislative vote or other major legislative action on that issue, and takes a position on an issue that the opponent has used to distinguish himself from Governor E.

Situation 16. Candidate A and Candidate B are candidates for the state senate in District W of State X. The issue of State X funding for a new mass transit project in District W is a prominent issue in the campaign. Both candidates have spoken out on the issue. Candidate A supports funding the new mass transit project. Candidate B opposes the project and supports State X funding for highway improvements instead. P is the executive director of C, a section 501(c)(3) organization that promotes community development in District W. At C `s annual fundraising dinner in District W, which takes place in the month before the election in State X, P gives a lengthy speech about community development issues including the transportation issues. P does not mention the name of any candidate or any political party. However, at the conclusion of the speech, P makes the following statement, "For those of you who care about quality of life in District W and the growing traffic congestion, there is a very important choice coming up next month. We need new mass transit. More highway funding will not make a difference. You have the power to relieve the congestion and improve your quality of life in District W. Use that power when you go to the polls and cast your vote in the election for your state senator." C has violated the political campaign intervention as a result of P `s remarks at C `s official function shortly before the election, in which P referred to the upcoming election after stating a position on an issue that is a prominent issue in a campaign that distinguishes the candidates.



Business Activity

The question of whether an activity constitutes participation or intervention in a political campaign may also arise in the context of a business activity of the organization, such as selling or renting of mailing lists, the leasing of office space, or the acceptance of paid political advertising. In this context, some of the factors to be considered in determining whether the organization has engaged in political campaign intervention include the following:

l Whether the good, service or facility is available to candidates in the same election on an equal basis,

l Whether the good, service, or facility is available only to candidates and not to the general public,

l Whether the fees charged to candidates are at the organization's customary and usual rates, and

l Whether the activity is an ongoing activity of the organization or whether it is conducted only for a particular candidate.

Situation 17. Museum K is a section 501(c)(3) organization. It owns an historic building that has a large hall suitable for hosting dinners and receptions. For several years, Museum K has made the hall available for rent to members of the public. Standard fees are set for renting the hall based on the number of people in attendance, and a number of different organizations have rented the hall. Museum K rents the hall on a first come, first served basis. Candidate P rents Museum K `s social hall for a fundraising dinner. Candidate P `s campaign pays the standard fee for the dinner. Museum K is not involved in political campaign intervention as a result of renting the hall to Candidate P for use as the site of a campaign fundraising dinner.

Situation 18. Theater L is a section 501(c)(3) organization. It maintains a mailing list of all of its subscribers and contributors. Theater L has never rented its mailing list to a third party. Theater L is approached by the campaign committee of Candidate Q, who supports increased funding for the arts. Candidate Q `s campaign committee offers to rent Theater L `s mailing list for a fee that is comparable to fees charged by other similar organizations. Theater L rents its mailing list to Candidate Q `s campaign committee. Theater L declines similar requests from campaign committees of other candidates. Theater L has intervened in a political campaign.

Web Sites

The Internet has become a widely used communications tool. Section 501(c)(3) organizations use their own web sites to disseminate statements and information. They also routinely link their web sites to web sites maintained by other organizations as a way of providing additional information that the organizations believe is useful or relevant to the public.

A web site is a form of communication. If an organization posts something on its web site that favors or opposes a candidate for public office, the organization will be treated the same as if it distributed printed material, oral statements or broadcasts that favored or opposed a candidate.

An organization has control over whether it establishes a link to another site. When an organization establishes a link to another web site, the organization is responsible for the consequences of establishing and maintaining that link, even if the organization does not have control over the content of the linked site. Because the linked content may change over time, an organization may reduce the risk of political campaign intervention by monitoring the linked content and adjusting the links accordingly.

Links to candidate-related material, by themselves, do not necessarily constitute political campaign intervention. All the facts and circumstances must be taken into account when assessing whether a link produces that result. The facts and circumstances to be considered include, but are not limited to, the context for the link on the organization's web site, whether all candidates are represented, any exempt purpose served by offering the link, and the directness of the links between the organization's web site and the web page that contains material favoring or opposing a candidate for public office.

Situation 19. M, a section 501(c)(3) organization, maintains a web site and posts an unbiased, nonpartisan voter guide that is prepared consistent with the principles discussed in Rev. Rul. 78-248. For each candidate covered in the voter guide, M includes a link to that candidate's official campaign web site. The links to the candidate web sites are presented on a consistent neutral basis for each candidate, with text saying "For more information on Candidate X, you may consult [URL]." M has not intervened in a political campaign because the links are provided for the exempt purpose of educating voters and are presented in a neutral, unbiased manner that includes all candidates for a particular office.

Situation 20. Hospital N, a section 501(c)(3) organization, maintains a web site that includes such information as medical staff listings, directions to Hospital N, and descriptions of its specialty health programs, major research projects, and other community outreach programs. On one page of the web site, Hospital N describes its treatment program for a particular disease. At the end of the page, it includes a section of links to other web sites titled "More Information." These links include links to other hospitals that have treatment programs for this disease, research organizations seeking cures for that disease, and articles about treatment programs. This section includes a link to an article on the web site of O, a major national newspaper, praising Hospital N `s treatment program for the disease. The page containing the article on O `s web site contains no reference to any candidate or election and has no direct links to candidate or election information. Elsewhere on O `s web site, there is a page displaying editorials that O has published. Several of the editorials endorse candidates in an election that has not yet occurred. Hospital N has not intervened in a political campaign by maintaining the link to the article on O `s web site because the link is provided for the exempt purpose of educating the public about Hospital N `s programs and neither the context for the link, nor the relationship between Hospital N and O nor the arrangement of the links going from Hospital N `s web site to the endorsement on O `s web site indicate that Hospital N was favoring or opposing any candidate.

Situation 21. Church P, a section 501(c)(3) organization, maintains a web site that includes such information as biographies of its ministers, times of services, details of community outreach programs, and activities of members of its congregation. B, a member of the congregation of Church P, is running for a seat on the town council. Shortly before the election, Church P posts the following message on its web site, "Lend your support to B, your fellow parishioner, in Tuesday's election for town council." Church P has intervened in a political campaign on behalf of B.

HOLDINGS

In situations 2, 4, 6, 9, 13, 15, 16, 18 and 21, the organization intervened in a political campaign within the meaning of section 501(c)(3). In situations 1, 3, 5, 7, 8, 10, 11, 12, 14, 17, 19 and 20, the organization did not intervene in a political campaign within the meaning of section 501(c)(3).

DRAFTING INFORMATION

The principal author of this revenue ruling is Judith Kindell of Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this revenue ruling contact Ms. Kindell on (202) 283-8964 (not a toll-free call).

Tax Help: Cost Sharing Software Held Not to be Inurement to Nonprofit Hosptitals

The IRS released a directive explaining that the Service will not treat the benefits that a hospital provides to its medical staff physicians as impermissible private benefit or inurement in violation of Code Sec. 501(c)(3) if the benefit falls within the range of Health IT Items and Services allowed by the Department of Health and Human Services' EHR regulations, and the hospital operates in accordance with the conditions set forth in the IRS directive. Lois Lerner, IRS director, Exempt Organizations, indicated in May that "taxable hospitals are already doing this." She added that "tax-exempt hospitals were concerned that there may be a concern from our end with regard [to these benefits] and exemption."

Excess Benefit Transaction

An IRS official from the Exempt Organizations Technical division clarified that if the parties meet the conditions described in the Service's directive, the IRS would not consider the subsidy or cost-sharing to be an EBT that would trigger excise taxes. However, if in the course of a field examination an IRS agent finds private benefit or inurement outside the context of an EHR, the agent could look into the benefits of the health IT as well. The IRS official also clarified that an EHR arrangement would not be treated as an EBT simply because a physician utilizing the subsidy is on the hospital board or is otherwise considered to be a "disqualified person."


Shared Access

Participants in the teleconference also addressed the extent to which physicians must provide the hospital with access to their patients' electronic health records. According to the IRS, hospitals should have some level of access to patient records or an EHR arrangement that is subsidized for the benefit of participating physicians, but gives the hospital no access, could constitute an impermissible private benefit or inurement in violation of Code Sec. 501(c)(3).


Cost-Sharing

Participants also addressed cost-sharing issues raised by the IRS's directive. According to the IRS, physicians would need to pay their share of costs for EHR arrangement prior to receiving the benefit. Otherwise, this may be viewed as reimbursement for expenses and monetary remuneration. However, the IRS stipulated that the directive allows hospitals to vary the allocation of costs between the hospital and participating physicians. The directive mandates that at a minimum, 15 percent of the costs be paid by physicians, but permits for different allocations among different groups of physicians.


Possible Limitations

According to Moroney, a hospital could limit the subsidy to a certain level of physicians, such as "active" medical staff. Marilyn Lamar, an attorney with Liss & Lamar in Oak Brook, Ill., noted that a hospital could provide the subsidy to a group practice that includes some physicians not on the hospital's medical staff without running afoul of the IRS's directive and the HHS's regulations. Lamar also indicated that it may also be possible to provide the EHR subsidy to physicians not on the hospital's medical staff as long as the community rationale is followed.





IRS EO Directive: Hospitals Providing Financial Assistance to Staff Physicians Involving Electronic Health Records

May 15, 2007

Exempt organizations: Hospitals: Electronic health records.



Internal Revenue Service



memorandum

date: 05/11/07

to: Director, Exempt Organizations, Examinations SE:T:EO:E

Director, Exempt Organizations, Rulings & Agreements SE:T:EO:RA


From: Director, Exempt Organizations SE:T:EO

/s/ Lois G. Lerner


subject: Hospitals Providing Financial Assistance to Staff Physicians Involving Electronic Health Records

The purpose of this memorandum is to provide a directive for handling examination and exemption application cases involving hospitals that provide physicians who have staff privileges at those hospitals ("medical staff physicians") with financial assistance to acquire and implement software that is used predominantly for creating, maintaining, transmitting, or receiving electronic health records ("EHRs") for their patients.

Many hospitals described in section 501(c)(3) of the Internal Revenue Code ("Code") plan to establish interoperable EHR systems to improve the effectiveness and efficiency of their medical care and to reduce medical errors. Some hospitals believe that their medical staff physicians need a financial incentive to acquire and implement EHR software that would allow the physicians to connect to the hospitals' EHR systems. On August 8, 2006, the U.S. Department of Health and Human Services ("HHS") issued final regulations (see 42 C.F.R. Section 411.357 and 42 C.F.R. Section 1001.952) ("HHS EHR Regulations") that allow hospitals to provide, within specific parameters, EHR software and technical support services ("Health IT Items and Services") to their medical staff physicians without violating the federal anti-kickback law, 42 USC §1320a-7b and physician self-referral law, 42 USC §1395nn.

We will not treat the benefits a hospital provides to its medical staff physicians as impermissible private benefit or inurement in violation of section 501(c)(3) of the Code if the benefits fall within the range of Health IT Items and Services that are permissible under the HHS EHR Regulations and the hospital operates in the manner described below.

A hospital that is otherwise described in section 501(c)(3) of the Code enters into Health IT Subsidy agreements with its medical staff physicians for the provision of Health IT Items and Services at a discount ("Health IT Subsidy Arrangements"). These Health IT Subsidy Arrangements require both the hospital and the participating physicians to comply with the HHS EHR Regulations on a continuing basis. The Health IT Subsidy Arrangements provide that, to the extent permitted by law, the hospital may access all of the electronic medical records created by a physician using the Health IT items and Services subsidized by the hospital. The hospital ensures that the Health IT Items and Services are available to all of its medical staff physicians. The hospital provides the same level of subsidy to all of its medical staff physicians or varies the level of subsidy by applying criteria related to meeting the heathcare needs of the community.

This memorandum does not apply to a hospital that allows its earnings to inure to the benefit of one or more medical staff physicians through arrangements that are other than Health IT Subsidy Arrangements, because the hospital would not be considered to be described in section 501(c)(3) of the Code.

If you have any questions regarding this memorandum, please contact Stephen Clark at 202-283-9474, or Steven Grodnitzky at 202-283-8941.



Q&A on Hospitals' Health IT Subsidy Arrangements with Medical Staff Physicians (as described in May 11, 2007 Field Memorandum)

June 25, 2007

Internal Revenue Service: Exempt Organizations Division Field Directive: Hospitals: Electronic health records: Questions and answers.




Q&A on Hospitals' Health IT Subsidy Arrangements with Medical Staff Physicians (as described in May 11, 2007 Field Memorandum)



Q1 --What if a hospital's Health IT Subsidy Arrangements with its medical staff physicians aren't entirely consistent with the conditions in the Memorandum? Would those arrangements result in impermissible private benefit or inurement?

A1 --Such arrangements will not be covered by the "safe harbor" described in the Memorandum. However, they will not necessarily generate impermissible private benefit or inurement, because the Memorandum is not meant to set forth the only permissible Health IT Subsidy Arrangement between hospitals and physicians. Rather, the facts and circumstances of any arrangement that does not meet the conditions described in the Memorandum will need to be reviewed to determine if it results in any impermissible private benefit or inurement.

Q2 --What is meant in the Memorandum by "financial assistance" and "subsidies" to medical staff physicians to acquire and implement electronic health records ("EHR")-related software and services that would enable the physicians to connect to the hospitals' EHR systems?

A2 - Consistent with the HHS regulations referenced in the Memorandum, "financial assistance" and "subsidy" do not include cash payments from the Hospital to the physicians. Rather, they refer to arrangements in which the hospital provides the physician with EHR-related software or information technology and training services, and the physician contributes a portion of the cost.

Q3 - What if the hospital provides a Health IT Subsidy to a "disqualified person" as defined in section 4958?

A3 - Assuming that the hospital meets all the conditions described in the Memorandum, the agent will not treat such Health IT Subsidy Arrangement as an excess benefit transaction.

Q4 --What if the agent finds inurement to a medical staff physician outside the context of the Health IT Subsidy Arrangement?

A4 --If the agent finds that the hospital's net earnings have inured to the benefit of one or more medical staff physicians outside the context of such arrangement, then the hospital would not be covered by the safe harbor set forth in the memorandum. Although the safe harbor would not apply in this situation, a determination of whether the Health IT Subsidy Arrangement results in impermissible private benefit or inurement will depend on all the facts and circumstances.

Q5 --What type of restrictions, if any, may a medical staff physician impose on the hospital's access to electronic medical records created by the physician using the Health IT Items and Services subsidized by the hospital?

A5 - A physician may deny a hospital access to such records if that access would violate federal and state privacy laws or the physician's contractual obligations to patients. Also, the hospital and physician may agree on reasonable conditions to the hospital's access. For example, their agreement could allow the hospital to access a patient's medical records only when that patient becomes a patient of the hospital, and could deny the hospital access to nonmedical information such as billing, insurance eligibility, and referral information.

Q6 --Does the hospital have to ensure that the Health IT Items and Services are available to all of its medical staff physicians at the same time?

A6 --The hospital may provide access to various groups of physicians at different times according to criteria related to meeting the health care needs of the community. The hospital should establish a plan for providing such access.

Tax Attorney: IRS New Part Payment Requirements for About Offers in Compromise



The offer must also include the required partial payment of 20 percent of the amount offered or the first proposed installment, depending on the type of offer submitted on or after July 16, 2006. In addition if an offer in compromise is not rejected within 24 months after submission of the offer, the offer shall be deemed to be accepted.


Offers in compromise must be submitted using Form 656, Offer in Compromise (Rev. July 2004). The offer should include all information necessary to verify the grounds for compromise. If the offer is based on doubt as to collectibility, the taxpayer must include a completed financial statement on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B, Collection Information Statement for Businesses, or any other financial statement prepared by the taxpayer, as long as it conforms with the information requested on either of the forms and is signed by the taxpayer under penalties of perjury. If a taxpayer is self-employed, both financial statements are required (Instructions to Form 656, Offer in Compromise). If the offer is based on doubt as to liability, submission of a financial statement is not required, but the taxpayer must submit a detailed statement as to why the amount is not owed to the IRS.

Fixed monthly payment option. A simplified method of settling taxpayer debts under the offer in compromise program will allow taxpayers a fixed monthly payment option and will assist taxpayers and practitioners in situations where the full amount of the debt cannot be met. Under the program, the IRS will calculate the exact amount an individual will owe during the life of the offer in compromise payments (Instructions to Form 656, Offer in Compromise (Rev. July 2004); IRS News Release, IR-1999-105, December 29, 1999).



Taxpayers are required to make nonrefundable partial payments with the submission of any offer in compromise on or after July 16, 2006. Taxpayers who submit a lump-sum offer in compromise must include a payment of 20 percent of the amount offered. Taxpayers who submit a periodic payment offer in compromise must include payment of the first proposed installment with the offer and continue making payments under the terms proposed while the offer is being evaluated (Code Sec. 7122(c), as added by the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222)). For purposes of the partial payment requirement, lump-sum offers include any offer that will be paid in five or fewer installments (Code Sec. 7122(c)(1)(A)(ii), as added by P.L. 109-222). The required partial payments are applied to the taxpayer's unpaid liability and are not refundable. However, taxpayers may specify the liability to which they want their payments applied (Code Sec. 7122(c)(2)(A), as added by P.L. 109-222).

An offer in compromise that is submitted to the IRS without the required partial payment will be returned to the taxpayer as unprocessable (Code Sec. 7122(d)(3)(C), as redesignated and amended by P.L. 109-222). Additionally, taxpayers who fail to make payments under the terms of a periodic payment offer during the evaluation period will be deemed to have withdrawn their offers (Code Sec. 7122(c)(1)(B), as added by P.L. 109-222).



Offers in compromise must be submitted using Form 656, Offer in Compromise (Rev. July 2004). The offer should include all information necessary to verify the grounds for compromise. If the offer is based on doubt as to collectibility, the taxpayer must include a completed financial statement on Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, and/or Form 433-B, Collection Information Statement for Businesses, or any other financial statement prepared by the taxpayer, as long as it conforms with the information requested on either of the forms and is signed by the taxpayer under penalties of perjury. If a taxpayer is self-employed, both financial statements are required (Instructions to Form 656, Offer in Compromise). The offer must also include the required partial payment of 20 percent of the amount offered or the first proposed installment, depending on the type of offer submitted on or after July 16, 2006.

If the offer is based on doubt as to liability, submission of a financial statement is not required, but the taxpayer must submit a detailed statement as to why the amount is not owed to the IRS.

Fixed monthly payment option. A simplified method of settling taxpayer debts under the offer in compromise program will allow taxpayers a fixed monthly payment option and will assist taxpayers and practitioners in situations where the full amount of the debt cannot be met. Under the program, the IRS will calculate the exact amount an individual will owe during the life of the offer in compromise payments (Instructions to Form 656, Offer in Compromise (Rev. July 2004); IRS News Release, IR-1999-105, December 29, 1999).



Notice 2006-68 , I.R.B. 2006-31, July 11, 2006.

Compromises: Offer in compromise program: Procedure: Partial payments. --

The Tax Increase Prevention and Reconciliation Act of 2005 ( P.L. 109-222) made major changes to the offers in compromise (OIC) program, tightening the rules for lump-sum and periodic payment offers received by the IRS on or after July 16, 2006. Taxpayers submitting a request for a lump-sum OIC, defined as an offer of payment made in five or fewer installments, must include a payment of 20 percent of the amount offered. Taxpayers submitting requests for periodic-payment OICs must include the first proposed installment payment with their application and continue making payments under the terms proposed while the offer is being evaluated. The IRS will treat the payments as payments of tax, rather than refundable deposits. Unless a waiver applies, failure to pay the 20 percent on a lump-sum offer, or the first installment payment on a periodic payment offer may result in the IRS returning the offer to the taxpayer as nonprocessable. Taxpayers qualifying as low-income or filing an offer based solely on doubt as to liability can receive a waiver of the new partial payment requirements. The IRS will deem an OIC accepted that is not withdrawn, returned or rejected within 24 months after receipt of the offer. When submitting Form 656, taxpayers must include user fee of $150 unless they qualify for a waiver.

As amended, section 7122 provides that a lump-sum offer (one payable in five or fewer installments) must be accompanied by the payment of 20 percent of the amount of the offer. Section 7122 also provides that a periodic payment offer (one payable in six or more installments) must be accompanied by the payment of the amount of the first proposed installment and additional installments must be paid while the offer is being evaluated by the Internal Revenue Service.

This Notice provides interim guidance under section 7122, as amended by section 509 of TIPRA, until regulations or other guidance is issued and Form 656 is revised. Taxpayers may rely on this Notice until regulations or other guidance is issued and may continue to use the current version of Form 656 (Rev. 7-2004) to submit offers until a revised Form 656 is available. The revised Form 656 will be made available on the Internal Revenue Service's website at www.IRS.gov and taxpayers may call 1 (800) Tax-Form to request a copy of Form 656.

SECTION 1. BACKGROUND AND GENERAL RULES

.01 Section 7122 permits the Service to compromise any civil liability arising under the internal revenue laws before the case is referred to the Department of Justice for prosecution or defense. Section 509 of TIPRA amended section 7122, effective for offers in compromise submitted on or after July 16, 2006. An offer in compromise will be treated as submitted on or after July 16, 2006, if the offer is received on or after that date by the Service. The postmark date is irrelevant in determining when an offer is submitted.

.02 Section 7122(c)(1), as amended by TIPRA, requires that an offer in compromise be accompanied by a partial payment. In the case of a lump-sum offer, the partial payment required is 20 percent of the amount of the offer. If the taxpayer does not make the required 20-percent payment, the offer may be returned to the taxpayer as unprocessable. Section 7122(d)(3)(C). The Service will treat the required 20-percent payment as a payment of tax, rather than a refundable deposit under section 7809(b) or Treas. Reg. §301.7122-1(h). Voluntary payments submitted in connection with an offer in compromise, to the extent they exceed the payment or payments required under section 7122(c)(1), will be treated as refundable deposits if they are not designated as tax payments by the taxpayer.

.03 If the taxpayer submits a periodic payment offer, the taxpayer must include the first proposed installment with the offer. If the taxpayer does not make the first installment payment, the offer may be returned to the taxpayer as unprocessable. Section 7122(d)(3)(C). While a periodic payment offer is being evaluated by the Service, the taxpayer must make subsequent proposed installment payments as they become due. If the taxpayer fails to make an installment payment other than the first installment, the failure may be treated as a withdrawal of the offer. Section 7122(c)(1)(B)(ii). The Service will treat installment payments required for a periodic payment offer as payments of tax, rather than refundable deposits under section 7809(b) or Treas. Reg. §301.7122-1(h). Voluntary payments submitted in connection with an offer in compromise, to the extent they exceed the payment or payments required under section 7122(c)(1), will be treated as refundable deposits if they are not designated as tax payments by the taxpayer.

.04 Section 7122(c)(2)(A) allows the taxpayer to specify how any payment made pursuant to section 7122(c)(1) is to be applied to the assessed taxes, penalties, interest, etc. The specification must be made in writing when the offer is submitted or when the payment is made. The specification should clearly indicate how the partial payment or partial payments (in the case of a periodic payment offer) are to be applied to specific taxable years (or other taxable periods) or to specific liabilities (e.g., income taxes, employment taxes, and trust fund recovery penalties under section 6672(a)). Once the taxpayer specifies how a payment is to be applied, the specification cannot later be changed. In the absence of a specification, the Service will apply the payment or payments required by section 7122(c) in the best interests of the government.

.05 Section 7122(c)(2)(B) provides that the assessed tax or other amounts shall be reduced by any user fee imposed with respect to the taxpayer's offer in compromise. The applicable regulations provide that a $150 user fee is generally charged for processing an offer in compromise, but no fee is charged if the offer is based solely on doubt as to liability or is made by a low-income taxpayer. Treas. Reg. §300.3(b)(1). Because a taxpayer may not specify how the $150 user fee for processing an offer in compromise will be applied, the Service will apply the user fee in the best interests of the government.

.06 Section 7122(c)(2)(C) provides that the Secretary may issue regulations waiving any payment required under section 7122(c)(1) in a manner consistent with the practices established in accordance with the requirements under section 7122(d)(3). See Section 4 of this Notice for information concerning waivers for low-income taxpayers and for offers based solely on doubt as to liability.

.07 Section 7122(f) provides that if an offer in compromise is not rejected within 24 months after submission of the offer, the offer shall be deemed to be accepted. Any period during which any tax liability which is the subject of the offer is in dispute in any judicial proceeding is not taken into account in determining the expiration of the 24-month period. The date of submission of an offer for purposes of section 7122(f) is the date on which the offer is received by the Service. The postmark date is irrelevant in determining when an offer is submitted. An offer will not be deemed to be accepted if the offer is, within the 24-month period, rejected by the Service, returned by the Service to the taxpayer as nonprocessable or no longer processable, withdrawn by the taxpayer, or deemed withdrawn under section 7122(c)(1)(B)(ii) because of the taxpayer's failure to make the second or later installment due on a periodic payment offer. The date an offer is rejected for purposes of section 7122(f) is the date on which the Service issues a written notice of rejection under Treas. Reg. §301.7122-1(f)(1). The period during which the IRS Office of Appeals considers a rejected offer in compromise is not included as part of the 24-month period because the offer was rejected by the Service within the meaning of section 7122(f) prior to consideration of the offer by the Office of Appeals.



SECTION 2. GUIDANCE FOR LUMP-SUM OFFERS

.01 Unless a waiver under Section 4 of this Notice applies, a lump-sum offer in compromise received on or after July 16, 2006, will be returned as not processable if the offer is not accompanied by a partial payment of the amount of the offer.

.02 If the taxpayer makes a partial payment when a lump-sum offer is submitted, but the payment is less than the 20-percent required amount, the Service may accept the offer for processing and solicit payment of the remaining portion of the 20-percent amount. If the taxpayer does not pay the balance of the 20-percent amount within the time allowed by the Service, the Service may return the offer as not processable unless the Service determines that continued processing of the offer would be in the best interests of the government.



SECTION 3. GUIDANCE FOR PERIODIC PAYMENT OFFERS

.01 Unless a waiver under Section 4 of this Notice applies, a periodic payment offer in compromise received on or after July 16, 2006, will be returned as not processable if the submission of the offer is not accompanied by the full amount of the first proposed installment.

.02 If a periodic payment offer has been accepted for processing and the taxpayer fails to make full payment of the second or subsequent proposed installment while the offer is being evaluated, the Service may solicit payment from the taxpayer of the unpaid amount of the subsequent installment. The Service may issue a letter advising the taxpayer that the offer is considered withdrawn if the taxpayer does not make full payment of the installment within the time allowed unless the Service determines that continued processing of the offer is in the best interests of the government.



SECTION 4. WAIVER OF PAYMENTS UNDER SECTION 7122(c)(2)(C)

.01 The Treasury Department and the Service intend to issue regulations pursuant to section 7122(c)(2)(C) that will waive payments otherwise required by section 7122(c)(1) in two situations. Waivers will apply with respect to offers submitted by low-income taxpayers and with respect to offers submitted by other taxpayers based solely on doubt as to liability. Although regulations have not been issued, on an interim basis the Service will waive the payments otherwise required by section 7122(c)(1) using the criteria described in Sections 4.02 and 4.03 below.

.02 No payment under section 7122(c)(1) will be required when an offer is submitted by a low-income taxpayer. A low-income taxpayer is an individual whose income falls at or below poverty levels based on guidelines established by the U.S. Department of Health and Human Services under the authority of section 673(2) of the Omnibus Reconciliation Act of 1981 (95 Stat. 357, 511), or another measure that is adopted by the Secretary. Until further guidance is issued, a taxpayer should use the worksheet to Form 656-A, Income Certification for Offer in Compromise Application Fee, to determine if the taxpayer qualifies as a low-income taxpayer who is not required to make partial payments pursuant to section 7122(c)(1).

.03 No payment under section 7122(c)(1) will be required when an offer is submitted by a taxpayer based solely on doubt as to liability. An offer is considered to be submitted solely on the basis of doubt as to liability if the taxpayer submits the offer on Form 656-L, Offer in Compromise (Doubt as to Liability), or, if the offer is submitted on Form 656, Offer in Compromise, it is clear on the face of the Form that the only basis on which the taxpayer relies in making the offer is doubt as to liability.

Back Taxes: Taxpayer’s need to have all tax returns filed if they want the IRS to approve either an Installment Agreement or an Offer in Compromise. The IRS Office of Appeals did not abuse its discretion in sustaining a levy, rather than granting the taxpayer an installment agreement, when the underlying deficiency arose out of five years of unfiled tax returns and the taxpayer still had an outstanding unfiled return on the date of the Appeals Office hearing. In balancing the need for efficient collection of tax against the taxpayer's concern that collection action not be more intrusive than necessary, the IRS was entitled to consider the taxpayer's history of noncompliance.


Roger Pavlica v. Commissioner, Dkt. No. 5861-06L , TC Memo. 2007-163, June 21, 2007.





Discussion



Generally, under section 6331(a) respondent may lawfully collect by levy upon property belonging to a taxpayer outstanding taxes which remain unpaid 10 days after respondent's notice and demand therefor.



Prior to making a levy upon a taxpayer's property, respondent must give to the taxpayer written notice of both the proposed levy and of the taxpayer's right to an Appeals Office hearing relating to the proposed levy. Secs. 6330(a), 6331(d)(1), (4).



In such a hearing, respondent is to verify whether the requirements of applicable law and administrative procedure have been met and consider other appropriate issues such as collection alternatives raised by the taxpayer. Sec. 6330(c).



Under section 6330(c)(3)(C), respondent also is to consider whether respondent's proposed levy balances the need for efficient collection of taxes with the taxpayer's concern that respondent's collection action be no more intrusive than necessary.



Under section 6330(d)(1), we have jurisdiction to review respondent's notice of determination relating to a section 6330 hearing. Where the underlying Federal income tax liability is not at issue, we review for abuse of discretion respondent's determination adverse to a taxpayer sustaining respondent's collection activity. Sego v. Commissioner, 114 T.C. 604, 610 (2000).



Petitioner argues that respondent's Appeals Office should have granted petitioner an installment agreement. Because, however, petitioner had a history of noncompliance with his Federal income tax obligations and was not compliant with his current tax obligations as of the date of the Appeals Office hearing, respondent's Appeals Office did not abuse its discretion in declining to grant petitioner an installment agreement. See Orum v. Commissioner, 412 F.3d 819, 821 (7th Cir. 2005), affg. 123 T.C. 1 (2004) (no abuse of discretion when rejecting an installment agreement from a taxpayer who had a history of not fulfilling Federal income tax obligations); Rodriguez v. Commissioner, T.C. Memo. 2003-153 (no abuse of discretion when rejecting an offer-in-compromise from a taxpayer who had not filed current and previous returns); Londono v. Commissioner, T.C. Memo. 2003-99 (no abuse of discretion when rejecting an offer-in-compromise from a taxpayer who had a history of not fulfilling Federal income tax obligations); McCorkle v. Commissioner, T.C. Memo. 2003-34 (no abuse of discretion when rejecting an installment agreement from a taxpayer who had not filed a current return).



We sustain respondent's levy.



To reflect the foregoing,



Decision will be entered for respondent.

Tax Help: The IRS Office of Chief Counsel has updated the procedures it will follow in Tax Court cases where the Code Sec. 6651(a)(2) addition to tax has been determined on the basis of a substitute return. Today's guidance updates and modifies CC-2007-005, providing Chief Counsel employees with updated telephone numbers to call to obtain a copy of an Automated Substitute for Return. Guidance was also provided regarding what to do when a Code Sec. 6020(b) return was filed, but the return is missing from the administrative file.


June 22, 2007

Chief Counsel Notice: CC-2007-14: Addition to tax: Substitute return.



Department of the Treasury



Internal Revenue Service



Office of Chief Counsel



Notice CC-2007-014



June 18, 2007

Subject: Contact Information for Obtaining Section 6020(b) Returns

Cancel Date : Effective until further notice



Purpose

This Notice updates and modifies Notice CC-2007-005, Litigating Position for Returns Prepared under Section 6020(b), issued February 4, 2007, regarding the Service's litigating position and the procedures to be followed in Tax Court cases in which the section 6651(a)(2) addition to tax has been determined on the basis of a substitute for return. Notice CC-2007-005 lists Service telephone numbers to call to obtain a copy of an Automated Substitute for Return (known as a section 6020(b) ASFR Certification). This Notice updates those telephone numbers and provides more detailed information on obtaining documentation for section 6020(b) returns from the campuses when the documentation is not in the administrative file.



Background

As explained in Notice CC-2007-005, the Service prepares two types of section 6020(b) returns: (1) Forms 13496, and (2) ASFR Certifications. Both the Form 13496 (when packaged with Forms 4549 and 886-A) and the ASFR Certification (with accompanying 30-day letter) can be a valid section 6020(b) return if they identify the taxpayer's name and TIN and contain adequate information to compute the taxpayer's tax liability. See Temp. Treas. Reg. §301.6020-1T; Notice CC-2007-005. To meet the burden of production with respect to the section 6651(a)(2) addition to tax for a non-filer, the ASFR Certification or Form 13496 package that satisfies these elements should be put into evidence. When it is apparent that a section 6020(b) return was prepared (e.g., a transcript of the taxpayer's account shows a TC 150 with $0.00 assessed), but the section 6020(b) return is missing from the administrative file, all reasonable efforts should be made to obtain the necessary documentation.



How to Obtain Documentation



Determine the Type of Return

The contacts for obtaining documentation differ depending on the type of section 6020(b) return involved. The first step is to determine whether an ASFR Certification or a Form 13496 was prepared. The answer will be evident from the administrative file or a transcript of the taxpayer's account. If TC 494 appears on the transcript, an ASFR Certification was most likely, but not invariably, prepared (the return could have been incorrectly coded on the account). If the transcript shows "SFR" at the far right on the TC 150 line or shows a TC 420 or 424 followed by "SPCL-PROJ>0277," then a Form 13496 return was prepared.



ASFR Certifications

ASFR Certifications are generated electronically and archived for seven years. The system on which the returns are stored allows certain Service personnel in any of the campuses that currently prepare ASFR Certifications (Andover, Austin, Brookhaven, and Fresno) to access any archived ASFR Certification.

The three phone numbers listed in Notice CC-2007-005 for Counsel to call to obtain ASFR documentation (the certification and the 30-day letter) are no longer current. After the release of the notice, the responsibilities of contact personnel in the campuses changed. As a result, to obtain an ASFR Certification, Counsel should now contact a Supervisory Tax Examining Assistant at (978) 474-1423 or (978) 474-1392 or a Tax Examining Technician at (559) 454-6598. The employees at these numbers are only able to provide information on ASFR Certifications and do not have access to returns prepared on Form 13496.



Form 13496 Returns

Forms 13496 are prepared either electronically or manually by Examination personnel. The campus where a return was prepared may be able to provide documentation of the return when all or part of a Form 13496 package is not in the file. Counsel should contact the originating campus, which is designated on the lower right-hand portion of the Form 13496, if available, and by the first two digits of the Document Locator Number on the transcript (a key can be found at page 4-3 of Document 6209, IRS Processing Codes and Information (2007)). Current phone numbers are below:





______________________________________________________________________

Atlanta (678) 530-5632 Cincinnati (859) 669-2023



______________________________________________________________________

Austin (512) 460-0198 Fresno (559) 454-6206



______________________________________________________________________

Brookhaven (631) 447-4748 Kansas City (816) 325-8012 (or

or -8015)

(631) 654-6134

(631) 654-6618



___________________________________

Memphis (901) 395-1608



___________________________________

Philadelphia (215) 516-3581



___________________________________

Ogden (801) 620-2058



______________________________________________________________________



Obtaining the documentation, however, could be difficult as well as time-consuming and may not be possible in some cases. Form 13496 documentation is likely to be less readily available than ASFR documentation. If, despite best efforts, the documentation cannot be obtained in time to meet litigation deadlines, the section 6651(a)(2) addition to tax should be conceded.

For further guidance on section 6020(b) returns, please contact Branch 1 or 2 of Procedure & Administration at (202) 622-4910 or (202) 622-4940, respectively.

_________/s/ __________

DEBORAH A. BUTLER

Associate Chief Counsel

(Procedure & Administration)



SEC. 6651. FAILURE TO FILE TAX RETURN OR TO PAY TAX.

6651(a) ADDITION TO THE TAX. --In case of failure --





6651(a)(1) to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), subchapter A of chapter 51 (relating to distilled spirits, wines, and beer), or of subchapter A of chapter 52 (relating to tobacco, cigars, cigarettes, and cigarette papers and tubes) or of subchapter A of chapter 53 (relating to machine guns and certain other firearms), on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;





6651(a)(2) to pay the amount shown as tax on any return specified in paragraph (1) on or before the date prescribed for payment of such tax (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate; or



6651(a)(3) to pay any amount in respect of any tax required to be shown on a return specified in paragraph (1) which is not so shown (including an assessment made pursuant to section 6213(b)) within 21 calendar days from the date of notice and demand therefor (10 business days if the amount for which such notice and demand is made equals or exceeds $100,000), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount of tax stated in such notice and demand 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.



In the case of a failure to file a return of tax imposed by chapter 1 within 60 days of the date prescribed for filing of such return (determined with regard to any extensions of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, the addition to tax under paragraph (1) shall not be less than the lesser of $100 or 100 percent of the amount required to be shown as tax on such return.



6651(b) PENALTY IMPOSED ON NET AMOUNT DUE. --For purposes of --



6651(b)(1) subsection (a)(1), the amount of tax required to be shown on the return shall be reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed on the return,



6651(b)(2) subsection (a)(2), the amount of tax shown on the return shall, for purposes of computing the addition for any month, be reduced by the amount of any part of the tax which is paid on or before the beginning of such month and by the amount of any credit against the tax which may be claimed on the return, and



6651(b)(3) subsection (a)(3), the amount of tax stated in the notice and demand shall, for the purpose of computing the addition for any month, be reduced by the amount of any part of the tax which is paid before the beginning of such month.



6651(c) LIMITATIONS AND SPECIAL RULE. --



6651(c)(1) ADDITIONS UNDER MORE THAN ONE PARAGRAPH. --With respect to any return, the amount of the addition under paragraph (1) of subsection (a) shall be reduced by the amount of the addition under paragraph (2) of subsection (a) for any month (or fraction thereof) to which an addition to tax applies under both paragraphs (1) and (2). In any case described in the last sentence of subsection (a), the amount of the addition under paragraph (1) of subsection (a) shall not be reduced under the preceding sentence below the amount provided in such last sentence.



6651(c)(2) AMOUNT OF TAX SHOWN MORE THAN AMOUNT REQUIRED TO BE SHOWN. --If the amount required to be shown as tax on a return is less than the amount shown as tax on such return, subsections (a)(2) and (b)(2) shall be applied by substituting such lower amount.



6651(d) INCREASE IN PENALTY FOR FAILURE TO PAY TAX IN CERTAIN CASES. --



6651(d)(1) IN GENERAL. --In the case of each month (or fraction thereof) beginning after the day described in paragraph (2) of this subsection, paragraphs (2) and (3) of subsection (a) shall be applied by substituting "1 percent" for "0.5 percent" each place it appears.



6651(d)(2) DESCRIPTION. --For purposes of paragraph (1), the day described in this paragraph is the earlier of --



6651(d)(2)(A) the day 10 days after the date of which notice is given under section 6331(d), or



6651(d)(2)(B) the day on which notice and demand for immediate payment is given under the last sentence of section 6331(a).



6651(e) EXCEPTION FOR ESTIMATED TAX. --This section shall not apply to any failure to pay any estimated tax required to be paid by section 6654 or 6655.



6651(f) INCREASE IN PENALTY FOR FRAUDULENT FAILURE TO FILE. --If any failure to file any return is fraudulent, paragraph (1) of subsection (a) shall be applied --



6651(f)(1) by substituting "15 percent" for "5 percent" each place it appears, and



6651(f)(2) by substituting "75 percent" for "25 percent".



6651(g) TREATMENT OF RETURNS PREPARED BY SECRETARY UNDER SECTION 6020(b). --In the case of any return made by the Secretary under section 6020(b) --



6651(g)(1) such return shall be disregarded for purposes of determining the amount of the addition under paragraph (1) of subsection (a), but



6651(g)(2) such return shall be treated as the return filed by the taxpayer for purposes of determining the amount of the addition under paragraphs (2) and (3) of subsection (a).



6651(h) LIMITATION ON PENALTY ON INDIVIDUAL'S FAILURE TO PAY FOR MONTHS DURING PERIOD OF INSTALLMENT AGREEMENT. --In the case of an individual who files a return of tax on or before the due date for the return (including extensions), paragraphs (2) and (3) of subsection (a) shall each be applied by substituting "0.25" for "0.5" each place it appears for purposes of determining the addition to tax for any month during which an installment agreement under section 6159 is in effect for the payment of such tax.

SEC. 6020. RETURNS PREPARED FOR OR EXECUTED BY SECRETARY.

6020(a) PREPARATION OF RETURN BY SECRETARY. --If any person shall fail to make a return required by this title or by regulations prescribed thereunder, but shall consent to disclose all information necessary for the preparation thereof, then, and in that case, the Secretary may prepare such return, which, being signed by such person, may be received by the Secretary as the return of such person.





6020(b) EXECUTION OF RETURN BY SECRETARY. --



6020(b)(1) AUTHORITY OF SECRETARY TO EXECUTE RETURN. --If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.



6020(b)(2) STATUS OF RETURNS. --Any return so made and subscribed by the Secretary shall be prima facie good and sufficient for all legal purposes.

Tax Attorney: Frivolous argument was identified by the Tax Court in Chester E. Davis v. Commissioner, Dkt. No. 4284-06L , TC Memo. 2007-160, June 20, 2007.

The IRS did not abuse its discretion in its determination to sustain the filing of a Notice of Tax Lien and proceed with collection against the taxpayer who asserted tax-protestor type arguments during his Collection Due Process hearing. The IRS Appeals officer was not required to meet with the taxpayer's representative, who was permanently barred from providing tax services and representing taxpayers before the IRS. Barring the representative did not prevent the taxpayer from finding another representative or representing himself, as he ended up doing.

The taxpayer was also not entitled to a face-to-face meeting with the Appeals officer because he raised only tax-protestor arguments of the type that had previously been rejected. No arguments or information was presented to address the merits of the underlying tax liability, the validity of the assessment or whether the proceeding was in compliance with the requirements. Also rejected as frivolous was the taxpayer's argument that the IRS's representatives did not show that they were authorized to represent the Secretary of the Treasury.

The Appeals officer could also use Forms 4340 to verify the assessment and was not required to provide to the taxpayer Form 4340 or other documents maintained by the IRS with respect to the taxpayer's account. The taxpayer was not entitled to contest the underlying tax liability because he received a notice of deficiency to which he did not respond. Even assuming he could contest the liability, the return he presented had only zeros in the boxes.

Finally, the taxpayer was liable for the penalty for advancing frivolous arguments. The penalty was appropriate for taxpayers who abuse the protections provided in collection actions. The taxpayer made arguments that had been previously rejected by the courts, resulting in a waste of time and resources.


Face-to-Face Meeting

Section 6320(a)(1) requires the Secretary to give persons liable to pay taxes a written notice of the filing of an NFTL. Section 6320(a)(3)(B) and (b)(1) provides that the notice shall inform such persons of the right to request a hearing in respondent's Appeals Office. Section 6320(c) provides that an Appeals Office hearing generally shall be conducted consistently with the procedures set forth in section 6330(c), (d), and (e). The Appeals officer must verify at the hearing that the applicable laws and administrative procedures have been followed. Sec. 6330(c)(1). At the hearing, the person against whom the lien is filed may raise any relevant issues relating to the unpaid tax or the lien, including appropriate spousal defenses, challenges to the appropriateness of collection actions, and collection alternatives. Sec. 6330(c)(2)(A). The person may challenge the existence or amount of the underlying tax, however, only if he did not receive any statutory notice of deficiency for the tax liability or did not otherwise have an opportunity to dispute the tax liability. Sec. 6330(c)(2)(B).



In the instant case, the record indicates that the only issues petitioner raised throughout the section 6320 administrative process and in his petition to this Court were frivolous and/or tax protester type arguments. We do not address petitioner's frivolous arguments with somber reasoning and copious citations of precedent, as to do so might suggest that these arguments possess some degree of colorable merit. See Crain v. Commissioner, 737 F.2d 1417, 1417 (5th Cir. 1984).



For example, petitioner contended that the NFTLs are "counterfeited securities". Likewise, he contended that the Notice of Determination was fraudulent because it does not carry a proper number from the Office of Management and Budget. Amongst others, he has also raised the well-worn argument that he is not subject to or required to pay any income tax unless the Commissioner or his agents can show him a statute that expressly states that he is subject to tax.



To the extent petitioner complains that he did not receive a face-to-face hearing, this Court has held that it is neither necessary nor productive to remand cases to an Appeals Office for face-to-face hearings when a taxpayer raises only frivolous arguments. Lunsford v. Commissioner, supra at 189.



The arguments or information expressed by petitioner in the telephonic conference were, at best, superficial and did not go to the merits of the underlying 2001 tax liability. Instead and true to form, petitioner posed the well-worn protester sophistry that he would gladly pay the tax if someone could identify the statute that makes him liable to pay. The only other matter raised by petitioner was his request that the Appeals officer provide him with the underlying assessment document(s) referenced in the Form 4340 certification that had been sent to him.



The Court has also reviewed all of the materials forwarded to respondent by petitioner in connection with the administrative proceeding and, likewise, found them to contain "protester type" and frivolous arguments.



Petitioner did not make any justiciable arguments or present any information that properly addressed the merits of the underlying tax liability,2 the validity of the assessment, or the conduct of the proceeding or compliance with section 6330 requirements. Accordingly, the fact that petitioner was not offered a face-to-face hearing was, in this instance, not an abuse of discretion.




Appeals Officer's Authority

There is little need to dwell on petitioner's argument that the administrative proceeding was flawed because respondent's representatives did not show that they were properly authorized to represent the interests of the Secretary of the Treasury. To the extent that petitioner's argument implies that only the Secretary of the Treasury could conduct a proper proceeding it is frivolous. In the context of whether there was an abuse of discretion or any meaningful procedural flaw attributable to any failure of respondent's representative to prove to petitioner that they were authorized, we find that factor to be irrelevant. See Nestor v. Commissioner, 118 T.C. 162, 166 (2002). This is especially true in this case where petitioner's arguments are without substance and where he failed to present any meaningful arguments or information bearing on the merits of the underlying tax liability or respondent's collection efforts.




Form 4340

Petitioner argues that under section 6330 he is entitled to the underlying assessment documents and, ostensibly, that the Form 4340 certification does not meet the statutory requirements. The Appeals officer used Forms 4340, to verify the assessments. We have held that "it was not an abuse of discretion for the Appeals officer to use Forms 4340 for purposes of complying with section 6330(c)(1)." Nestor v. Commissioner, supra at 166; see also Davis v. Commissioner, 115 T.C. 35, 41 (2000); Lindsay v. Commissioner, T.C. Memo. 2001-285, affd. 56 Fed. Appx. 800 (9th Cir. 2003).



Section 6330(c)(1) does not require the Appeals officer to provide taxpayers with a copy of a document verifying that the requirements of any applicable law or administrative procedure have been met. Section 301.6330-1(e)(1), Proced. & Admin. Regs., requires that the Appeals officer obtain verification before issuing the determination, not that he or she provide it to the taxpayer. Further, there is no legal requirement that the Appeals officer provide a taxpayer with copies of the delegations of authority, assessment records, or other underlying documents maintained by respondent with respect to a taxpayer's account. Nestor v. Commissioner, supra at 166. Accordingly, the Appeals officer in this case sufficiently verified the 2001 tax assessments and was not required to provide more.




The 2001 Tax Liability

A taxpayer may challenge the existence or amount of the underlying tax, however, only if he did not receive any statutory notice of deficiency for the tax liability or did not otherwise have an opportunity to dispute the tax liability. Sec. 6330(c)(2)(B). Where the validity of the underlying tax liability is properly in issue, the Court will review the matter de novo. Where the validity of the underlying tax is not properly in issue, however, the Court will review the Commissioner's administrative determination for abuse of discretion. Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. at 181-182.



In this case petitioner was not entitled to contest the underlying tax liability for 2001, the only year that this Court has jurisdiction to consider. Even if petitioner had been entitled to contest the underlying tax liability, other than protester arguments, he presented nothing more than an income tax return with a zero in each pertinent box. Accordingly, respondent's motion for summary judgment will be granted, and petitioner's cross-motion for summary judgment will be denied.




Section 6673 Penalty

Respondent has requested that the Court impose a penalty under section 6673 on the ground that the arguments advanced by petitioner to respondent and the Court are frivolous. Section 6673(a)(1) authorizes the Court to impose a penalty not in excess of $25,000 when it appears to the Court that, inter alia, proceedings have been instituted or maintained by the taxpayer primarily for delay or that the position of the taxpayer in such proceeding is frivolous or groundless. In Pierson v. Commissioner, 115 T.C. 576, 581 (2000), we issued a warning concerning the imposition of a penalty under section 6673(a)(1) on those taxpayers abusing the protections afforded by sections 6320 and 6330 through the bringing of dilatory or frivolous lien or levy actions. The Court has since repeatedly disposed of cases premised on arguments akin to those raised herein summarily and with imposition of the section 6673 penalty. See, e.g., Craig v. Commissioner, 119 T.C. 252, 264-265 (2002) (and cases cited therein).



Petitioner's arguments in this case are frivolous and without substance. He has taken numerous unrelated legal concepts, most of which have been rejected by the courts, and posed them as reasons why he is not compelled to report or pay Federal income tax. He has wasted the time and tied up the resources of the Government with matters that are without substance or merit. Accordingly, a $2,000 penalty under section 6673 will be imposed against petitioner.3



To reflect the foregoing,



An appropriate order and decision will be entered.

Back Taxes: In G.L. Colvin, TC Memo. 2007-157, June 19, 2007, Dkt. No. 16557-04,
the Tax Court concluded that taxpayer was not either an independent contractor or a statutory employee under Code Sec. 3121(d)(3).



The Tax Court did not allow the taxpayer to claim business expenses on a Schedule C rather than on a Schedule A. and, therefore, avoided the two-percent floor on miscellaneous itemized deductions. The Tax Court determined that taxpayers was a common law employee under Code Sec. 3121(d)(2). The determining factor was the degree of control exerted over the taxpayer by his employer. His trade or business expenses were, therefore, subject to the two-percent floor.

The taxpayer was not allowed unsubstantiated deductions in excess of those allowed by the IRS. The taxpayer did not provide any documentation that indicated the amount of mileage for which he used his personal vehicles in his employment, but instead improperly extrapolated the amount of miles driven by the amount of gas purchased. The taxpayer's claim that he paid his mother for the preparation of his business income tax return was denied because he could provide no proof that the check with which he paid ever cleared. The taxpayer also was denied additional deductions for the cost of goods sold because he failed to substantiate the cost and because he had no income from the sale of goods.

The taxpayer was denied a deduction for interest incurred in connection with a loan from his mother under Code Sec. 163 because the loan did not survive the scrutiny put on intra-family loans and because the loan and the terms of repayment and interest were not put in writing. The taxpayer was allowed a deduction for legal fees because they were in connection to a lawsuit arising out of his trade or business.





OPINION





I. Burden of Proof

As a general rule, the Commissioner's determination of a taxpayer's liability is presumed correct, and the taxpayer bears the burden of proving that the determination is improper. See Rule 142(a); Welch v. Helvering [3 USTC ¶1164], 290 U.S. 111, 115 (1933). However, pursuant to section 7491(a), the burden of proof on factual issues that affect the taxpayer's tax liability may be shifted to the Commissioner where the "taxpayer introduces credible evidence with respect to * * * such issue". The burden will shift only if the taxpayer has, inter alia, complied with substantiation requirements pursuant to the Internal Revenue Code and "cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews". Sec. 7491(a)(2). In the instant case, petitioner failed to comply with substantiation requirements and did not present credible evidence at trial. Petitioner's original bank statements were apparently lost during the tax examination. However, petitioner's lack of substantiation and failure to present credible evidence were pervasive. Accordingly, the burden of proof remains on petitioner.




II. Mailing of Notice of Deficiency

Petitioner argues that this Court lacks jurisdiction. The two requirements for this Court's jurisdiction in a deficiency case are a valid notice of deficiency issued by the Commissioner and a timely filed petition by the taxpayer. Frieling v. Commissioner [Dec. 40,284], 81 T.C. 42, 46 (1983). Because petitioner filed his petition on time, the only jurisdictional issue is the validity of the notice of deficiency.



The purpose of the mailing under section 6212 is to provide the taxpayer with notice that a deficiency has been determined against him or her, and to provide the taxpayer with an opportunity to petition this Court to challenge the Commissioner's determination.13 Id. at 53. When a taxpayer receives actual notice of a deficiency and does not suffer prejudicial delay in filing timely a petition with this Court, the notice of deficiency, even though incorrectly addressed, is valid under section 6212(a).14 Estate of Greenwood v. Commissioner, T.C. Memo. 2003-98 (citing St. Joseph Lease Capital Corp. v. Commissioner [2001-1 USTC ¶50,146], 235 F.3d 886, 891-892 (4th Cir. 2000), affg. [Dec. 51,377(M)] T.C. Memo. 1996-256; Estate of Biskis v. Commissioner [Dec. 54,312(M)], T.C. Memo. 2001-94; Estate of Citrino v. Commissioner [Dec. 44,323(M)], T.C. Memo. 1987-565). Petitioner had actual notice of the deficiency as he requested, and received, a copy of the notice of deficiency from the IRS TAS. Petitioner filed a petition that was timely and, therefore, did not suffer prejudicial delay. Accordingly, the Court concludes that the notice of deficiency is valid, and this Court has jurisdiction.




III. Statutory Employee

A. General Rules



A statutory employee may properly reflect business income and expenses in full on Schedule C of Form 1040, and thereby avoid the Schedule A, Itemized Deductions, limitations on the deduction of employee business expenses and the phaseout of itemized deductions.15 See Prouty v. Commissioner, T.C. Memo. 2002-175 (citing Rev. Rul. 90-93, 1990-2 C.B. 33). An individual qualifies as a statutory employee pursuant to section 3121(d)(3) only if such individual is not a common law employee pursuant to section 3121(d)(2). Ewens & Miller, Inc. v. Commissioner [Dec. 54,561], 117 T.C. 263, 269 (2001). Section 3121(d) defines employee, in pertinent part, as follows:



(1) any officer of a corporation; or



(2) any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee; or



(3) any individual (other than an individual who is an employee under paragraph (1) or (2)) who performs services for remuneration for any person --



*******



(D) as a traveling or city salesman, other than as an agent-driver or commission-driver, engaged upon a full-time basis in the solicitation on behalf of, and the transmission to, his principal (except for side-line sales activities on behalf of some other person) of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments for merchandise for resale or supplies for use in their business operations; if the contract of service contemplates that substantially all of such services are to be performed personally by such individual; except that an individual shall not be included in the term "employee" under the provisions of this paragraph if such individual has a substantial investment in facilities used in connection with the performance of such services (other than in facilities for transportation), or if the services are in the nature of a single transaction not part of a continuing relationship with the person for whom the services are performed * * *



As an individual qualifies as a statutory employee only if the individual is not a common law employee, the Court will initially determine whether petitioner was a common law employee of TIG.



B. Common Law Employee



Whether an individual is an independent contractor or common law employee is a question of fact. Weber v. Commissioner [Dec. 50,087], 103 T.C. 378, 386 (1994), affd. [95-2 USTC ¶50,409] 60 F.3d 1104 (4th Cir. 1995). In the Fifth Circuit, to which this case would normally be appealable, doubtful questions should be resolved in favor of employment. Breaux & Daigle, Inc. v. United States [90-2 USTC ¶50,491], 900 F.2d 49, 52 (5th Cir. 1990). Generally, petitioner has the burden of proving error in respondent's notice of deficiency determination that he was a common law employee. See Rule 142(a); Profl. & Executive Leasing, Inc. v. Commissioner [Dec. 44,087], 89 T.C. 225, 231 (1987), affd. [88-2 USTC ¶9622] 862 F.2d 751 (9th Cir. 1988). However, respondent conceded on brief that he bears the burden of proof on the statutory employee issue because it constitutes a new matter under Rule 142.16



In determining whether a worker is a common law employee or an independent contractor, the Court generally considers: (1) The degree of control exercised by the principal; (2) which party invests in work facilities used by the individual; (3) the opportunity of the individual for profit or loss; (4) whether the principal can discharge the individual; (5) whether the work is part of the principal's regular business; (6) the permanency of the relationship; (7) the relationship the parties believed they were creating; and (8) the provision of employee benefits. See Ewens & Miller, Inc. v. Commissioner, supra at 270; Weber v. Commissioner, supra at 387; Profl . & Executive Leasing, Inc. v. Commissioner, supra at 232; Simpson v. Commissioner [Dec. 33,402], 64 T.C. 974, 984-985 (1975); Cole v. Commissioner [Dec. 56,450(M)], T.C. Memo.2006-44. All of the facts and circumstances of each case are considered, and no single factor is dispositive. Ewens & Miller, Inc. v. Commissioner, supra at 270.



1. Degree of Control



The right of the principal to exercise control over the agent, whether or not the principal does so, is the "crucial test" for the employer-employee relationship. Weber v. Commissioner, supra at 387. "The employment relationship exists when the principal retains the right to direct the manner in which the work is done, and to control the methods used in doing the work, and to control the details and means by which the desired result is accomplished." Ellison v. Commissioner [Dec. 30,394], 55 T.C. 142, 152-153 (1970). In order to obtain the requisite degree of control, "the alleged employer need not 'stand over the employee and direct every move that he makes.'" Simpson v. Commissioner, supra at 985 (citing Atl. Coast Life Ins. Col. v. United States, 76 F. Supp. 627, 630 (E.D.S.C. 1948). In fact, the employer need not set the employee's hours. Workers who set their own hours are not necessarily independent contractors. Ewens & Miller, Inc. v. Commissioner, supra at 270.



In his argument that petitioner was a common law employee, respondent relies predominately on the employment agreement and the TIG Employee Handbook Manual (employee manual). Respondent contends that TIG controlled the details of petitioner's work because the employment agreement provides that the "Employee shall perform such duties as are customarily performed by an Account Executive, and such other duties as the President of Employer * * * may require from time to time". Respondent then asserts, based on the employee manual, that "Such duties include TIG's requirement that Petitioner attend weekly meetings. TIG prescribed appropriate dress for Petitioner. TIG specified how its telephones, software, and company vehicles were to be used." Respondent also presented as evidence a "WRITTEN WARNING NOTICE" from Mr. Rasmussen, petitioner's supervisor, that reprimanded petitioner for argumentative comments made during a "lunch-nlearn" session with a vendor of TIG.



Petitioner contends that he set his own work hours and sales territory, defined the manner in which he performed his tasks, worked principally from home, and was not required to utilize TIG's support staff or attend routine meetings. Other than his own testimony, petitioner did not provide any substantiation of these facts.



The Court concludes that respondent has met his burden of proof as to the degree of control that TIG exercised over petitioner. The documentary evidence that respondent presented indicates that TIG had the right to control, whether or not exercised, how petitioner performed his work. This is particularly exemplified by the "WRITTEN WARNING NOTICE" issued by Mr. Rasmussen and the employment history it recites. Accordingly, this "crucial" factor weighs in favor of employee status.



2. Investment in Facilities



The fact that a worker provides his or her own tools, or owns a vehicle that is utilized for work, is indicative of independent contractor status. Id. at 271 (citing Breaux & Daigle, Inc. v. United States, [90-2 USTC ¶50,491], 900 F.2d at 53). Additionally, maintenance of a home office is consistent with independent contractor status, although alone it does not constitute sufficient basis for a finding of independent contractor status. Lewis v. Commissioner [Dec. 49,516(M)], T.C. Memo. 1993-635.



Petitioner owned two vehicles and claimed he utilized both for work purposes for 2000, although the extent of such use is disputed. The employment agreement provided that petitioner was to maintain motor vehicle insurance at all times and that all other related expenses were his responsibility. The record reflects that petitioner worked at least part-time from home. Petitioner claimed as a Schedule C deduction $3,191 for business use of his home, which respondent allowed. Accordingly, the Court concludes that this factor tends to weigh in favor of independent contractor status.



3. Opportunity for Profit or Loss



Compensation on a commission basis is entirely consistent with an employer-employee relationship. Tex. Carbonate Co. v. Phinney, 307 F.2d 289, 292 (5th Cir. 1962); Capital Life & Health Ins. Co. v. Bowers, 186 F.2d 943, 944-945 (4th Cir. 1951). While petitioner could have conceivably suffered some loss as a result of his sales activity for TIG, he may still be an employee under the common law test if his risk of loss was negligible. See Lewis v. Commissioner, supra. Petitioner worked for TIG for approximately 6 months in 2000. Petitioner was paid a nonrecoverable draw in the amount of $5,000 for the first 4 months, and then $2,500 for the fifth and sixth months. Thereafter, petitioner's draw was recoverable against his sales commission on a month-to-month basis. In 2000, petitioner was entitled to a nonrecoverable draw for the entire period he worked; therefore, petitioner's risk of loss was negligible, if not nil. The Court concludes that this factor weighs in favor of an employer-employee relationship.



4. Right To Discharge



Employers typically have the power to terminate employees at will. Ellison v. Commissioner, supra at 155. The employment agreement provided that TIG could terminate petitioner at will with or without cause or notice. Notably, TIG exercised its termination right. Accordingly, the Court concludes that this factor weighs in favor of an employer-employee relationship.



5. Integral Part of Business



Petitioner contends that he was not an integral part of TIG's business. Petitioner claims that TIG was a "diverse company with separate divisions that sold" the following: (1) Services, (2) computer hardware, (3) office furnishings, (4) office supplies, (5) outside help-desk functions, and (6) "Application Service Processing". Petitioner further asserts that TIG performed computer training and installed networking cable and telephone systems. As a result, petitioner argues that he "was not a key connection with customers, only one of many resources available to them", and was therefore not an integral part of TIG's business. However, the fact that TIG had several separate divisions does not affect the analysis of whether petitioner's services were integral to TIG. Petitioner's services could have been integral to the division in which he worked, which would indicate that petitioner was an employee. See Ewens & Miller, Inc., v. Commissioner [Dec. 54,561], 117 T.C. at 272-273.



Respondent was silent on the issue. The Court concludes that this factor is neutral and indicates neither independent contractor status nor employee status.



6. Permanency of the Relationship



A transitory work relationship may weigh in favor of independent contractor status. Ewens & Miller, Inc. v. Commissioner, supra at 273 (citing Herman v. Express Sixty-Minutes Delivery Serv., Inc., 161 F.3d 299, 305 (5th Cir. 1998)). The principal's right to discharge the worker, and the worker's right to quit, at any time, is an important factor. Id. Petitioner's position at TIG was for renewable 1-year terms. It was also at will and terminable by either party at any time, with or without cause or notice, and petitioner was in fact terminated. The Court concludes that petitioner's position was transitory as he worked for TIG for less than 13 months.17 Accordingly, this factor weighs in favor of independent contractor status.



7. Relationship the Parties Thought They Created



The offer and employment agreement refer to workers, such as petitioner, as employees, and to TIG as the employer. Notably, TIG did not check the box on line 15 of petitioner's 2000 Form W-2 indicating that he was a statutory employee. It is evident that for taxable year 2000 TIG thought of petitioner as an employee based on the employment agreement, and that TIG treated petitioner as a common law employee based on Forms W-2 and W-4, Employee's Withholding Allowance Certificate.18 Thus, the Court concludes that petitioner and TIG intended to create an employer-employee relationship.



8. Provision of Employee Benefits



The offer and employment agreement provide that TIG employees are eligible to participate in a health insurance plan and a section 401(k) plan. These are benefits that are typically provided to employees rather than independent contracts. See Weber v. Commissioner [Dec. 50,087], 103 T.C. at 393-394. Although petitioner did not participate in TIG's health insurance plan because he was covered by his girlfriend's health insurance, and did not participate in TIG's section 401(k) plan, the benefits were available to him if needed. See id. Accordingly, this factor tends to weigh in favor of employee status.



9. Conclusion



The relationship between petitioner and TIG had aspects that were characteristic of an employer and employee relationship and others characteristic of a principal and independent contractor relationship. After weighing the above factors, the Court concludes that petitioner was a common law employee of TIG for the 2000 taxable year.



Petitioner was a common law employee of Daou Systems during his employment from August 1995 to March 1997. As a result, the settlement he received from Daou Systems in 2000 is related to his common law employment. Petitioner claims to have conducted a computer assembly and consulting business, Computer Consulting Forum Company, in 2000. As discussed infra, petitioner's lack of gross sales, as well as lack of substantiation, leads the Court to conclude otherwise.



C. Statutory Employee



As the Court has concluded that petitioner was a common law employee of TIG for taxable year 2000, petitioner is precluded from being a statutory employee pursuant to section 3121(d)(3). Accordingly, petitioner is not entitled to deduct expenses on Schedule C.




IV. Petitioner's Deductions

In light of the Court's conclusion that petitioner is not entitled to deduct expenses on Schedule C, the Court must now decide whether petitioner is entitled to deduct expenses incurred in connection with his employment on Schedule A. See sec. 67(a).



A. Schedule A Deductions



An individual performing services as an employee may deduct miscellaneous itemized deductions incurred in the performance of services as an employee only to the extent such expenses exceed 2 percent of the individual's adjusted gross income. Sec. 67(a).



B. General Deduction Rules



Deductions are a matter of legislative grace, and the taxpayer bears the burden of proving that he is entitled to any claimed deductions. INDOPCO, Inc. v. Commissioner [92-1 USTC ¶50,113], 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering [4 USTC ¶1292], 292 U.S. 435, 440 (1934). Taxpayers must maintain records relating to their income and expenses and must prove their entitlement to all claimed deductions, credits, and expenses in controversy. See Sec. 6001; Rule 142(a).



Pursuant to section 162(a), a taxpayer is entitled to deduct all of the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. The deduction for an employed individual's unreimbursed business expenses under section 162 is claimed on Form 2106, Employee Business Expenses, and included in the miscellaneous itemized deductions taken on Form 1040 Schedule A. Expenses incurred in the performance of services as an employee are to be reported and memorialized as required by the regulations promulgated under section 162. See sec. 1.162-17(a), Income Tax Regs. The taxpayer bears the burden of proving that the claimed expenses were ordinary and necessary according to section 162. The employee must show the relationship between the expenditures and the employment. See Evans v. Commissioner [Dec. 33,003(M)], T.C. Memo. 1974-267, affd. in part, revd. in part [77-2 USTC ¶9596] 557 F.2d 1095 (5th Cir. 1977). In certain instances, the taxpayer must meet specific substantiation requirements in addition to the requirements of section 162. See sec. 274.



Generally, a claimed expense (other than those subjected to heightened scrutiny under section 274) may be deductible even where the taxpayer is unable to fully substantiate it, if there is an evidentiary basis for doing so. Cohan v. Commissioner [2 USTC ¶489], 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner [Dec. 42,468], 85 T.C. 731, 742-743 (1985); Sanford v. Commissioner [Dec. 29,122], 50 T.C. 823, 827-828 (1968), affd. per curiam [69-2 USTC ¶9491] 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). In these instances, the Court is permitted to make as close an approximation of the allowable expense as it can, bearing heavily against the taxpayer whose inexactitude is of his or her own making. Cohan v. Commissioner, supra.



C. Automobile Mileage



Pursuant to section 162, expenses relating to the use of an automobile that a taxpayer pays or incurs while commuting between the taxpayer's residence and the taxpayer's place of business or employment are not deductible because such expenses are personal, and not business, expenses. Sec. 1.162-2(e), Income Tax Regs. Automobile mileage deductions are also subject to the strict substantiation requirements of section 274(d). Where petitioner shows that his automobile expenses satisfy the requirements of section 162, but fails to establish that his records satisfy the heightened substantiation requirements of section 274(d), the expenses will not be allowable.



Section 274(d) applies to: (1) Any traveling expense, including meals and lodging away from home; (2) entertainment, amusement, and recreational expenses; or (3) the use of "listed property", as defined in section 280F(d), including personal computers and passenger automobiles. To deduct such expenses, the taxpayer must substantiate by adequate records or sufficient evidence to corroborate the taxpayer's own testimony: (1) The amount of the expenditure or use, which includes mileage in the case of automobiles; (2) the time and place of the travel, entertainment, or use; (3) its business purpose; and in the case of entertainment, (4) the business relationship to the taxpayer of each expenditure or use. Sec. 274(d)(4).



To satisfy the adequate records requirement of section 274, a taxpayer must maintain records and documentary evidence that in combination are sufficient to establish each element of an expenditure or use. Sec. 1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985). Although a contemporaneous log is not required, corroborative evidence to support a taxpayer's reconstruction of the elements of the expenditure or use must have "a high degree of probative value to elevate such statement" to the level of credibility of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).



In lieu of substantiating the actual amount of any expenditure relating to the business use of a passenger automobile, a taxpayer may use a standard mileage rate as established by the IRS. See sec. 1.274-5(j)(2), Income Tax Regs. The standard mileage rate is to be multiplied by the number of business miles traveled. The use of the standard mileage rate establishes only the amount deemed expended with respect to the business use of a passenger automobile. Id. The taxpayer must still establish the amount (i.e., business mileage), the time, and the business purpose of each use. Id.



Petitioner claimed a car and truck deduction of $6,033 on his 2000 Schedule C. Respondent allowed only $780 of the claimed deduction. At trial, petitioner produced little additional documentation. Petitioner was unable to identify which of his two vehicles, the Volkswagen or the Honda, was "Vehicle 1" on his Schedule C. Petitioner explained that he arrived at his total mileage figure of 18,200 by estimation based on his fuel expenditures for taxable year 2000, divided by the average miles per gallon for his two vehicles.19 Petitioner has failed to meet the substantiation requirements of section 274 to establish his automobile mileage. Accordingly, petitioner is allowed a miscellaneous itemized Schedule A deduction in the amount of $780, subject to the overall 2-percent of adjusted gross income limitation.



D. Loan Interest



Pursuant to section 163(a), interest is deductible. However, personal interest generally is not deductible. Sec. 163(h). Debt arrangements between family members are subject to a high level of scrutiny. Zohoury v. Commissioner [Dec. 40,498(M)], T.C. Memo. 1983-597. The following factors are used to scrutinize intrafamily loans: (1) Whether a specific rate of interest is charged to the taxpayer for the use of the money; (2) whether there is a specific date for repayment; (3) whether there is a written instrument evidencing the debt; (4) whether there is a legitimate purpose for obtaining the loan; (5) whether the taxpayer intended to repay the debt; (6) whether the relative receiving the payments on the loan was impecunious; and (7) whether the loan has economic substance. Id.



Petitioner claimed $5,195 in interest expenses on his Schedule C for 2000. Respondent disallowed the entire deduction. Petitioner's only substantiation was a copy of a check he had issued to his mother in the amount of $5,000. Notations on the check indicate that the $5,000 was to be put towards numerous uses, including loan payment and interest in the amount of $4,575, petitioner's March 2000 mortgage in the amount of $425, and a car loan in the amount of $300. At trial, petitioner testified that he was unsure how much of the $5,000 check constituted interest.



Notably, petitioner did not have a written loan agreement. The loan was based on an oral agreement. Petitioner's mother kept records relating to the loan in a written journal. Those records indicate that petitioner was not held to a strict repayment schedule and that the interest rate fluctuated. Petitioner has failed to satisfy the requirements to deduct interest on an intrafamily loan. Accordingly, the Court sustains respondent's determination on this issue.



E. Accounting Fees



Petitioner claimed $1,750 in fees he allegedly paid to his mother for accounting services, tax preparation, and representation, on his 2000 Form 1040 Schedule C. Respondent disallowed the entire deduction. The only substantiation petitioner offered was an invoice from his mother's business that indicated petitioner paid $500 for her services. The invoice specifically referenced payment by check No. 6718, which apparently never cleared petitioner's bank account. Petitioner has failed to substantiate his claimed accounting, tax preparation, and representation fees. Accordingly, the Court sustains respondent on this issue. Petitioner is not entitled to a deduction for accounting fees.



F. Cost of Goods Sold



"The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income." Sec. 1.162-1(a), Income Tax Regs. A taxpayer may also deduct the cost of supplies and materials consumed in the operation of his or her business during the taxable year. See sec. 1.162-3, Income Tax Regs.



Petitioner claimed on Schedule C $3,323 for CGS. Respondent disallowed $659 of petitioner's CGS. Petitioner asserted that he purchased the items constituting his CGS for use in his sales activity for TIG and then provided substantiation for $58.50 in computer software.20 The remaining items listed as his CGS were allegedly used in his computer assembly and consulting business, Computer Consulting Forum Company. Petitioner claimed to have assembled and sold some computers at cost during the 2000 taxable year, although he failed to provide substantiation. Notably, petitioner's 2000 Federal tax return did not report any gross receipts from the alleged sales.



The regulations promulgated under section 162 clearly provide that CGS is deductible from "gross sales". Petitioner did not report any "gross sales" from his computer assembly business. Petitioner failed to substantiate the cost of materials and supplies allegedly used in his computer assembly business. Further, petitioner's testimony established that he purchased items he believed were CGS, such as the Palm Pilot, for use, not for resale. Petitioner has failed to substantiate the CGS disallowed by respondent. Accordingly, the Court sustains respondent on this issue. Petitioner is entitled to $2,664 in CGS for taxable year 2000.



G. Legal Fees



Generally, legal fees are deductible on a Schedule C only if the matter with respect to which the fees were incurred originated in the taxpayer's trade or business and only if the claim is sufficiently connected to that business. Test v. Commissioner [Dec. 54,133(M)], T.C. Memo. 2000-362 (citing United States v. Gilmore [63-1 USTC ¶9285], 372 U.S. 39 (1963)), affd. [2002-2 USTC ¶50,692] 49 Fed. Appx. 96 (9th Cir. 2002). Expenses not incurred in a trade or business activity but in the production or collection of income are deductible only as miscellaneous itemized deductions on Schedule A. See secs. 67(b), 212(l); Test v. Commissioner, supra. It is well established that even though a taxpayer's employee status may be regarded as a trade or business, legal fees stemming from a taxpayer's employee status are not deductible in computing adjusted gross income but are to be treated as miscellaneous itemized deductions. Test v. Commissioner, supra.



The case Smyth v. Daou Systems, Inc., No. 97-CV-02013 (S.D. Cal. filed Nov. 7, 1997), is related to petitioner's former employment with Daou Systems. As a result of the litigation, petitioner recovered a total of $8,000 from Daou Systems (which was subject to withholding). The net amount of $5,918.82 was actually paid to petitioner's attorney, Mr. Conger, who deducted his legal fees of $1,689.65 and paid the remainder to petitioner. The Court concludes that petitioner is entitled to deduct $1,689.65 as a miscellaneous itemized expense on Schedule A, subject to the overall 2-percent of adjusted gross income limitation.



The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.



To reflect the foregoing and concessions by both parties,



Decision will be entered under Rule 155.